[Federal Register Volume 79, Number 99 (Thursday, May 22, 2014)]
[Proposed Rules]
[Pages 29508-29617]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: R1-2014-05806]
[[Page 29507]]
Vol. 79
Thursday,
No. 99
May 22, 2014
Part II
Securities and Exchange Commission
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17 CFR Part 240
Standards for Covered Clearing Agencies; Proposed Rule; Republication
Federal Register / Vol. 79, No. 99 / Thursday, May 22, 2014 /
Proposed Rules
[[Page 29508]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-71699; File No. S7-03-14]
RIN 3235-AL48
Standards for Covered Clearing Agencies
Republication
Editorial Note: Proposed rule document 2014-05806 was originally
published on pages 16865 through 16975 in the issue of Wednesday,
March 26, 2014. In that publication the footnotes contained
erroneous entries. The corrected document is republished in its
entirety.
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') proposes to amend Rule 17Ad-22 and add Rule 17Ab2-2
pursuant to Section 17A of the Securities Exchange Act of 1934
(``Exchange Act'') and the Payment, Clearing, and Settlement
Supervision Act of 2010 (``Clearing Supervision Act''), adopted in
Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (``Dodd-Frank Act''). Among other things, the proposed
rules would establish standards for the operation and governance of
certain types of registered clearing agencies that meet the definition
of a ``covered clearing agency.''
DATES: Submit comments on or before May 27, 2014.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-03-14 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments to Kevin M. O'Neill, Deputy Secretary,
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-1090. All submissions should refer to File Number S7-03-14.
To help us 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/proposed.shtml).
Comments are also 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. 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.
FOR FURTHER INFORMATION CONTACT: Katherine Martin, Senior Special
Counsel; Stephanie Park, Special Counsel; Mark Saltzburg, Special
Counsel; Matthew Lee, Attorney-Adviser; and Abraham Jacob, Attorney-
Adviser; Office of Clearance and Settlement, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-7010, at (202) 551-5710.
SUPPLEMENTARY INFORMATION: The Commission proposes to amend Rule 17Ad-
22 to add new Rule 17Ad-22(e) to establish requirements for risk
management, operations, and governance of registered clearing agencies
that meet the definition of a ``covered clearing agency.'' Covered
clearing agencies would include registered clearing agencies that (i)
have been designated as systemically important by the Financial
Stability Oversight Council (``FSOC'') and for which the Commission is
the supervisory agency, pursuant to the Clearing Supervision Act
(``designated clearing agencies''), (ii) provide central counterparty
(``CCP'') services for security-based swaps or are involved in
activities the Commission determines to have a more complex risk
profile, where in either case the Commodity Futures Trading Commission
(``CFTC'') is not the supervisory agency for such clearing agency as
defined in Section 803(8) of the Clearing Supervision Act, or (iii) are
otherwise determined to be covered clearing agencies by the Commission.
The Commission also proposes to add new Rule 17Ad-22(f) to codify the
Commission's statutory authority and new Rule 17Ab2-2 to establish
procedures for making determinations regarding covered clearing
agencies under proposed Rule 17Ad-22(e). The Commission also proposes
to amend existing Rule 17Ad-22(d) to limit its application to clearing
agencies other than covered clearing agencies and to revise existing
Rule 17Ad-22(a) to add 15 new definitions. The Commission has begun,
and intends to continue, consultation with the FSOC and the Board of
Governors of the Federal Reserve System (``the Board'') and has
considered the relevant international standards as required by Section
805(a)(2)(A) of the Clearing Supervision Act.\1\
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\1\ See Committee on Payment and Settlement Systems and
Technical Committee of the International Organization of Securities
Commissions (``CPSS-IOSCO''), Principles for Financial Market
Infrastructures (Apr. 16, 2012), available at http://www.bis.org/publ/cpss101a.pdf (``PFMI Report'').
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Table of Contents
I. Current Regulatory Framework for Clearing Agencies
A. Section 17A of the Exchange Act
B. OTC Swaps Clearing and the Dodd-Frank Act
1. Title VII of the Dodd-Frank Act
2. Title VIII of the Dodd-Frank Act
C. Rule 17Ad-22 Under the Exchange Act
D. Relevant International Standards
II. Discussion of the Proposed Amendments To Rule 17AD-22 and
Proposed Rule 17AB2-2
A. Overview
1. Scope of Proposed Rule 17Ad-22(e)
2. Role of Written Policies and Procedures
3. Frequency of Review Required Under Certain Policies and
Procedures
4. Anticipated Impact of Proposed Rule 17Ad-22(e)
5. General Request for Comments
B. Proposed Rule 17Ad-22(e)
1. Proposed Rule 17Ad-22(e)(1): Legal Risk
2. Proposed Rule 17Ad-22(e)(2): Governance
3. Proposed Rule 17Ad-22(e)(3): Framework for the Comprehensive
Management of Risks
a. Policies and Procedures Requirements, Periodic Review, and
Annual Board Approval
b. Recovery and Orderly Wind-Down Plans
c. Risk Management and Internal Audit
d. Request for Comments
4. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk
Management
a. Overview of Financial Risks Faced by Clearing Agencies
b. Current Financial Risk Management Requirements for CCPs
c. Proposed Rule 17Ad-22(e)(4): Credit Risk
i. Prefunded Financial Resources
ii. Combined or Separately Maintained Clearing or Guaranty Funds
iii. Testing the Sufficiency of Financial Resources
iv. Annual Conforming Model Validation
d. Proposed Rule 17Ad-22(e)(5): Collateral
e. Proposed Rule 17Ad-22(e)(6): Margin
i. Active Management of Model Risk
ii. Collection of Margin
iii. Ninety-Nine Percent Confidence Level
iv. Price Data Source
v. Method for Measuring Credit Exposure
vi. Backtesting and Sensitivity Analysis
vii. Annual Conforming Model Validation
f. Proposed Rule 17Ad-22(e)(7): Liquidity Risk
[[Page 29509]]
i. Sufficient Liquid Resources
ii. Qualifying Liquid Resources
iii. Access to Account Services at a Federal Reserve Bank or
Other Relevant Central Bank
iv. Liquidity Providers
v. Maintenance and Annual Testing of Liquidity Provider
Procedures and Operational Capacity
vi. Testing the Sufficiency of Liquid Resources
vii. Annual Conforming Model Validation
viii. Address Liquidity Shortfalls and Seek to Avoid Unwinding
Settlement
ix. Replenishment of Liquid Resources
x. Feasibility Analysis for ``Cover Two''
g. Request for Comments
5. Proposed Rule 17Ad-22(e)(8): Settlement Finality
6. Proposed Rule 17Ad-22(e)(9): Money Settlements
7. Proposed Rule 17Ad-22(e)(10): Physical Delivery Risks
8. Proposed Rule 17Ad-22(e)(11): Central Securities Depositories
a. Controls to Safeguard the Rights of Securities Issuers and
Holders and Prevent the Unauthorized Creation or Deletion of
Securities
b. Periodic and At Least Daily Reconciliation of Securities
Maintained
c. Protect Assets against Custody Risk
d. Request for Comments
9. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement
Systems
10. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and
Procedures
a. Address Allocation of Credit Losses
b. Describe Replenishment of Financial Resources
c. Test Default Procedures Annually and Following Material
Changes
d. Request for Comments
11. Proposed Rule 17Ad-22(e)(14): Segregation and Portability
12. Proposed Rule 17Ad-22(e)(15): General Business Risk
a. Determining Liquid Net Assets for Recovery and an Orderly
Wind-Down
b. Requirements for Liquid Net Assets
c. Plan for Raising Additional Equity
d. Request for Comments
13. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks
14. Proposed Rule 17Ad-22(e)(17): Operational Risk Management
15. Proposed Rule 17Ad-22(e)(18): Access and Participation
Requirements
16. Proposed Rule 17Ad-22(e)(19): Tiered Participation
Agreements
17. Proposed Rule 17Ad-22(e)(20): Links
18. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness
19. Proposed Rule 17Ad-22(e)(22): Communication Procedures and
Standards
20. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key
Procedures, and Market Data
a. Comprehensive Public Disclosure
b. Updates to the Comprehensive Public Disclosure
c. Request for Comments
C. Proposed Rule 17Ab2-2
1. Determination that a Registered Clearing Agency is a Covered
Clearing Agency
2. Determination that a Covered Clearing Agency Is Systemically
Important in Multiple Jurisdictions
3. Determination that a Clearing Agency Has a More Complex Risk
Profile
4. Request for Comments
D. Proposed Rule 17Ad-22(f)
E. Proposed Amendment to Rule 17Ad-22(d)
III. Paperwork Reduction Act
A. Overview and Organization
B. Summary of Collection of Information and Proposed Use of
Information for Proposed Rule 17Ad-22(e) and Proposed Rule 17Ab2-2
1. Proposed Rules 17Ad-22(e)(1) through (3): General
Organization
a. Proposed Rule 17Ad-22(e)(1)
b. Proposed Rule 17Ad-22(e)(2)
c. Proposed Rule 17Ad-22(e)(3)
2. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk
Management
a. Proposed Rule 17Ad-22(e)(4)
b. Proposed Rule 17Ad-22(e)(5)
c. Proposed Rule 17Ad-22(e)(6)
d. Proposed Rule 17Ad-22(e)(7)
3. Proposed Rules 17Ad-22(e)(8) through (10): Settlement
a. Proposed Rule 17Ad-22(e)(8)
b. Proposed Rule 17Ad-22(e)(9)
c. Proposed Rule 17Ad-22(e)(10)
4. Proposed Rules 17Ad-22(e)(11) through (12): CSDs and
Exchange-of-Value Settlement Systems
a. Proposed Rule 17Ad-22(e)(11)
b. Proposed Rule 17Ad-22(e)(12)
5. Proposed Rules 17Ad-22(e)(13) through (14): Default
Management
a. Proposed Rule 17Ad-22(e)(13)
b. Proposed Rule 17Ad-22(e)(14)
6. Proposed Rules 17Ad-22(e)(15) through (17): General Business
and Operational Risk Management
a. Proposed Rule 17Ad-22(e)(15)
b. Proposed Rule 17Ad-22(e)(16)
c. Proposed Rule 17Ad-22(e)(17)
7. Proposed Rules 17Ad-22(e)(18) through (20): Access
a. Proposed Rule 17Ad-22(e)(18)
b. Proposed Rule 17Ad-22(e)(19)
c. Proposed Rule 17Ad-22(e)(20)
8. Proposed Rules 17Ad-22(e)(21) through (22): Efficiency
a. Proposed Rule 17Ad-22(e)(21)
b. Proposed Rule 17Ad-22(e)(22)
9. Proposed Rule 17Ad-22(e)(23): Disclosure
10. Proposed Rule 17Ab2-2
C. Respondents
D. Total Annual Reporting and Recordkeeping Burden for Proposed
Rule 17Ad-22(e)
1. Proposed Rules 17Ad-22(e)(1) through (3): General
Organization
a. Proposed Rule 17Ad-22(e)(1)
b. Proposed Rule 17Ad-22(e)(2)
c. Proposed Rule 17Ad-22(e)(3)
2. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk
Management
a. Proposed Rule 17Ad-22(e)(4)
b. Proposed Rule 17Ad-22(e)(5)
c. Proposed Rule 17Ad-22(e)(6)
d. Proposed Rule 17Ad-22(e)(7)
3. Proposed Rules 17Ad-22(e)(8) through (10): Settlement
a. Proposed Rule 17Ad-22(e)(8)
b. Proposed Rule 17Ad-22(e)(9)
c. Proposed Rule 17Ad-22(e)(10)
4. Proposed Rules 17Ad-22(e)(11) through (12): CSDs and
Exchange-of-Value Settlement Systems
a. Proposed Rule 17Ad-22(e)(11)
b. Proposed Rule 17Ad-22(e)(12)
5. Proposed Rules 17Ad-22(e)(13) through (14): Default
Management
a. Proposed Rule 17Ad-22(e)(13)
b. Proposed Rule 17Ad-22(e)(14)
6. Proposed Rules 17Ad-22(e)(15) through (17): General Business
and Operational Risk Management
a. Proposed Rule 17Ad-22(e)(15)
b. Proposed Rule 17Ad-22(e)(16)
c. Proposed Rule 17Ad-22(e)(17)
7. Proposed Rules 17Ad-22(e)(18) through (20): Access
a. Proposed Rule 17Ad-22(e)(18)
b. Proposed Rule 17Ad-22(e)(19)
c. Proposed Rule 17Ad-22(e)(20)
8. Proposed Rules 17Ad-22(e)(21) through (22): Efficiency
a. Proposed Rule 17Ad-22(e)(21)
b. Proposed Rule 17Ad-22(e)(22)
9. Proposed Rule 17Ad-22(e)(23): Disclosure
10. Total Burden for Proposed Rule 17Ad-22(e)
E. Total Annual Reporting and Recordkeeping Burden for Proposed
Rule 17Ab2-2
F. Collection of Information is Mandatory
G. Confidentiality
H. Request for Comments
IV. Economic Analysis
A. Introduction
B. Economic Baseline
1. Overview
2. Current Regulatory Framework for Clearing Agencies
a. Basel III Capital Requirements
b. Other Regulatory Efforts
3. Current Practices
a. General Organization
i. Legal Risk
ii. Governance
iii. Framework for the Comprehensive Management of Risks
b. Financial Risk Management
i. Credit Risk
ii. Collateral and Margin
iii. Liquidity Risk
c. Settlement
d. CSDs and Exchange-of-Value Settlement Systems
i. CSDs
ii. Exchange-of-Value Settlement Systems
e. Default Management
i. Participant-Default Rules and Procedures
ii. Segregation and Portability
f. General Business and Operational Risk Management
i. General Business Risk
ii. Custody and Investment Risks
iii. Operational Risk
g. Access
i. Access and Participation Requirements
ii. Tiered Participation Arrangements
iii. Links
h. Efficiency
i. Efficiency and Effectiveness
ii. Communication Procedures and Standards
i. Transparency
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4. Determinations by the Commission
C. Consideration of Benefits, Costs, and the Effect on
Competition, Efficiency, and Capital Formation
1. General Economic Considerations
a. Systemic Risk
b. Discretion
c. Market Integrity
d. Concentration
e. Qualifying CCP Status and Externalities on Clearing Members
2. Effect on Competition, Efficiency, and Capital Formation
a. Competition
b. Efficiency
c. Capital Formation
3. Effect of Proposed Amendments to Rule 17Ad-22 and Proposed
Rule 17Ab2-2
a. Proposed Rule 17Ad-22(e)
i. Proposed Rule 17Ad-22(e)(1): Legal Risk
ii. Proposed Rule 17Ad-22(e)(2): Governance
iii. Proposed Rule 17Ad-22(e)(3): Comprehensive Framework for
the Management of Risks
iv. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk
Management
(1) Proposed Rule 17Ad-22(e)(4): Credit Risk
(2) Proposed Rule 17Ad-22(e)(5): Collateral
(3) Proposed Rule 17Ad-22(e)(6): Margin
(4) Proposed Rule 17Ad-22(e)(7): Liquidity Risk
(5) Testing and Validation of Risk Models
v. Proposed Rules 17Ad-22(e)(8) through (10): Settlement and
Physical Delivery
vi. Proposed Rule 17Ad-22(e)(11): CSDs
vii. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement
Systems
viii. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules
and Procedures
ix. Proposed Rule 17Ad-22(e)(14): Segregation and Portability
x. Proposed Rule 17Ad-22(e)(15): General Business Risk
xi. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks
xii. Proposed Rule 17Ad-22(e)(17): Operational Risk Management
xiii. Proposed Rules 17Ad-22(e)(18) through (20): Membership
Requirements, Tiered Participation, and Linkages
(1) Proposed Rule 17Ad-22(e)(18): Member Requirements
(2) Proposed Rule 17Ad-22(e)(19): Tiered Participation
Arrangements
(3) Proposed Rule 17Ad-22(e)(20): Links
xiv. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness
xv. Proposed Rule 17Ad-22(e)(22): Communication Procedures and
Standards
xvi. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key
Procedures, and Market Data
b. Proposed Rule 17Ab2-2
c. Proposed Rule 17Ad-22(f)
d. Quantifiable Costs and Benefits
D. Request for Comments
V. Regulatory Flexibility Act Certification
A. Registered Clearing Agencies
B. Certification
VI. Small Business Regulatory Enforcement Fairness Act
VII. Statutory Authority and Text of Amended Rule 17AD-22 and
Proposed Rule 17AB2-2
I. Current Regulatory Framework for Clearing Agencies
A. Section 17A of the Exchange Act
When Congress added Section 17A to the Exchange Act as part of the
Securities Acts Amendments of 1975, it directed the Commission to
facilitate the establishment of a national system for the prompt and
accurate clearance and settlement of securities transactions.\2\ In
Section 17A of the Exchange Act, Congress directed the Commission to
have due regard for the public interest, the protection of investors,
the safeguarding of securities and funds, and maintenance of fair
competition among brokers and dealers, clearing agencies, and transfer
agents.\3\ The Commission's ability to achieve these goals and its
supervision of securities clearance and settlement systems is based
upon the regulation of clearing agencies registered with the Commission
(``registered clearing agencies''). Clearing agencies are broadly
defined under the Exchange Act and undertake a variety of functions.\4\
One such function is to act as a CCP, which is an entity that
interposes itself between the counterparties to a trade.\5\ Over the
years, registered clearing agencies have become an essential part of
the infrastructure of the U.S. securities markets.\6\ Registered
clearing agencies help reduce the costs and increase the safety and
efficiency of securities trading and are required to be structured to
manage and reduce counterparty risk.\7\
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\2\ See 15 U.S.C. 78q-1; Report of the Senate Committee on
Banking, Housing & Urban Affairs, S. Rep. No. 94-75, at 4 (1975)
(urging that ``[t]he Committee believes the banking and security
industries must move quickly toward the establishment of a fully
integrated national system for the prompt and accurate processing
and settlement of securities transactions'').
\3\ See 15 U.S.C. 78q-1(a)(2)(A).
\4\ Section 3(a)(23)(A) of the Exchange Act defines the term
``clearing agency'' to mean any person who acts as an intermediary
in making payments or deliveries or both in connection with
transactions in securities or who provides facilities for the
comparison of data regarding the terms of settlement of securities
transactions, to reduce the number of settlements of securities
transactions, or for the allocation of securities settlement
responsibilities. Such term also means any person, such as a
securities depository, who acts as a custodian of securities in
connection with a system for the central handling of securities
whereby all securities of a particular class or series of any issuer
deposited within the system are treated as fungible and may be
transferred, loaned or pledged by bookkeeping entry without physical
delivery of securities certificates, or otherwise permits or
facilitates the settlement of securities transactions or the
hypothecation or lending of securities without physical delivery of
securities certificates. See 15 U.S.C. 78c(a)(23)(A).
\5\ See id.; see also Exchange Act Release No. 34-68080 (Oct.
22, 2012), 77 FR 66219, 66221-22 (Nov. 2, 2012) (``Clearing Agency
Standards Release''). An entity that acts as a CCP for securities
transactions is a clearing agency as defined in the Exchange Act and
is required to register with the Commission. For further discussion
of the economic effects of CCPs, see infra notes 19, 563, and
accompanying text.
\6\ See Risk Management Supervision of Designated Clearing
Entities (July 2011), Report by the Commission, the Board & CFTC to
the Senate Committees on Banking, Housing & Urban Affairs and
Agriculture in fulfillment of Section 813 of Title VIII of the Dodd-
Frank Act, at 3 (stating that designated clearing entities ``play a
vital role in the proper functioning of financial markets and are
increasingly important given the mandated central clearing of
certain swaps and security-based swaps that is required by the
[Dodd-Frank] Act'') (``Risk Management Supervision Report'').
\7\ See id. at 12 (describing the risk management practices of
designated clearing entities and the economic and legal incentives
for sound risk management).
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Section 17A of the Exchange Act and Rule 17Ab2-1 require entities
to register with the Commission prior to performing the functions of a
clearing agency.\8\ Under the statute, the Commission is not permitted
to grant registration unless it determines that the rules and
operations of the clearing agency meet the standards set forth in
Section 17A of the Exchange Act.\9\ If the Commission registers a
clearing agency, the Commission oversees the clearing agency to
facilitate compliance with the Exchange Act using various tools that
include, among other things, the rule filing process for self-
regulatory organizations (``SROs'') and on-site examinations by
Commission staff.\10\ The Commission also oversees registered clearing
agencies through regular contact, including onsite visits, by
Commission staff with clearing agency senior management and other
personnel and ongoing interactions of Commission staff with the
registered
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clearing agencies regarding current and expected proposed rule changes
under Section 19(b) of the Exchange Act.
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\8\ See 15 U.S.C. 78q-1(b) and 17 CFR 240.17Ab2-1 thereunder;
see also infra notes 20-23 and accompanying text (noting that the
Dodd-Frank Act also added new paragraphs (g), (i), and (j) to
Section 17A of the Exchange Act to establish requirements for any
entity that performs the functions of a clearing agency for
security-based swaps).
\9\ A clearing agency can be registered with the Commission only
if the Commission makes a determination that the clearing agency
satisfies the requirements set forth in Section 17A(b)(3)(A) through
(I) of the Exchange Act. See 15 U.S.C. 78q-1(b)(3)(A) through (I).
In 1980, the Commission published a statement of the views and
positions of the Commission staff regarding the requirements of
Section 17A in its Announcement of Standards for the Registration of
Clearing Agencies. See Exchange Act Release No. 34-16900 (June 17,
1980), 45 FR 41920 (June 23, 1980).
\10\ Under the Clearing Supervision Act, the supervisory agency
must consult annually with the Board regarding the scope and
methodology of on-site examinations of designated FMUs, and those
examinations may include participation by the Board, if requested.
See infra note 32 and accompanying text; see also 15 U.S.C. 78u(a)
(providing the Commission with authority to initiate and conduct
investigations to identify potential violations of the federal
securities laws); 15 U.S.C. 78s(h) (providing the Commission with
authority to institute civil actions seeking injunctive and other
equitable remedies and/or administrative proceedings).
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B. OTC Swaps Clearing and the Dodd-Frank Act
The Commission drew on its experience regulating clearing agencies
to address recent developments in the over-the-counter (``OTC'')
derivatives markets. In December 2008, the Commission acted to
facilitate the central clearing of credit default swaps (``CDS'') by
permitting certain entities that performed CCP services to clear and
settle CDS on a temporary, conditional basis.\11\ Consequently, some
CDS transactions were centrally cleared prior to the enactment of the
Dodd-Frank Act.
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\11\ The Commission authorized five entities to clear CDS. See
Exchange Act Release Nos. 60372 (July 23, 2009), 74 FR 37748 (July
29, 2009), 61973 (Apr. 23, 2010), 75 FR 22656 (Apr. 29, 2010) and
63389 (Nov. 29, 2010), 75 FR 75520 (Dec. 3, 2010) (CDS clearing by
ICE Clear Europe Limited); 60373 (July 23, 2009), 74 FR 37740 (July
29, 2009), 61975 (Apr. 23, 2010), 75 FR 22641 (Apr. 29, 2010) and
63390 (Nov. 29, 2010), 75 FR 75518 (Dec. 3, 2010) (CDS clearing by
Eurex Clearing AG); 59578 (Mar. 13, 2009), 74 FR 11781 (Mar. 19,
2009), 61164 (Dec. 14, 2009), 74 FR 67258 (Dec. 18, 2009), 61803
(Mar. 30, 2010), 75 FR 17181 (Apr. 5, 2010) and 63388 (Nov. 29,
2010), 75 FR 75522 (Dec. 3, 2010) (CDS clearing by Chicago
Mercantile Exchange, Inc.); 59527 (Mar. 6, 2009), 74 FR 10791 (Mar.
12, 2009), 61119 (Dec. 4, 2009), 74 FR 65554 (Dec. 10, 2009), 61662
(Mar. 5, 2010), 75 FR 11589 (Mar. 11, 2010) and 63387 (Nov. 29,
2010), 75 FR 75502 (Dec. 3, 2010) (CDS clearing by ICE Trust US
LLC); 59164 (Dec. 24, 2008), 74 FR 139 (Jan. 2, 2009) (temporary CDS
clearing by LIFFE A&M and LCH.Clearnet Ltd.) (collectively ``CDS
clearing exemption orders''). LIFFE A&M and LCH.Clearnet Ltd.
allowed their orders to lapse without seeking renewal.
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On July 21, 2010, President Barack Obama signed the Dodd-Frank Act
into law.\12\ The Dodd-Frank Act was enacted, among other reasons, to
promote the financial stability of the United States by improving
accountability and transparency in the financial system.\13\ It is
intended, among other things, to bolster the existing regulatory
structure and provide regulatory tools to address risks in the OTC
derivatives markets, which have experienced dramatic growth in recent
years and are capable of affecting significant sectors of the U.S.
economy.\14\
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\12\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376
(2010).
\13\ See id.
\14\ From their beginnings in the early 1980s, the notional
value of these markets grew to approximately $693 trillion globally
by June 2013. See Bank for International Settlements (``BIS''),
Statistical Release: OTC Derivatives Statistics at End-June 2013, at
2 (Nov. 2013), available at http://www.bis.org/publ/otc_hy1311.pdf.
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1. Title VII of the Dodd-Frank Act
Title VII of the Dodd-Frank Act (``Title VII'') provides the
Commission and the CFTC with enhanced authority to regulate certain OTC
derivatives in response to the 2008 financial crisis.\15\ Title VII
provides that the CFTC will regulate ``swaps,'' the Commission will
regulate ``security-based swaps,'' and both the CFTC and the Commission
will regulate ``mixed swaps.'' \16\ Title VII provides the Commission
with new regulatory authority over security-based swaps by requiring,
among other things, that security-based swaps generally be cleared and
that clearing agencies for security-based swaps register with the
Commission.
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\15\ See Dodd-Frank Act, 124 Stat. at 1641-1802.
\16\ Section 712(d) of the Dodd-Frank Act provides that the
Commission and the CFTC, in consultation with the Board, shall
further define the terms ``swap,'' ``security-based swap,'' ``swap
dealer,'' ``security-based swap dealer,'' ``major swap
participant,'' ``major security-based swap participant,'' ``eligible
contract participant,'' and ``security-based swap agreement.'' 124
Stat. at 1644. The Commission and the CFTC jointly adopted rules to
further define the terms ``swap dealer,'' ``security-based swap
dealer,'' ``major swap participant,'' ``major security-based swap
participant,'' and ``eligible contract participant,'' as well as
rules to further define the terms ``swap,'' ``security-based swap,''
and ``security-based swap agreement'' and to govern the regulation
of mixed swaps. See Exchange Act Release Nos. 34-67453 (July 18,
2012), 77 FR 48208 (Aug. 13, 2012); 34-66868 (Apr. 27, 2012), 77 FR
30596 (May 23, 2012).
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The swap and security-based swap markets traditionally have been
characterized by privately negotiated transactions entered into by two
counterparties, in which each assumes the credit risk of the other
counterparty.\17\ Title VII amended the Exchange Act to require that
transactions in security-based swaps be cleared through a clearing
agency if they are of a type that the Commission determines must be
cleared, unless an exemption from mandatory clearing applies.\18\ When
structured and operated appropriately, clearing agencies may improve
the management of counterparty risk in security-based swap markets and
may provide additional benefits, such as the multilateral netting of
trades.\19\
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\17\ See, e.g., Exchange Act Release No. 34-60372 (July 23,
2009), 74 FR 37748 (July 29, 2009), at 37748 n.2 (discussing credit
default swaps).
\18\ See 15 U.S.C. 78c-3; see also Exchange Act Release No. 34-
67286 (June 28, 2012), 77 FR 41602 (July 13, 2012) (adopting rules
establishing a process for submissions for review of security-based
swaps for mandatory clearing); Exchange Act Release No. 34-63556
(Dec. 15, 2010), 75 FR 79992 (Dec. 21, 2010) (proposing an end-user
exception to the mandatory clearing requirement).
\19\ See Stephen G. Cecchetti, Jacob Gyntelberg & Marc
Hollanders, Central Counterparties for Over-the-Counter Derivatives,
BIS Q. Rev., Sept. 2009, at 46, available at http://www.bis.org/publ/qtrpdf/r_qt0909f.pdf (stating that the structure of a CCP
``has three clear benefits. First, it improves the management of
counterparty risk. Second, it allows the CCP to perform multilateral
netting of exposures as well as payments. Third, it increases
transparency by making information on market activity and
exposures--both prices and quantities--available to regulators and
the public'') (emphasis omitted); see also Exchange Act Release No.
34-60372, supra note 17, at 37749 (discussing the benefits of using
well-regulated CCPs to clear transactions in credit default swaps).
But see infra note 563 and accompanying text (discussing the limits
of clearing through central counterparties).
---------------------------------------------------------------------------
Title VII also added new provisions to the Exchange Act that
require entities performing the functions of a clearing agency with
respect to security-based swaps (``security-based swap clearing
agencies'') to register with the Commission and require the Commission
to adopt rules with respect to security-based swap clearing
agencies.\20\ Specifically, new Section 17A(j) requires the Commission
to adopt rules governing security-based swap clearing agencies, and new
Section 17A(i) gives the Commission authority to promulgate rules that
establish standards for security-based swap clearing agencies.\21\
Compliance with any such rules is a prerequisite to the registration of
a clearing agency that clears security-based swaps with the Commission
and is also a condition to maintain its continued registration.\22\
Section 17A(i) also provides that the Commission, in establishing
clearing agency standards and in its oversight of clearing agencies,
may conform such standards and such oversight to reflect evolving
international standards.\23\ Before commencing any rulemaking
regarding, among other things, security-based swap clearing agencies,
Title VII provides that the Commission shall consult and coordinate, to
the extent possible, with the CFTC and the prudential regulators for
the purpose of assuring regulatory consistency and comparability, to
the extent possible.\24\
---------------------------------------------------------------------------
\20\ See 15 U.S.C. 78q-1(g); Dodd-Frank Act, Sec. 763(b), Public
Law 111-203, 124 Stat. 1376, 1768 (2010) (adding paragraph (g) to
Section 17A of the Exchange Act). Pursuant to Section 774 of the
Dodd-Frank Act, the requirement in Section 17A(g) of the Exchange
Act for security-based swap clearing agencies to be registered with
the Commission took effect on July 16, 2011. See 124 Stat. at 1802.
\21\ See 15 U.S.C. 78q-1(i), (j); Dodd-Frank Act, Sec. 763(b),
124 Stat. at 1768-69 (adding paragraphs (i) and (j) to Section 17A
of the Exchange Act).
\22\ See supra note 9 (describing the requirements under Section
17A(b)(3) of the Exchange Act, 15 U.S.C. 78q-1(b)(3)).
\23\ See 15 U.S.C. 78q-1(i) (stating that, in establishing
standards for security-based swap clearing agencies, and in the
exercise of its oversight of such a clearing agency pursuant to this
title, the Commission may conform such standards or oversight to
reflect evolving United States and international standards).
\24\ See Dodd-Frank Act, Sec. 712(a)(2), 124 Stat. at 1641-42.
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Title VII further provides that some of the entities that the
Commission permitted to clear and settle CDS on a temporary,
conditional basis prior to the
[[Page 29512]]
July 21, 2010 enactment of the Dodd-Frank Act are deemed under the
Dodd-Frank Act to be registered clearing agencies (the ``deemed
registered provision'').\25\ As a result, the Chicago Mercantile
Exchange, Inc. (``CME''), ICE Clear Credit LLC (``ICE''), and ICE Clear
Europe LLC (``ICEEU'') became clearing agencies deemed registered with
the Commission on July 16, 2011, solely for the purpose of clearing
security-based swaps.
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\25\ See 15 U.S.C. 78q-1(l). The deemed registered provision
applies to certain depository institutions that cleared swaps as
multilateral clearing organizations and certain derivatives clearing
organizations (``DCOs'') that cleared swaps pursuant to an exemption
from registration as a clearing agency before the date of enactment
of the Dodd-Frank Act. Under the deemed registered provision, such a
clearing agency is deemed registered for the purpose of clearing
security-based swaps and is therefore required to comply with all
requirements of the Exchange Act, and the rules thereunder,
applicable to registered clearing agencies, including, for example,
the obligation to file proposed rule changes under Section 19(b) of
the Exchange Act. See infra note 96 (describing the requirements in
Section 19(b) of the Exchange Act).
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2. Title VIII of the Dodd-Frank Act
The Clearing Supervision Act, adopted in Title VIII of the Dodd-
Frank Act (``Title VIII''), provides for enhanced regulation of
financial market utilities (``FMUs''), such as clearing agencies that
manage or operate a multilateral system for the purpose of
transferring, clearing, or settling payments, securities, or other
financial transactions among financial institutions or between
financial institutions and the FMU.\26\ The enhanced regulatory regime
in Title VIII applies only to FMUs that the FSOC designates as
systemically important (or likely to become systemically important) in
accordance with Section 804 of the Clearing Supervision Act.\27\ On
July 11, 2011, the FSOC published a final rule concerning its authority
to designate FMUs as systemically important.\28\
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\26\ The definition of ``financial market utility'' in Section
803(6) of the Clearing Supervision Act contains a number of
exclusions that include, but are not limited to, certain designated
contract markets, registered futures associations, swap data
repositories, swap execution facilities, national securities
exchanges, national securities associations, alternative trading
systems, security-based swap data repositories, security-based swap
execution facilities, brokers, dealers, transfer agents, investment
companies and futures commission merchants. See 12 U.S.C.
5462(6)(B).
\27\ Pursuant to Section 803(9) of the Clearing Supervision Act,
an FMU is systemically important if the failure of or a disruption
to the functioning of such FMU could create or increase the risk of
significant liquidity or credit problems spreading among financial
institutions or markets and thereby threaten the stability of the
U.S. financial system. See 12 U.S.C. 5462(9).
\28\ See 76 FR 44763 (July 27, 2011). Under Section 804 of the
Clearing Supervision Act, the FSOC has the authority, on a non-
delegable basis and by a vote of no fewer than two-thirds of the
members then serving, including the affirmative vote of its
chairperson, to designate those FMUs that the FSOC determines are,
or are likely to become, systemically important. See 12 U.S.C. 5463.
The FSOC may, using the same procedures as discussed above, rescind
such designation if it determines that the FMU no longer meets the
standards for systemic importance. Before making either
determination, the FSOC is required to consult with the Board and
the relevant supervisory agency (as determined in accordance with
Section 803(8) of the Clearing Supervision Act). See id. Finally,
Section 804 of the Clearing Supervision Act sets forth the
procedures for giving entities a 30-day notice and the opportunity
for a hearing prior to a designation or rescission of the
designation of systemic importance. See id.
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Section 806(e) of the Clearing Supervision Act requires FMUs
designated as systemically important to file 60 days advance notice of
changes to its rules, procedures, or operations that could materially
affect the nature or level of risk presented by the FMU (``Advance
Notice'').\29\ In addition, Section 806(e) requires each supervisory
agency to adopt rules, in consultation with the Board, that define and
describe when a designated FMU is required to file an Advance Notice
with its supervisory agency.\30\ The Commission published a final rule
concerning the Advance Notice process for designated clearing agencies
on June 28, 2012.\31\ In evaluating an Advance Notice filed with the
Commission, the Commission would assess, among other things, the
consistency of the Advance Notice with the rules proposed herein, if
adopted.
---------------------------------------------------------------------------
\29\ See 12 U.S.C. 5465(e)(1)(A).
\30\ Section 803(8) of the Clearing Supervision Act defines the
term ``supervisory agency'' in reference to the primary regulatory
authority for the FMU. For example, it provides that the Commission
is the supervisory agency for any FMU that is a registered clearing
agency. See 12 U.S.C. 5462(8). To the extent that an entity is both
a clearing agency registered with the Commission and registered with
another agency, such as a DCO registered with the CFTC, the statute
requires the two agencies to agree on one agency to act as the
supervisory agency, and if the agencies cannot agree on which agency
has primary jurisdiction, the FSOC shall decide which agency is the
supervisory agency for purposes of the Clearing Supervision Act. See
12 U.S.C. 5462(8).
\31\ See Exchange Act Release No. 34-67286 (June 28, 2012), 77
FR 41602 (July 13, 2012).
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The Clearing Supervision Act also provides for enhanced
coordination between the Commission, the Board, and the CFTC by
facilitating examinations and information sharing. Under Section 807 of
the Clearing Supervision Act, the Commission and the CFTC must consult
annually with the Board regarding the scope and methodology of any
examination of a designated FMU, and the Board is authorized to
participate in any such examination.\32\ Section 809 of the Clearing
Supervision Act authorizes the Commission, the Board, and the CFTC to
disclose to each other copies of examination reports or similar reports
regarding any designated FMU.\33\ It further authorizes the Commission,
the Board, and the CFTC to promptly notify each other of material
concerns about a designated FMU and share appropriate reports,
information, or data relating to such concerns.\34\ Section 813 of the
Clearing Supervision Act requires the Commission and the CFTC to
coordinate with the Board to develop risk management supervision
programs for designated clearing agencies.\35\
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\32\ See 12 U.S.C. 5466.
\33\ See 12 U.S.C. 5468.
\34\ See id.
\35\ See 12 U.S.C. 5472; see also Risk Management Supervision
Report, supra note 6.
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Section 805(a) of the Clearing Supervision Act \36\ also provides
that the Commission may prescribe risk management standards governing
the operations related to payment, clearing, and settlement activities
(``PCS activities'') of designated FMUs for which it acts as the
supervisory agency, in consultation with the FSOC and the Board and
taking into consideration relevant international standards and existing
prudential requirements.\37\
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\36\ 12 U.S.C. 5464(a).
\37\ See 12 U.S.C. 5464(a)(2) (stating that these regulations
may govern the operations related to payment, clearing, and
settlement activities of such designated clearing entities, and the
conduct of designated activities by such financial institutions).
PCS activities are defined in Section 803(7) of the Clearing
Supervision Act. See 12 U.S.C 5462(7).
---------------------------------------------------------------------------
On July 18, 2012, the FSOC designated as systemically important the
following registered clearing agencies: CME, The Depository Trust
Company (``DTC''), Fixed Income Clearing Corporation (``FICC''), ICE,
National Securities Clearing Corporation (``NSCC''), and The Options
Clearing Corporation (``OCC'').\38\ Under the Clearing Supervision Act,
the Commission is the supervisory agency for DTC, FICC, NSCC, and
OCC.\39\ The
[[Page 29513]]
Commission jointly regulates DTC with the Board and OCC with the
CFTC.\40\ The Commission also jointly regulates CME and ICE with the
CFTC, which serves as their supervisory agency.\41\
---------------------------------------------------------------------------
\38\ See U.S. Treasury Dep't, Financial Stability Oversight
Council Makes First Designations in Effort to Protect Against Future
Financial Crises (July 18, 2012), http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx; see also 12 U.S.C. 5321
(establishing the FSOC and designating its voting and non-voting
members); 12 U.S.C. 5463 (describing the designation of systemic
importance by the FSOC); supra note 28 (describing the process by
which the FSOC would make or rescind a designation of systemic
importance). Section 804 of the Clearing Supervision Act, 12 U.S.C.
5463, further sets forth procedures that give entities 30 days
advance notice and an opportunity for a hearing prior to being
designated as systemically important. See FSOC, 2012 Annual Report,
at app. A, available at http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf.
\39\ See supra note 30 (discussing designation as the
supervisory agency); see also FSOC, 2013 Annual Report, at 99-101,
113 (further discussing the same), available at http://www.treasury.gov/initiatives/fsoc/Documents/FSOC%202013%20Annual%20Report.pdf.
\40\ As a member of the U.S. Federal Reserve System and a
limited purpose trust company under New York State banking law, DTC
is subject to regulation by the Board.
\41\ In addition, the Commission jointly regulates ICEEU, which
is not currently designated as systemically important by the FSOC,
with the CFTC and the Bank of England.
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C. Rule 17Ad-22 Under the Exchange Act
On October 22, 2012, the Commission adopted Rule 17Ad-22 under the
Exchange Act.\42\ Through Rule 17Ad-22, the Commission sought to
strengthen the substantive regulation of registered clearing agencies,
promote the safe and reliable operation of registered clearing
agencies, and improve efficiency, transparency, and access to
registered clearing agencies by establishing minimum requirements with
due consideration given to observed practices and international
standards.\43\ At that time, the Commission noted that the
implementation of Rule 17Ad-22 would be an important first step in
developing the regulatory changes contemplated by Titles VII and VIII
of the Dodd-Frank Act.\44\ Rule 17Ad-22 requires all registered
clearing agencies to establish, implement, maintain and enforce written
policies and procedures that are reasonably designed to meet certain
minimum requirements for their operations and risk management practices
on an ongoing basis.\45\ These requirements are designed to work in
tandem with the SRO rule filing process and the requirement in Section
17A of the Exchange Act that the Commission must make certain
determinations regarding a clearing agency's rules and operations for
purposes of initial and ongoing registration.\46\ Rule 17Ad-22 does not
apply to entities that are operating pursuant to an exemption from
registration as a clearing agency granted by the Commission,\47\ and it
does not give particular consideration to issues relevant to clearing
agencies designated as systemically important FMUs.
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\42\ See Clearing Agency Standards Release, supra note 5.
\43\ See id. at 66225, 66263-64.
\44\ See Clearing Agency Standards Release, supra note 5, at
66225.
\45\ Rules 17Ad-22(b)(1) through (4) contain several
requirements that address risk management practices by registered
clearing agencies that provide CCP services. Rules 17Ad-22(b)(5)
through (7) establish certain requirements regarding access to
registered clearing agencies that provide CCP services. Rule 17Ad-
22(c) requires that a registered clearing agency providing CCP
services calculate and maintain a record of its financial resources
and requires each registered clearing agency to publish annual
audited financial statements. Rule 17Ad-22(d) sets forth certain
minimum standards for the operations of registered clearing agencies
providing CCP or central securities depository (``CSD'') services.
See infra Part II.B.4.b (discussing the current requirements for
CCPs under Rule 17Ad-22); see also Clearing Agency Standards
Release, supra note 5 (adopting the existing standards under Rule
17Ad-22).
\46\ See supra note 9 (describing the requirements under Section
17A(b)(3) of the Exchange Act, 15 U.S.C. 78q-1(b)(3)) and infra note
96 (further describing the Commission's framework for regulation of
SROs and the SRO rule filing process).
\47\ See, e.g., Exchange Act Release No. 34-44188 (Apr. 17,
2001), 66 FR 20494 (Apr. 23, 2011) (the Omgeo exemption); Exchange
Act Release No. 34-39643 (Feb. 11, 1998), 63 FR 8232 (Feb. 18, 1998)
(the Euroclear exemption); Exchange Act Release No 34-38328 (Feb.
24, 1997), 62 FR 9225 (Feb. 28, 1997) (the Clearstream exemption).
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D. Relevant International Standards
In proposing amendments to Rule 17Ad-22, the Commission considered
international standards, as required by Section 805(a) of the Clearing
Supervision Act, that are relevant to its supervision of covered
clearing agencies.\48\ CPSS-IOSCO published in April 2012 the PFMI
Report \49\ to replace previous standards applicable to clearing
agencies contained in two earlier reports: Recommendations for
Securities Settlement Systems (2001) (``RSSS'') and Recommendations for
Central Counterparties (2004) (``RCCP'') (collectively ``CPSS-IOSCO
Recommendations'').\50\ Commission staff participated in the
development and drafting of the PFMI Report,\51\ and the Commission
believes that the standards set forth in the PFMI Report are generally
consistent with the requirements applicable to clearing agencies set
forth in the Exchange Act.\52\ Regulatory authorities around the world
are in various stages of updating their regulatory regimes to adopt
measures that are in line with the standards set forth in the PFMI
Report.\53\ The rule
[[Page 29514]]
proposals set forth below are a continuation of the Commission's active
efforts to foster the development of the national clearance and
settlement system.
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\48\ See supra note 36. In addition, the Basel Committee on
Banking Supervision (``BCBS''), the international body that sets
standards for the regulation of banks, published in July 2012 the
Capital Requirements for Bank Exposures to Central Counterparties
(``Basel III capital requirements''). The Basel III capital
requirements set forth interim rules governing the capital charges
arising from bank exposures to CCPs related to OTC derivatives,
exchange-traded derivatives, and securities financing transactions
(which term, as used throughout this release, refers generally to
repurchase agreements and securities lending). Among other things,
the Basel III framework imposes lower capital requirements on CCPs
that obtain ``qualifying CCP'' (``QCCP'') status and would apply
QCCP status only to CCPs that are subject to a regulatory framework
consistent with the standards set forth in the PFMI Report. See
BCBS, Capital Requirements for Bank Exposures to Central
Counterparties (July 2012), available at http://www.bis.org/publ/bcbs227.pdf (setting forth he interim requirements set forth in this
report, currently under revision by the BCBS, in consultation with
CPSS and IOSCO). See also BCBS, Capital Treatment of Bank Exposures
to Central Counterparties: Consultative Document (rev. July 2013),
available at http://www.bis.org/publ/bcbs253.pdf; BIS, Basel III: A
Global Regulatory Framework for More Resilient Banks and Banking
Systems (rev. June 2011), available at http://www.bis.org/publ/bcbs189.htm (``Basel III framework''). The Basel III capital
requirements are one component of the Basel III framework.
\49\ See supra note 1.
The PFMI Report defines a ``financial market infrastructure''
(``FMI'') as a multilateral system among participating institutions,
including the operator of the system, used for the purposes of
clearing, settling, or recording payments, securities, derivatives,
or other financial transactions. See id. at 7; FMIs include CCPs,
CSDs, securities settlement systems (``SSSs''), and trade
repositories (``TRs''). Cf. 12 U.S.C. 5462(6)(B), supra note 30
(defining ``financial market utility'' under the Clearing
Supervision Act).
The PFMI Report presumes that all CSDs, SSSs, CCPs, and TRs are
systemically important in their home jurisdiction. See PFMI Report,
supra note 1, at 131 & n.177 (noting the ``presumption . . . that
all CSDs, SSSs, CCPs, and TRs are systemically important because of
their critical roles in the markets they serve,'' but also noting
that ultimately ``national law will dictate the criteria to
determine whether an FMI is systemically important'').
The Commission notes that the PFMI Report's definition of
``financial market infrastructure'' is consistent with the
Commission's prior use of the term. See Study of Unsafe and Unsound
Practices of Brokers and Dealers, H.R. Doc. No. 231, 92d Cong., 1st
Sess. 13 (1971) (defining ``financial market infrastructure'' as a
multilateral system among participating institutions, including the
operator of the system, used for the purposes of clearing, settling,
or recording payments, securities, derivatives, or other financial
transactions).
\50\ The CPSS-IOSCO Recommendations are available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD123.pdf and http://www.iosco.org/library/pubdocs/pdf/IOSCPD176.pdf.
The Board applies these standards in its supervisory process and
expects systemically important FMUs, as determined by the Board and
subject to its authority, to complete a self-assessment against the
standards set forth in the policy. See Financial Market Utilities,
77 FR 45907 (Aug. 2, 2012) (the Board adopting Regulation HH for
FMUs) (``Reg. HH''); Policy on Payments System Risk, 72 FR 2518
(Jan. 12, 2007).
The Board has proposed to amend the standards in Regulation HH
to replace the current standards for payment systems with standards
based those set forth in the PFMI Report. It has also proposed to
amend its Policy on Payments System Risk. See infra note 53.
\51\ Commission staff co-chaired the Editorial Team, a working
group within CPSS-IOSCO that drafted both the consultative and final
versions of the PFMI Report.
\52\ See 15 U.S.C. 78q-1; 15 U.S.C. 78s(b).
\53\ See CPSS-IOSCO, Implementation Monitoring of PFMIs--Level 1
Assessment Report (Aug. 2013), available at http://www.bis.org/publ/cpss111.pdf (describing efforts by various jurisdictions to adopt
standards for FMIs in line with the PFMI Report) (``PFMI
Implementation Monitoring Report''); see also Reg. HH, supra note
50; Financial Market Utilities, 79 FR 3665 (Jan. 22, 2014) (the
Board proposing to amend Reg. HH) (``proposed Reg. HH''); Policy on
Payment System Risk, 79 FR 2838 (Jan. 16, 2014) (the Board proposing
to amend its Federal Reserve Policy on Payments System Risk)
(``proposed PSR Policy''); Derivatives Clearing Organizations and
International Standards, 78 FR 72475 (Dec. 2, 2013) (CFTC adopting
rules for DCOs in line with international standards) (``DCO Int'l
Standards Release''); Enhanced Risk Management Standards for
Systemically Important Derivatives Clearing Organizations, 78 FR
49663 (Aug. 15, 2013) (CFTC adopting rules for systemically
important DCOs) (``SIDCO Release''); Derivatives Clearing
Organization General Provisions and Core Principles, 76 FR 69334
(Nov. 8, 2011) (CFTC adopting rules for DCOs); (``DCO Principles
Release'').
In addition, the Board and the Office of the Comptroller of the
Currency have adopted rules implementing the material elements of
the BCBS interim framework for capitalization of bank exposures to
CCPs. See Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 76 FR 62017, 62099 (Oct. 11, 2013) (``Regulatory Capital
Rules''). The Board also noted the ongoing international discussions
on this topic and stated that it intends to revisit its rules once
the Basel III capital framework is revised. See id. The Board and
the Office of the Comptroller of the Currency's final rules define
``QCCP'' to mean, among other things, a designated FMU under the
Clearing Supervision Act. See 12 CFR 217.2; see also Regulatory
Capital Rules, supra, at 62100.
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II. Discussion of the Proposed Amendments to Rule 17Ad-22 and Proposed
Rule 17Ab2-2
The Commission is proposing to amend Rule 17Ad-22 and add Rule
17Ab2-2 pursuant to Section 17A of the Exchange Act and the Clearing
Supervision Act to provide a new regulatory framework for ``covered
clearing agencies,'' as defined below.
Generally, Section 17A directs the Commission to facilitate the
establishment of a national system for the prompt and accurate
clearance and settlement of securities transactions, having due regard
for the public interest, the protection of investors, the safeguarding
of securities and funds, and the maintenance of fair competition among
brokers and dealers.\54\ It further requires that a clearing agency be
so organized and have the capacity and rules designed to, among other
things, facilitate the prompt and accurate clearance and settlement of
securities transactions, and to comply with the provisions of the
Exchange Act and the rules and regulations thereunder.\55\ In
establishing a regulatory framework for clearance and settlement, the
Exchange Act requires that a registered clearing agency's rules not
impose any burden on competition not necessary or appropriate in the
furtherance of the purposes of the Exchange Act.\56\
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\54\ See 15 U.S.C. 78q-1(a)(2)(A).
\55\ See 15 U.S.C. 78q-1(a)(3)(A), (F).
\56\ See 15 U.S.C. 78q-1(b)(3)(I).
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Consistent with these statutory objectives, the Commission
previously adopted Rule 17Ad-22(d) to establish minimum requirements
for registered clearing agencies and indicated that it might consider
further rulemaking at a later date.\57\ In furtherance of the
provisions of Section 17A of the Exchange Act and the Clearing
Supervision Act described above and as previously considered by the
Commission, the Commission is proposing Rule 17Ad-22(e) to establish
new requirements for covered clearing agencies, which the Commission
preliminarily believes are appropriate given the risks that their size,
operation, and importance pose to the U.S. securities markets, the
risks inherent in the products they clear, and the goals of Title VII
and the Exchange Act.\58\ In connection with its supervision of
registered clearing agencies under Section 17A of the Exchange Act,
including after the adoption of Rule 17Ad-22,\59\ the Commission has
considered whether enhanced requirements for covered clearing agencies
could contribute to the stability of U.S. securities markets, as
described further in Part IV, and has determined to issue this proposal
for comment.
---------------------------------------------------------------------------
\57\ See Clearing Agency Standards Release, supra note 5, at
66224-25.
\58\ See id. (contemplating future Commission action on clearing
agency standards).
\59\ See Clearing Agency Standards Release, supra note 5, at
66227 (stating that Rule 17Ad-22 generally codifies existing
practices that reflect the CPSS-IOSCO Recommendations published in
2001 and 2004).
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The Commission has preliminarily chosen to retain Rule 17Ad-22(d)
and to continue to apply it to registered clearing agencies that are
not covered clearing agencies.\60\ The Commission preliminarily
believes that retaining Rule 17Ad-22(d) ensures that clear,
comprehensive, and transparent standards for registered clearing
agencies that are not covered clearing agencies will continue to exist
and, because they are narrower in scope, would thereby provide a more
flexible regime for new entrants seeking to establish and operate
registered clearing agencies, consistent with the continuing
development of the national system for clearance and settlement, than
would otherwise be the case with a single regime under proposed Rule
17Ad-22(e).
---------------------------------------------------------------------------
\60\ See infra Part II.E (discussing the proposed language
amending Rule 17Ad-22(d) to apply to registered clearing agencies
that are not covered clearing agencies).
---------------------------------------------------------------------------
The Commission notes that it is not proposing to alter the existing
requirements under Rule 17Ad-22(b), which establishes risk-management
and participant access requirements for registered clearing agencies
that perform CCP services for security-based swaps, or Rule 17Ad-22(c),
which requires registered clearing agencies that provide CCP services
to maintain a record of financial resources and all registered clearing
agencies to post on their Web sites annual audited financial
statements.\61\ These requirements continue to be appropriate for all
registered clearing agencies because they promote prompt and accurate
clearance and settlement of securities and security-based swap
transactions. Notably, Rule 17Ad-22(b) reduces the likelihood, in a
participant default scenario, that losses from default would disrupt
the operations of the clearing agency, and Rule 17Ad-22(c) provides an
additional layer of information about the activities and financial
strength of a registered clearing agency that market participants may
find useful in assessing their use of the registered clearing agency's
services while also assisting the Commission in its oversight of
registered clearing agencies' compliance with Rule 17Ad-22 by providing
a clear record of the method used by the clearing agency to, among
other things, maintain sufficient financial resources.\62\
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\61\ The standards in Rules 17Ad-22(b) and (c) were also adopted
by the Commission in 2012. See 17 CFR 240.17Ad-22(b), (c); see also
Clearing Agency Standards Release, supra note 5.
The Commission is proposing to revise Rule 17Ad-22(a) to account
for new proposed definitions. See proposed revision of Rule 17Ad-
22(a), infra Part VII. The existing definitions in 17 CFR 240.17Ad-
22(a) would be renumbered to account for new terms. In addition, the
definition of ``participant family'' would be amended to include
references to its use in proposed paragraphs (e)(4) and (e)(7). See
proposed Rule 17Ad-22(a)(13), infra Part VII.
\62\ See Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR
14474, 14477-83 (Mar. 16, 2011); see also Clearing Agency Standards
Release, supra note 5, at 66244.
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A. Overview
The Commission is proposing Rule 17Ad-22(e) to establish
requirements for covered clearing agencies with respect to general
organization,\63\ financial risk management,\64\ settlement,\65\ CSDs
and exchange-of-
[[Page 29515]]
value settlement systems,\66\ default management,\67\ general business
risk and operational risk management,\68\ access,\69\ efficiency,\70\
and transparency.\71\ The discussion below provides greater detail
regarding each respective requirement in proposed Rule 17Ad-22(e).
Several aspects of proposed Rule 17Ad-22(e) are similar to existing
Rule 17Ad-22(d),\72\ but in general the Commission preliminarily notes
that certain requirements under proposed Rule 17Ad-22(e) would require
covered clearing agencies to consider and adopt policies and procedures
more closely tailored to the risks that are posed by covered clearing
agencies, which the Commission preliminarily identified as appropriate
in connection with its experience in supervising registered clearing
agencies under Section 17A of the Exchange Act, including since the
adoption of Rule 17Ad-22.
---------------------------------------------------------------------------
\63\ See infra Parts II.B.1-3 (discussing proposed Rules 17Ad-
22(e)(1) (legal risk), 17Ad-22(e)(2) (governance), and 17Ad-22(e)(3)
(framework for the comprehensive management of risk)).
\64\ See infra Part II.B.4 (discussing proposed Rules 17Ad-
22(e)(4) (credit risk), 17Ad-22(e)(5) (collateral), 17Ad-22(e)(6)
(margin), and 17Ad-22(e)(7) (liquidity risk)).
\65\ See infra Parts II.B.5-7 (discussing proposed Rules 17Ad-
22(e)(8) (settlement finality), 17Ad-22(e)(9) (money settlements),
and 17Ad-22(e)(10) (physical delivery risks)).
\66\ See infra Parts II.B.8-9 (discussing proposed Rules 17Ad-
22(e)(11) (CSDs) and 17Ad-22(e)(12) (exchange-of-value settlement
systems)).
\67\ See infra Parts II.B.10-11 (discussing proposed Rules 17Ad-
22(e)(13) (participant-default rules and procedures) and 17Ad-
22(e)(14) (segregation and portability)).
\68\ See infra Parts II.B.12-14 (discussing proposed Rules 17Ad-
22(e)(15) (general business risk), 17Ad-22(e)(16) (custody and
investment risk), and 17Ad-22(e)(17) (operational risk management)).
\69\ See infra Parts II.B.15-17 (discussing proposed Rules 17Ad-
22(e)(18) (access and participation requirements), 17Ad-22(e)(19)
(tiered participation arrangements), and 17Ad-22(e)(20) (links)).
\70\ See infra Parts II.B.18-19 (discussing proposed Rules 17Ad-
22(e)(21) (efficiency and effectiveness) and 17Ad-22(e)(22)
(communication procedures and standards)).
\71\ See infra Part II.B.20 (discussing proposed Rule 17Ad-
22(e)(23) (disclosure of rules, key procedures, and market data)).
\72\ See infra Part II.A.4 (discussing the anticipated impact of
proposed Rule 17Ad-22(e) given the existing requirements for
registered clearing agencies under Rule 17Ad-22).
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The Commission preliminarily believes that the requirements of
proposed Rule 17Ad-22(e) would help promote governance, operations, and
risk management practices more closely tailored to the risks raised by
registered clearing agencies that have been designated systemically
important, are engaged in activities with a more complex risk profile,
or are determined to be covered clearing agencies by the Commission,
consistent with Section 17A of the Exchange Act. The Commission
preliminarily believes these requirements would also enable consistent
supervision of designated FMUs and would reflect the Commission's
consideration of international standards, as contemplated by Section
17A(i) and the Clearing Supervision Act.\73\ While the Commission has
made its own determination to issue the proposed rules for comment, the
Commission preliminarily believes that generally updating its rules,
where appropriate, to take into account the standards set forth in the
PFMI Report would contribute to the efforts of regulators around the
world, described above,\74\ to implement consistent standards for
FMIs.\75\ The Commission also preliminarily believes that Rule 17Ad-
22(e) would provide an additional benefit of providing support for a
determination by foreign bank regulators that covered clearing agencies
providing CCP services for derivatives and securities financing
transactions meet the requirements for QCCP status under the Basel III
framework and could therefore help reduce competitive frictions among
CCPs in different jurisdictions.
---------------------------------------------------------------------------
\73\ See supra Part I.B.2, in particular notes 36-37 and
accompanying text (discussing the requirements under Section 17A(i)
of the Exchange Act, 15 U.S.C. 78q-1(i), and Section 805(a) of the
Clearing Supervision Act, 12 U.S.C. 5464(a)).
\74\ See supra note 53 and accompanying text.
\75\ See infra Part IV.C.1.e (further discussing the economic
effects of obtaining QCCP status under the Basel III capital
requirements); see also supra note 48.
---------------------------------------------------------------------------
Part II.A first discusses the scope of proposed Rule 17Ad-22(e),
the role that written policies and procedures play in framing the
proposed rule, and the reasons for imposing certain frequency of review
requirements throughout the proposed rules. It then discusses the
anticipated impact of the proposed rules given the existing
requirements applicable to registered clearing agencies under Rules
17Ad-22(b) through (d), with which a covered clearing agency must
already be in compliance.
Part II.B next discusses the proposed rules under Rule 17Ad-22(e).
Finally, Parts II.C, D, and E discuss, in turn, proposed Rule 17Ab2-2,
proposed Rule 17Ad-22(f), and the proposed amendment to Rule 17Ad-
22(d).
1. Scope of Proposed Rule 17Ad-22(e)
The Commission is proposing to add four terms to Rule 17Ad-22(a) to
identify the registered clearing agencies that would be subject to
proposed Rule 17Ad-22(e). First, the Commission is proposing to add
Rule 17Ad-22(a)(9) to define ``financial market utility'' (``FMU'') as
defined in Section 803(6) of the Clearing Supervision Act.\76\ Second,
the Commission is proposing Rule 17Ad-22(a)(8) to define ``designated
clearing agency.'' \77\ A designated clearing agency would mean a
clearing agency registered with the Commission under Section 17A of the
Exchange Act that has been designated as a systemically important FMU
by the FSOC and for which the Commission is the supervisory agency as
defined in Section 803(8) of the Clearing Supervision Act.\78\ Third,
the Commission is proposing to add Rule 17Ad-22(a)(4) to define
``clearing agency involved in activities with a more complex risk
profile'' \79\ to mean a clearing agency registered with the Commission
under Section 17A of the Exchange Act that either (i) provides central
counterparty services for security-based swaps or (ii) has been
determined by the Commission to be involved in activities with a more
complex risk profile (``complex risk profile clearing agency''), either
at the time of its initial registration or upon a subsequent
determination by the Commission pursuant to proposed Rule 17Ab2-2.\80\
Fourth, the Commission is proposing to add Rule 17Ad-22(a)(7) to define
a ``covered clearing agency'' as a designated clearing agency, a
complex risk profile clearing agency, or any clearing agency determined
to be a covered clearing agency by the Commission pursuant to proposed
Rule 17Ab2-2.\81\
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\76\ See proposed Rule 17Ad-22(a)(9), infra Part VII; see also
12 U.S.C. 5462(6) (defining ``financial market utility'' pursuant to
the Clearing Supervision Act); supra note 26 (providing further
explanation of ``financial market utility'').
\77\ See proposed Rule 17Ad-22(a)(8), infra Part VII.
\78\ Rule 17Ad-22 does not currently apply to entities operating
pursuant to an exemption from clearing agency registration. The
proposed amendments to Rule 17Ad-22 would not broaden the scope of
Rule 17Ad-22 to an entity operating pursuant to an exemption from
registration as a clearing agency granted by the Commission.
\79\ See proposed Rule 17Ad-22(a)(4), infra Part VII.
\80\ The Commission is proposing Rule 17Ab2-2 to establish a
process for making determinations regarding clearing agencies
involved in activities with a more complex risk profile. See infra
Part II.C (further discussing the purpose, scope, and application of
proposed Rule 17Ab2-2) and Part VII (proposed text of Rule 17Ab2-2).
The Commission is also proposing Rule 17Ad-22(a)(16) to define
``security-based swap'' to mean security-based swap as defined in
Section 3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68). See
infra Part VII.
\81\ See proposed Rule 17ad-22(a)(7), infra Part VII.
---------------------------------------------------------------------------
The Commission preliminarily believes there could be several
different bases under which registered clearing agencies would be
required to comply with proposed Rule 17Ad-22(e). For instance, because
DTC, FICC, NSCC, and OCC are registered clearing agencies pursuant to
Section 17A of the Exchange Act and are designated clearing agencies
for which the Commission is the supervisory agency
[[Page 29516]]
under the Clearing Supervision Act,\82\ they would be covered clearing
agencies under proposed Rule 17Ad-22(a)(7) and would be subject to the
requirements for covered clearing agencies in proposed Rule 17Ad-22(e).
In addition, because ICEEU provides CCP services for security-based
swaps and has been deemed registered with the Commission as a security-
based swap clearing agency,\83\ it would be a complex risk profile
clearing agency under proposed Rule 17Ad-22(a)(4) and also subject to
the requirements for covered clearing agencies proposed in Rule 17Ad-
22(e).
---------------------------------------------------------------------------
\82\ See supra Part I.B.2.
\83\ See supra note 41 and accompanying text.
---------------------------------------------------------------------------
By comparison, CME and ICE would not be subject to the proposed
requirements for covered clearing agencies in Rule 17Ad-22(e) because
(i) they have been designated as systemically important FMUs under
Section 804 of the Clearing Supervision Act; \84\ (ii) they are each
dually registered with the Commission and the CFTC as a clearing agency
and DCO, respectively; and (iii) the CFTC is their supervisory agency
under the Clearing Supervision Act.\85\ The Commission preliminarily
believes that, because CME and ICE would be subject to the CFTC's
requirements for systemically important DCOs,\86\ applying proposed
Rule 17Ad-22(e) to them could impose duplicative requirements. Given
the Commission's existing regulatory authority under Section 17A(l) of
the Exchange Act,\87\ however, CME and ICE would remain subject to the
continuing requirements for registered clearing agencies in Rules 17Ad-
22(b) through (d).
---------------------------------------------------------------------------
\84\ See 12 U.S.C. 5463.
\85\ See supra Part I.B.2; see also FSOC, 2013 Annual Report,
supra note 39, at 100.
\86\ See supra note 41 and accompanying text.
\87\ See 15 U.S.C. 78q-1(l).
---------------------------------------------------------------------------
Two dormant clearing agencies, the Stock Clearing Corporation of
Philadelphia (``SCCP'') and the Boston Stock Exchange Clearing
Corporation (``BSECC''), have not been designated systemically
important by the FSOC and are not involved in activities with a more
complex risk profile.\88\ Accordingly, each would also remain subject
to the requirements in Rules 17Ad-22(b) through (d).
---------------------------------------------------------------------------
\88\ In 2008, NASDAQ OMX Group, Inc. acquired SCCP and BSECC.
See Exchange Act Release No. 34-58324 (Aug. 7, 2008), 73 FR 46936
(Aug. 12, 2008) (order approving acquisition of BSECC); Exchange Act
Release No. 34-58180 (July 17, 2008), 73 FR 42890 (July 23, 2008)
(order approving acquisition of SCCP).
Both SCCP and BSECC are currently registered with the Commission
as clearing agencies but conduct no clearing or settlement
activities. See Exchange Act Release No. 34-63629 (Jan. 3, 2011), 76
FR 1473 (Jan. 10, 2011); Exchange Act Release No. 34-63268 (Nov. 8,
2010), 75 FR 69730 (Nov. 15, 2010).
---------------------------------------------------------------------------
Further, proposed Rule 17Ab2-2 would provide the Commission
flexibility to determine that the operations or circumstances of a
registered clearing agency, including a registered clearing agency that
is exempt from certain requirements applicable to registered clearing
agencies generally, warrant designation as a covered clearing
agency.\89\ It would also provide flexibility to make determinations
regarding newly registered clearing agencies.
---------------------------------------------------------------------------
\89\ See infra Parts II.C and VII (discussing determinations
under proposed Rule 17Ab2-2 and providing rule text, respectively).
---------------------------------------------------------------------------
The Commission preliminarily believes the requirements proposed in
Rule 17Ad-22(e) aid the regulation of covered clearing agencies by, as
noted above, establishing requirements more closely tailored to the
risks they pose to the U.S. securities markets. For example, designated
clearing agencies are systemically important because of their
significance to the U.S. financial system and the risk that the failure
of, or a disruption to, their functioning would increase the risk of
significant liquidity or credit problems spreading among financial
institutions, thereby threatening the stability of the U.S. financial
system.\90\ Similarly, the Commission preliminarily believes that
complex risk profile clearing agencies, such as those providing CCP
services for security-based swaps, subject the U.S. securities markets
to a material level of systemic risk due to the nature of the products
that they clear.\91\ The requirements proposed in Rule 17Ad-22(e) are
intended to ensure that covered clearing agencies have robust policies
and procedures that help promote sound governance, operations, and risk
management.
---------------------------------------------------------------------------
\90\ See supra note 27 and accompanying text.
\91\ See generally Gov't Accountability Office, Systemic Risk:
Regulatory Oversight and Recent Initiatives to Address Risk Posed by
Credit Default Swaps (Mar. 2009), available at http://www.gao.gov/new.items/d09397t.pdf.
---------------------------------------------------------------------------
As noted above,\92\ the Commission preliminarily believes that
establishing separate rules for covered clearing agencies and
registered clearing agencies that are not covered clearing agencies is
appropriate given the Commission's goals to facilitate the development
of a national system for the prompt and accurate clearance and
settlement of securities consistent with Section 17A of the Exchange
Act and to mitigate systemic risk consistent with Titles VII and VIII
of the Dodd-Frank Act.\93\ In this regard, the Commission intends that
Rule 17Ad-22(d) would continue to provide minimum requirements for the
operation and governance of registered clearing agencies that also
facilitate the entrance of new participants, as appropriate, into the
market for clearance and settlement services.\94\ The Commission
preliminarily believes that Rule 17Ad-22(e) would establish new
requirements for established participants in the market for clearance
and settlement services commensurate to the risks that their size,
operation, and importance pose to the U.S. securities markets.\95\
---------------------------------------------------------------------------
\92\ See supra notes 54-61 and accompanying text.
\93\ See supra notes 2, 13-14, and accompanying text (noting the
goals of, respectively, Section 17A of the Exchange Act and the
Dodd-Frank Act).
\94\ See supra note 43 and accompanying text (noting the
Commission's intent in adopting Rule 17Ad-22 in the Clearing Agency
Standards Release).
\95\ See supra note 44 and accompanying text (noting further
that the requirements adopted under Rule 17Ad-22 constituted an
important first step to enhance the substantive regulation of
registered clearing agencies pursuant to the Dodd-Frank Act); see
also infra Part IV.C.1.a (addressing systemic risk in the context of
discussing the general economic considerations undertaken by the
Commission in proposing Rule 17Ad-22(e)).
---------------------------------------------------------------------------
Request for Comments. The Commission generally requests comments on
all aspects of the scope of proposed Rule 17Ad-22(e), the relationship
between proposed Rule 17Ad-22(e) and Rule 17Ad-22(d), and on proposed
Rules 17Ad-22(a)(4), (7), (8), and (9). In addition, the Commission
requests comments on the following specific issues:
Is the scope of proposed Rule 17Ad-22(e) appropriate? Why
or why not? Is the scope sufficiently clear? Why or why not? Has the
Commission provided sufficient guidance regarding the scope of the
proposed rule? Are there aspects of the scope of the proposed rule for
which the Commission should consider providing additional guidance? If
so, please explain.
Given that all non-dormant registered clearing agencies
would either be covered clearing agencies subject to Commission
supervision or be subject to CFTC regulation as designated clearing
entities for which the CFTC is the supervisory agency, should the
Commission replace the existing requirements under Rule 17Ad-22(d) with
the requirements proposed under Rule 17Ad-22(e)? Why or why not?
Is the Commission's proposed definition of ``financial
market utility'' appropriate and sufficiently clear given the proposed
requirements? Why or why not? Should the definition be modified? If so,
how? Is there an
[[Page 29517]]
alternative definition the Commission should consider?
Is the Commission's proposed definition of ``designated
clearing agency'' appropriate and sufficiently clear given the
requirements proposed? Why or why not? Should the definition be
modified? If so, how? Is there an alternative definition the Commission
should consider?
Is the Commission's proposed definition of ``clearing
agency involved in activities with a more complex risk profile''
appropriate and sufficiently clear given the requirements proposed? Why
or why not? Should the definition be modified? If so, how? Is there an
alternative definition the Commission should consider?
Is the Commission's proposed definition of ``covered
clearing agency'' appropriate and sufficiently clear given the
requirements proposed? Why or why not? Should the definition be
modified? If so, how? Is there an alternative definition the Commission
should consider?
Are the requirements in proposed Rule 17Ad-22(e)
necessary, or do the existing provisions in Rule 17Ad-22(d) already
sufficiently address the issues identified in this release as
justification for increased regulation?
2. Role of Written Policies and Procedures
Proposed Rule 17Ad-22(e) would require covered clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to, as applicable, fulfill the
requirements set forth in paragraphs (e)(1) through (23) of the
proposed rule. The Commission preliminarily believes that this approach
would facilitate the Commission's supervision of covered clearing
agencies, is appropriate given their role as SROs,\96\ and is
consistent with the approach taken by the Commission elsewhere in Rule
17Ad-22.\97\ The Commission preliminarily believes that, by requiring
written policies and procedures and, where appropriate, their
disclosure, proposed Rule 17Ad-22(e) should help promote the
development of improved standards for clearing agencies by allowing
market participants to compare certain of the operations of covered
clearing agencies with those of other clearing entities, which choose
to make their policies and procedures publicly available or are
required to do so by equivalent regulatory standards.\98\
---------------------------------------------------------------------------
\96\ Registered clearing agencies are SROs as defined in Section
3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26). After a clearing
agency has been registered with the Commission, the clearing agency,
as an SRO, must submit most proposed rule changes to the Commission,
for approval pursuant to Rule 19b-4 under the Exchange Act. A stated
policy, practice, or interpretation of an SRO, such as a clearing
agency's written policies and procedures, would generally be deemed
to be a proposed rule change. See 17 CFR 240.19b-4.
\97\ See Clearing Agency Standards Release, supra note 5, at
66228-29 (describing the scope of Rule 17Ad-22 at adoption).
\98\ Compare proposed Rule 17Ad-22(e)(23), infra Part VII
(requiring public disclosure of, among other things, a covered
clearing agency's rules, policies, and procedures) with proposed
Reg. HH, supra note 53, at 3666-67, 3686-88, 3693 (the Board
proposing disclosure requirements intended to be in line with the
PFMI Report in Sec. 234.3(a)(23)); DCO Int'l Standards Release,
supra note 53, at 72493-94, 72521 (CFTC adopting disclosure
requirements intended to be in line with the PFMI Report in Sec.
39.37).
---------------------------------------------------------------------------
The Commission is proposing to require policies and procedures
developed by each covered clearing agency to fulfill the requirements
of proposed Rule 17Ad-22(e) because the Commission preliminarily
believes that it is important to allow covered clearing agencies enough
flexibility to use their market experience and understanding of their
institutions to shape the rules, policies, and procedures implementing
proposed Rule 17Ad-22(e). This proposed approach is consistent with the
Commission's established approach for supervising SROs, and the
Commission preliminarily believes continuing this practice under Rule
17Ad-22(e) will allow the Commission to continue to perform its
supervisory function through the SRO rule filing process under Section
19(b) of the Exchange Act and Rule 19b-4,\99\ periodic inspections and
examinations, other monitoring of the activities of registered clearing
agencies, and other established supervisory processes. Because of the
importance the Commission gives to both maintaining clearing agency
flexibility and to existing oversight mechanisms, the Commission
preliminarily believes that the proposed approach is appropriate.
---------------------------------------------------------------------------
\99\ See supra note 96 (describing requirements for SROs under
the Exchange Act and Rule 19b-4).
---------------------------------------------------------------------------
The Commission anticipates that a covered clearing agency's rules,
policies, and procedures will need to evolve over time so that it can
adequately respond to changes in technology, legal requirements, the
needs of its members and their customers, trading volumes, trading
practices, linkages between financial markets, and the financial
instruments traded in the markets that a covered clearing agency
serves. Accordingly, the Commission preliminarily believes that covered
clearing agencies should continually evaluate and make appropriate
updates and improvements to their operations and risk management
practices to facilitate prompt and accurate clearance and settlement.
3. Frequency of Review Required Under Certain Policies and Procedures
Many of the policies and procedures requirements proposed in Rule
17Ad-22(e) specify a frequency of review. Generally, the proposed
regularity of review falls into three categories-- daily, monthly, or
annually--and is based on the Commission's understanding of the current
review practices generally at covered clearing agencies. The
Commission's rationale for these differences is as follows:
Daily: For those activities that the Commission
understands to be directly related to the day-to-day operations of a
covered clearing agency,\100\ such as activities related to the
calculation and collection of margin, the Commission preliminarily
believes that a covered clearing agency should undertake a daily review
and make decisions on a daily basis;
---------------------------------------------------------------------------
\100\ See proposed Rules 17Ad-22(e)(4)(vi)(A); 17Ad-
22(e)(6)(ii); 17Ad-22(e)(6)(vi)(A); 17Ad-22(e)(7); 17Ad-
22(e)(7)(vi)(A); and 17Ad-22(e)(11)(ii), infra Part VII.
---------------------------------------------------------------------------
Monthly: For those activities that the Commission
understands to coincide with and complement the review and reporting
cycles of the governance structures related to the risk management
function of the covered clearing agency,\101\ the Commission
preliminarily believes that a covered clearing agency should undertake
a monthly review; based on its supervisory experience, the Commission
notes that well-functioning risk management committees of the board and
similar management committees or other board or management committees
commonly meet or receive reports and other risk management information
from management on a monthly basis and the monthly requirement would be
consistent with such meeting and reporting frequency;
---------------------------------------------------------------------------
\101\ See proposed Rules 17Ad-22(e)(4)(vi)(B); 17Ad-
22(e)(4)(vi)(C); 17Ad-22(e)(6)(vi)(B); 17Ad-22(e)(6)(vi)(C); 17Ad-
22(e)(7)(vi)(B); and 17Ad-22(e)(7)(vi)(C), infra Part VII.
---------------------------------------------------------------------------
Annually: For those activities that are less integral to
day-to-day operations, involve issues that merit review of information
collected over longer time periods, or require more high-level review
and consideration by, for example, the full board of directors of a
clearing agency,\102\ the Commission
[[Page 29518]]
preliminarily believes that a covered clearing agency should undertake
an annual review; additionally, the Commission preliminary believes
that an annual cycle is appropriate in certain instances because other
major reviews such as auditing of the financial statements of
registered clearing agencies and their disclosure are required to occur
on an annual basis.
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\102\ See proposed Rules 17Ad-22(e)(3)(i); 17Ad-22(e)(4)(vii);
17Ad-22(e)(5); 17Ad-22(e)(6)(vii); 17Ad-22(e)(7)(v); 17Ad-
22(e)(7)(vii); 17Ad-22(e)(7)(x); 17Ad-22(e)(13)(iii); and 17Ad-
22(e)(15)(iii), infra Part VII.
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Request for Comments. The Commission generally requests comments on
all aspects of the frequency of review that would be required to be
included in a covered clearing agency's policies and procedures under
each of the requirements in proposed Rule 17Ad-22(e). In addition, the
Commission requests comments on whether its assessment of daily,
monthly, and annual activities at covered clearing agencies is accurate
and appropriate given the proposed rules. The Commission also requests
comment on what factors should be considered in determining the nature,
timing, and extent of the required reviews and whether other
frequencies of review might be appropriate under some or all of the
proposed rules.
4. Anticipated Impact of Proposed Rule 17Ad-22(e)
Based on the Commission's experience supervising registered
clearing agencies, and given the current requirements applicable to
registered clearing agencies under Rule 17Ad-22, the Commission
preliminarily anticipates that the degree of changes that covered
clearing agencies may need to make to their policies and procedures to
satisfy the proposed requirements of Rule 17Ad-22(e) would vary among
the particular provisions of the proposed rule and depend in part on
the business model and operations of the clearing agency itself, as
discussed below. The Commission preliminarily believes that, for the
provisions in its proposal where a similar existing requirement has
been identified, covered clearing agencies may need to make only
limited changes to update their policies and procedures, and the table
below provides summary information regarding the Commission's
preliminary assessment of the impact of the proposed rules:
------------------------------------------------------------------------
Proposed requirement Existing requirement
------------------------------------------------------------------------
Rule 17Ad-22(e)(1)........................ Rule 17Ad-22(d)(1).
Rule 17Ad-22(e)(2)........................ Rule 17Ad-22(d)(8).
Rule 17Ad-22(e)(3)........................ None.
Rule 17Ad-22(e)(4)........................ Rules 17Ad-22(b)(1), (b)(3),
(d)(14) \103\.
Rule 17Ad-22(e)(5)........................ None.
Rule 17Ad-22(e)(6)........................ Rule 17Ad-22(b)(2), (b)(4)
\104\.
Rule 17Ad-22(e)(7)........................ None.
Rule 17Ad-22(e)(8)........................ Rules 17Ad-22(d)(12).
Rule 17Ad-22(e)(9)........................ Rule 17Ad-22(d)(5).
Rule 17Ad-22(e)(10)....................... Rule 17Ad-22(d)(15).
Rule 17Ad-22(e)(11)....................... Rule 17Ad-22(d)(10).
Rule 17Ad-22(e)(12)....................... Rule 17Ad-22(d)(13).
Rule 17Ad-22(e)(13)....................... Rule 17Ad-22(d)(11).
Rule 17Ad-22(e)(14)....................... None.
Rule 17Ad-22(e)(15)....................... None.
Rule 17Ad-22(e)(16)....................... Rule 17Ad-22(d)(3).
Rule 17Ad-22(e)(17)....................... Rule 17Ad-22(d)(4).
Rule 17Ad-22(e)(18)....................... Rules 17Ad-22(b)(5) through
(7), (d)(2).
Rule 17Ad-22(e)(19)....................... None.
Rule 17Ad-22(e)(20)....................... Rule 17Ad-22(d)(7).
Rule 17Ad-22(e)(21)....................... Rule 17Ad-22(d)(6).
Rule 17Ad-22(e)(22)....................... None.
Rule 17Ad-22(e)(23)....................... Rule 17Ad-22(d)(9).
------------------------------------------------------------------------
With respect to the provisions in its proposal where no similar
existing requirement has been identified, the Commission preliminarily
anticipates that covered clearing agencies may need to make more
extensive changes to their policies and procedures (or implement new
policies and procedures), and may need to take other steps, to satisfy
the proposed requirements of Rule 17Ad-22(e).
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\103\ The Commission notes that requirements under Rules 17Ad-
22(b) apply only to registered clearing agencies that provide CCP
services, the ``cover two'' requirement under Rule 17Ad-22(b)(3)
applies only to registered clearing agencies that provide CCP
services for security-based swaps, and requirements under Rule 17Ad-
22(d)(14) apply only to registered clearing agencies that provide
CSD services. See infra Part II.B.4 (discussing, among other things,
the relationship between existing requirements under Rule 17Ad-22
and proposed Rule 17Ad-22(e)(4)); see also 17 CFR 240.17Ad-22;
Clearing Agency Standards Release, supra note 5.
\104\ The Commission notes that the relevant requirement in Rule
17Ad-22(b)(4) concerns policies and procedures regarding an annual
model validation for margin models while proposed Rule 17Ad-22(e)(6)
would impose, in addition to requiring policies and procedures
regarding an annual model validation for margin models, additional
requirements that do not appear in Rule 17Ad-22(b)(4). See infra
Part II.B.4.e (discussing the requirements under proposed Rule 17Ad-
22(e)(6)).
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For further discussion of the anticipated impact and costs and
benefits of proposed Rule 17Ad-22(e), see Part IV.C.
5. General Request for Comments
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-22(e) and on all aspects of the definitions included
in proposed Rule 17Ad-22(a), as discussed in more detail in Part
II.B.\105\ In addition, the Commission requests comments on the
following issues:
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\105\ Part II.B also contains additional requests for comments
on each proposed rule regarding particular issues specific to each
proposed rule.
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Is each aspect of proposed Rules 17Ad-22(e)(1) through
(23), including any terms used therein, sufficiently clear given the
proposed requirements? Why or why not? Has the Commission provided
sufficient guidance as to the meaning of each provision of the proposed
rules? Are there aspects of the proposed rules for which the Commission
should consider providing additional guidance? If so, please explain.
Are the Commission's definitions in proposed Rule 17Ad-
22(a) accurate, appropriate, and sufficiently clear? Why or why not?
Should the definitions be modified? If so, how? Should the Commission
adopt alternative definitions than those proposed? Are there additional
terms used in Rule 17Ad-22(e) that should be defined? Please explain.
Is the Commission's use of certain terms it believes to be
commonly understood (e.g., ``high degree of confidence'' or ``due
diligence'') appropriate and accurate? Why or why not?
Would the proposed rules require covered clearing agencies
to change their current practices? If so, how? What are the expected
costs and benefits to covered clearing agencies in connection with
adding or revising their current practices with respect to the
implementation of the Commission's proposed rules? \106\
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\106\ For a complete discussion of the anticipated economic
effect of the proposed rules, see Part IV.
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Should the Commission consider an alternative approach
with respect to written policies and procedures included in the
proposed rules? Why or why not? If so, what alternative approaches
should the Commission consider? Please explain in detail.
Should the Commission's proposed rules be less or more
prescriptive? Why or why not? If so, what alternative approaches should
the Commission consider? Please explain in detail.
Are there any other factors that the Commission should
take into consideration with respect to the requirements of the
proposed rules?
Should there be a phase-in period with respect to any of
the requirements of proposed Rule 17Ad-22(e) ? If so, what should the
phase-in periods be? What facts and circumstances should the Commission
consider in evaluating whether to adopt a potential phase-in period?
Please explain in detail.
Could the proposed rules affect the ability of covered
clearing agencies to compete for certain types of business
[[Page 29519]]
either within the United States or internationally? If so, how? Please
provide specific examples and data.
Are there significant operational or legal impediments to
implementing the proposed rules? Would the proposed rules impact the
ability of covered clearing agencies to clear certain products? Are any
additional rules or regulations needed to facilitate compliance with
the proposed rules?
Are there any requirements under existing Rule 17Ad-22
that could be viewed as being consistent with the PFMI standards
without being supplemented or replaced by new requirements in proposed
Rule 17Ad-22(e)? Please explain in detail.
B. Proposed Rule 17Ad-22(e)
1. Proposed Rule 17Ad-22(e)(1): Legal Risk
Proposed Rule 17Ad-22(e)(1) would require a covered clearing agency
to establish, implement, maintain and enforce written 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.\107\ Rule 17Ad-22(d)(1)
currently requires a registered clearing agency's policies and
procedures to meet substantially the same requirement.\108\ Because the
requirements under Rule 17Ad-22(d)(1) and proposed Rule 17Ad-22(e)(1)
are substantially the same, the Commission anticipates that covered
clearing agencies may need to make only limited changes to update their
policies and procedures to comply with the proposed rule.\109\
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\107\ See proposed Rule 17Ad-22(e)(1), infra Part VII.
The Commission preliminarily believes that (i) the United States
is the relevant jurisdiction for covered clearing agencies that
perform the functions of a clearing agency in the United States for
purposes of Rule 17Ad-22(e)(1), and (ii) that covered clearing
agencies operating in multiple jurisdictions would be required to
address any conflicts of laws issues that they may encounter.
\108\ Rule 17Ad-22(d)(1) requires a registered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for a well-founded,
transparent, and enforceable legal framework for each aspect of its
activities in all relevant jurisdictions. See 17 CFR 240.17Ad-
22(d)(1); see also Clearing Agency Standards Release, supra note 5,
at 66245-46.
\109\ See supra Part II.A.4.
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Consistent with the Exchange Act requirements discussed above,\110\
the Commission is proposing Rule 17Ad-22(e)(1) to require that a
covered clearing agency have a legal basis for each aspect of its
activities in all relevant jurisdictions. The legal framework for a
particular clearing agency may cover a broad array of areas and issues,
in particular including but not limited to its (i) organizational and
governance documents, such as its charter, bylaws, and any charters for
board and management committees; \111\ (ii) rules, policies, and
procedures,\112\ including those regarding settlement finality,
netting,\113\ default of a member, margin, collateral,\114\ payments,
obligations to the participant or default fund, eligibility and
participation requirements for members, and recovery and wind-down
plans; (iii) contracts (notably including with service providers,
settlement banks and liquidity providers); (vi) its use of novation or
similar legal devices; \115\ and (vii) service restrictions that may be
imposed on participants such as restrictions on activities or access.
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\110\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\111\ The role of governance arrangements in promoting effective
risk management has also been a focus of rules proposed by the
Commission to mitigate conflicts of interest at certain registered
clearing agencies. See Exchange Act Release No. 34-64017 (Mar. 3,
2011), 76 FR 14472 (Mar. 16, 2011) (proposing Rule 17Ad-23 to
address conflicts of interest and Rule 17Ad-26 to require standards
for board members or board committee directors at registered
clearing agencies); Exchange Act Release No. 34-63107 (Oct. 14,
2010), 75 FR 65881, 65893 (Oct. 26, 2010) (proposing Regulation MC
to mitigate conflicts of interest at security-based swap clearing
agencies).
\112\ See supra note 96 (describing the requirements in Section
19(b) of the Exchange Act).
\113\ Netting offsets obligations between or among participants
in the netting arrangement, thereby reducing the number and value of
payments or deliveries needed to settle a set of transactions.
Netting can reduce potential losses in the event of a participant
default and may reduce the probability of a default. Netting
arrangements can differ as to both timing and the parties to the
arrangement: (i) Certain netting arrangements net payments or other
contractual obligations resulting from market trades (or both) on a
continuous basis, while others close-out payments or obligations
when an event such as insolvency occurs; and (ii) netting
arrangement may net obligations bilaterally among two parties or
multilaterally among multiple parties.
\114\ Collateral arrangements may involve either a pledge or a
title transfer. Therefore, regarding pledged assets, a covered
clearing agency would examine the degree of legal certainty that a
pledge has been validly created in the relevant jurisdiction and, as
appropriate, validly perfected. Regarding transfer of title to
assets, a covered clearing agency would examine the degree of legal
certainty that the transfer is validly created in the relevant
jurisdiction and will be enforced.
\115\ Novation enables a clearing agency to act as a CCP. In
novation, the original contract between the buyer and seller is
discharged and two new contracts are created, one between the CCP
and the buyer and the other between the CCP and the seller. The CCP
thereby assumes the original parties' contractual obligations to
each other. Legal certainty regarding novation may reinforce market
participants' confidence regarding CCP support for or guarantee of
the transaction.
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In addition, the Commission is proposing to add Rule 17Ad-22(a)(20)
to define ``transparent'' to mean, for proposed Rules 17Ad-22(e)(1),
(2), and (10), that relevant documentation is disclosed, as
appropriate, to the Commission and other relevant authorities, clearing
members and customers of clearing members, the owners of the covered
clearing agency, and the public, to the extent consistent with other
statutory and Commission requirements.\116\ In proposing this
definition, the Commission recognizes that certain types of
information, such as confidential information, may not be appropriate
for public disclosure or disclosure to certain third parties.
Confidential information might include, for instance, policies and
procedures with respect to the security of information technology or
other critical systems or governance arrangements relating to the
creation of special advisory committees by the board of directors. With
regard to public disclosures contemplated by proposed Rule 17Ad-
22(a)(20), a covered clearing agency could comply with the proposed
requirement by posting the relevant documentation to a covered clearing
agency's Web site. The Commission preliminarily believes that these
disclosures would support a participant's ability to evaluate the risks
associated with participating in the covered clearing agency. For
example, disclosures that facilitate market participants' understanding
of the legal basis for a covered clearing agency's activities and its
governance arrangements may encourage participation in the covered
clearing agency (with respect to prospective clearing members) and may
encourage trading in the United States that would result in clearance
and settlement through the covered clearing agency (with respect to
prospective investors).
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\116\ See proposed Rule 17Ad-22(a)(20), infra Part VII; see also
Parts II.B.2 and 7 (discussing proposed Rules 17Ad-22(e)(2) and
(10), respectively).
Separately, the Commission has proposed rules to require
policies and procedures to protect the confidentiality of trading
information and procedures. See Exchange Act Release No. 34-64017
(Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011) (proposing Rule 17Ad-
23).
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As was the case when the Commission considered Rule 17Ad-22(d)(1),
where a clearing agency is faced with significant uncertainty regarding
legal risk, the Commission preliminary believes this uncertainty may
undermine a covered clearing agency's ability to provide prompt and
accurate clearance and settlement, to safeguard securities and funds
and to provide fair procedures, as required under Section 17A of the
Exchange Act. For example, where a covered clearing
[[Page 29520]]
agency's procedures addressing a participant default and establishing a
security interest in collateral lack clarity or there is significant
uncertainty regarding enforceability, there is a risk the clearing
agency may face claims to void, stay or reverse its actions, which
could be made by a bankruptcy trustee or other type of receiver in an
insolvency of a participant, undermining the clearing agency's ability
to safeguard securities and funds. As a similar example, if covered
clearing agency netting activities are voided or reversed on legal
grounds, which could involve a participant's insolvency, clearing and
settlement could be disrupted as participant accounts are rebalanced.
Also, for example, if a covered clearing agency's plan for recovery and
wind-down is subject to legal uncertainty, the covered clearing agency
or governmental authorities may be delayed in or prevented from taking
appropriate actions, resulting in disorder that may undermine the
provision of prompt and accurate clearance and settlement.\117\
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\117\ Issues addressed in such wind-down plans may include
termination, netting, and the transfer of securities positions and
assets.
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Therefore, like Rule 17Ad-22(d)(1), the Commission preliminarily
believes that proposed Rule 17Ad-22(e)(1) would support the
effectiveness of a covered clearing agency's risk management procedures
in two ways. First, by imposing requirements addressing legal risk, it
would continue to promote effective risk management at covered clearing
agencies. Second, the proposed rule would reinforce covered clearing
agency policies and procedures regarding risks other than legal risk,
including, among others, credit, liquidity, operational, and general
business risk.\118\
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\118\ Cf. PFMI Report, supra note 1, at 21-25 (discussing
Principle 1, legal basis).
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(1) and proposed Rule 17Ad-
22(a)(20). In addition, the Commission requests comments on the
following specific issues:
Should the proposed rule include more specific
requirements based on the type of business or the types of services
offered by covered clearing agencies and/or whether the covered
clearing agency operates in multiple jurisdictions? If so, are there
any considerations, such as those concerning compliance with
regulations in other jurisdictions, the Commission should take into
account for covered clearing agencies operating in multiple
jurisdictions?
Should the Commission adopt more prescriptive or less
prescriptive rules to define how covered clearing agencies would
provide for a well-founded, clear, transparent, and enforceable legal
basis? Why or why not? If so, what would those rules be?
Should the Commission require a covered clearing agency to
maintain documentation to demonstrate the legal adequacy of the
mechanisms at the clearing agency that are in place to handle
participant defaults? If so, what kinds of documentation should the
Commission require?
In proposing Rule 17Ad-22(a)(20), has the Commission taken
the right approach with respect to requiring public disclosures? Why or
why not? Should the Commission adopt rules that would require either
more or less disclosure? Why or why not?
What should be the minimum level of public disclosure
required of a covered clearing agency? What information should a
covered clearing agency be permitted to withhold? What form should that
disclosure take? What content should be required? Please explain in
detail.
2. Proposed Rule 17Ad-22(e)(2): Governance
Proposed Rule 17Ad-22(e)(2)(i) through (iv) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for governance
arrangements that are clear and transparent, clearly prioritize the
safety and efficiency of the covered clearing agency, and support the
public interest requirements in Section 17A of the Exchange Act and the
objectives of owners and participants.\119\ The proposed rule contains
requirements similar to those currently applicable to registered
clearing agencies under Rule 17Ad-22(d)(8), but the proposed rule also
requires that a covered clearing agency's policies and procedures
provide for governance arrangements that clearly prioritize the safety
and efficiency of the covered clearing agency.\120\
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\119\ See proposed Rule 17Ad-22(e)(2), infra Part VII. Proposed
Rule 17Ad-22(e)(2) would complement other requirements that may
apply separately, including requirements in proposed Rules 17Ad-25
and 17Ad-26, and requirements for security-based swap clearing
agencies under Section 765 of the Dodd-Frank Act, 12 U.S.C. 8343.
See supra note 111 (noting rules proposed by the Commission to
address potential conflicts of interest).
\120\ Specifically, Rule 17Ad-22(d)(8) requires a registered
clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to have
governance arrangements that are clear and transparent to fulfill
the public interest requirements in Section 17A of the Exchange Act
applicable to clearing agencies, to support the objectives of owners
and participants, and to promote the effectiveness of the clearing
agency's risk management procedures. See 17 CFR 240.17Ad-22(d)(8);
see also Clearing Agency Standards Release, supra note 5, at 66251-
52.
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Governance arrangements are critical to the sound operation of
SROs, including covered clearing agencies.\121\ The Exchange Act
explicitly conditions clearing agency registration on a clearing agency
having rules that (i) assure a fair representation of shareholders or
members and participants in the selection of its directors and
administration of affairs, (ii) facilitate prompt and accurate
clearance and settlement, (iii) protect investors and the public
interest, (iv) do not permit unfair discrimination in the use of the
clearing agency by participants and (v) provide certain fair procedures
regarding participants and other interested parties.\122\ Accordingly,
the proper functioning of registered clearing agencies pursuant to the
requirements of the Exchange Act is premised on the existence of a
well-organized and operating governance function.
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\121\ See supra Part I.A and note 96 (describing the
Commission's framework for regulation of SROs and the SRO rule
filing process).
\122\ See 15 U.S.C. 78q-1(a)(3)(F), (H).
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Consistent with these requirements and the Exchange Act
requirements discussed above,\123\ the Commission preliminarily
believes that the governance requirements proposed in Rule 17Ad-
22(e)(2) are appropriate because governance arrangements are
fundamental to the functioning of a covered clearing agency pursuant to
Section 17A of the Exchange Act.\124\ Consistent with the Commission's
statutory mandate under the Exchange Act, the proposed rule would
specify that governance arrangements also be consistent with the public
interest requirements in Section 17A of the Exchange Act as applicable
to clearing agencies. Because a covered clearing agency's decisions can
have widespread impact, affecting multiple market participants,
financial institutions, markets, and jurisdictions, the Commission
preliminarily believes it is important that each covered clearing
agency place a high priority on the safety and efficiency of its
operations and explicitly support the objectives of owners and
participants. In addition, supporting the public interest is a broad
[[Page 29521]]
concept that includes, for example, contributing to the ongoing
development of the U.S. financial system, in particular the national
clearance and settlement system contemplated by Section 17A of the
Exchange Act, and protecting investors and fostering fair and efficient
markets. The Commission believes that, by supporting the public
interest, market participants can develop common processes that help
reduce uncertainty in the market, such as industry standards and market
protocols related to clearance and settlement that facilitate a common
understanding and interactions among clearing agencies and their
members. The Commission preliminarily believes that covered clearing
agencies, as SROs, are appropriately positioned to determine, based on
their experience in providing clearance and settlement services and
based on information obtained from their members and other
stakeholders, as appropriate in the circumstances, what governance
arrangements appropriately support the public interest requirements in
Section 17A applicable to clearing agencies consistent with the
expectations of such stakeholders,\125\ balancing the potentially
competing viewpoints of the various stakeholders. The Commission also
preliminarily believes that mechanisms through which a covered clearing
agency could support the objectives of owners and participants could
potentially include representation on the board of directors, user
committees, and various public consultation processes.
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\123\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\124\ See 15 U.S.C. 78q-1(a)(2)(A).
\125\ See supra note 95 (describing requirements for SROs under
the Exchange Act and Rule 19b-4).
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As with Rule 17Ad-22(d)(8), the Commission preliminarily believes
that requiring policies and procedures for clear and transparent
governance arrangements support accountability in the decisions, rules,
policies, and procedures of the covered clearing agency. Such policies
and procedures requirements for governance arrangements provide owners,
participants, and, if applicable, general members of the public, with
an opportunity to comment on or otherwise provide input to governance
arrangements and, in turn, provide a covered clearing agency with the
opportunity to balance the potentially competing viewpoints of various
stakeholders in its decision making.\126\ Similarly, these policies and
procedures requirements for governance arrangements may promote the
effectiveness of a covered clearing agency's risk management procedures
by fostering a focus on the critical role that risk management plays in
promoting prompt and accurate clearance and settlement.\127\
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\126\ See id.
\127\ See supra note 111 (discussing rules proposed by the
Commission to mitigate conflicts of interest at clearing agencies as
part of efforts to promote sound risk management and governance
arrangements).
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In addition, proposed Rule 17Ad-22(e)(2)(iv) would require that the
covered clearing agency establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for
governance arrangements establishing that the board of directors and
senior management have appropriate experience and skills to discharge
their duties and responsibilities.\128\ The Commission preliminarily
believes that these aspects of a covered clearing agency's governance
framework are particularly important and that establishing requirements
in these areas would be appropriate given the risks that a covered
clearing agency's size, operation, and importance pose to the U.S.
securities markets.\129\
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\128\ See proposed Rule 17Ad-22(e)(2), infra Part VII.
\129\ For a discussion of current practices at registered
clearing agencies regarding boards of directors and senior
management, and the anticipated impact of the proposed requirements
for governance, see Parts IV.B.3.a.ii and IV.C.3.a.ii, respectively.
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The Commission preliminarily believes that directors serving on the
board and board committees of a clearing agency play an important role
in creating a framework that supports prompt and accurate clearance and
settlement because of their role in the decision-making process within
a clearing agency. Additionally, the Commission preliminarily believes
that a covered clearing agency's senior management has an important
role in ensuring, under the board's direction, that the clearing
agency's activities are consistent with the objectives, strategy, and
risk tolerance of the clearing agency, as determined by the board.
Accordingly, the expertise and skills of senior management and
directors serving on the board of a covered clearing agency are likely
to affect its effective operation. For example, a lack of expertise by
board members may deter them from challenging decisions by management
and lessen the potential that management would escalate appropriate
issues to the board for the board's consideration. Similarly, board
members and management should not have conflicts of interests that
could undermine the decision-making process within a covered clearing
agency or interfere with fair representation and equitable treatment of
clearing members or other market participants by a covered clearing
agency.
The Commission believes that covered clearing agencies are well
positioned to determine which individuals would have the appropriate
experience, skills, incentives and integrity to discharge their duties
and responsibilities that reflect the particular characteristics of
each covered clearing agency. Accordingly, the Commission preliminarily
believes that the proposed requirement for policies and procedures
would provide the covered clearing agency with a process to evaluate
the expertise and skills of board members and senior management,
consistent with the particular circumstances of the covered clearing
agency. Such policies and procedures may include provisions requiring
the covered clearing agency to consider, for example, the specific
qualifications, experience, competence, character, skills, incentives,
integrity or other relevant attributes to support a conclusion that an
individual nominee can appropriately serve as a board member or on
senior management. Such policies and procedures could also include,
among other things, requirements as to industry experience relevant to
the services provided by the covered clearing agency, educational
background, the absence of a criminal or disciplinary record, or other
factors relevant to the qualifications of nominees being considered.
Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(2). In addition, the Commission
requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to provide for governance arrangements that
prioritize the safety and efficiency of the covered clearing agency?
Why or why not?
The Commission is not proposing at this time to require a
covered clearing agency's policies and procedures provide for
governance arrangements that also support the objectives of
participants' customers, securities issuers and holders, and other
stakeholders. Should the Commission consider such a requirement? Why or
why not? Are existing protections under the Exchange Act, such as those
in Section 17A(b)(3)(H) (requiring clearing agency rules to provide
fair procedures to persons with respect to access to services offered
by the clearing
[[Page 29522]]
agency),\130\ Section 17A(b)(5)(B) (establishing requirements for
clearing agencies when determining whether a person may be prohibited
or limited with respect to services offered),\131\ and Section 19(d)(2)
(persons aggrieved by SRO actions may apply to the Commission for
review) \132\ already satisfactory or would additional Commission
governance requirements also be appropriate? What would be the possible
advantages and disadvantages of expanding the scope of proposed Rule
17Ad-22(e)(2)(iii) to require covered clearing agency policies and
procedures to consider the interests of persons other than owners and
participants?
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\130\ See 15 U.S.C. 78q-1(b)(3)(H).
\131\ See 15 U.S.C. 78q-1(b)(5)(B).
\132\ See 15 U.S.C. 78s(d)(2).
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Should the Commission require a covered clearing agency's
policies and procedures to provide for governance arrangements
establishing that the board of directors and senior management have
appropriate experience and skills to discharge their duties and
responsibilities? Why or why not? Has the Commission provided
sufficient guidance on what ``experience and skills'' would require?
Why or why not?
Are there any other requirements that should be included
in the rule to promote clear and transparent governance arrangements?
The Commission is not proposing at this time to require a
covered clearing agency's policies and procedures provide for
governance arrangements to ensure that lines of responsibility and
accountability at the covered clearing agency are clear and direct.
Should the Commission consider such a requirement? Why or why not?
The Commission is not proposing at this time to require a
covered clearing agency's policies and procedures provide for
governance arrangements that ensure major decisions of the board of
directors are disclosed to the public. Should the Commission consider
such a requirement? Why or why not?
Should there be a phase-in period for covered clearing
agencies to comply with proposed Rule 17Ad-22(e)(2), such as until the
next annual meeting of shareholders of the covered clearing agency or
other time period? Why or why not?
Are the governance requirements in proposed Rule 17Ad-
22(e)(2) necessary to achieve the benefits discussed in Part
IV.C.3.a.ii? Why or why not? For example, how and why would particular
features of the proposed rules, such as expectations that directors and
officers of covered clearing agencies have certain skills and
experience, contribute to greater market stability and reduced risk of
insufficient internal controls endangering broader financial stability?
Are there existing requirements under Section 17A of the Exchange Act,
such as the ``fair representation'' requirement in Section
17A(b)(3)(C), rules and regulations adopted by the Commission and
applicable to SROs, or relevant interpretations published by the
Commission that already provide a clear and sufficient basis for the
Commission to supervise covered clearing agencies in the manner
contemplated by proposed Rule 17Ad-22(e)(2) without adopting the
proposed rule? What are the possible benefits of adopting the rule as
proposed and what possible detriments may arise that the Commission
should consider?
Are there disclosures that a covered clearing agency
should be required to make with respect to its governance arrangements?
Why or why not? If so, what should be the form and content of those
disclosures?
Should the Commission require that the performance of the
board of directors and senior management--individually and as a group--
are reviewed on a regular basis? If so, how often should this review be
conducted? Should this review be conducted independently?
Should the board of directors of covered clearing agencies
include individuals who are not executives, officers, or employees of
the covered clearing agency, or an affiliate of the covered clearing
agency? Should the board of directors of covered clearing agencies
include an independent audit committee?
Should the Commission be involved in and/or set
requirements and standards with respect to board and management
governance at covered clearing agencies? Does the Commission have the
requisite statutory authority to adopt the rule proposals and matters
addressed in the related questions set forth in this release as to
governance arrangements, standards, composition, and qualifications of
covered clearing agencies' boards and management? Is the Commission's
oversight and establishment of corporate governance measures and
standards at clearing agencies a proper and good use of Commission
resources? What are the potential costs and benefits of these corporate
governance provisions?
3. Proposed Rule 17Ad-22(e)(3): Framework for the Comprehensive
Management of Risks
Proposed Rule 17Ad-22(e)(3) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain a sound risk management
framework for comprehensively managing legal, credit, liquidity,
operational, general business, investment, custody, and other risks
that arise in or are borne by the covered clearing agency.\133\
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\133\ See proposed Rule 17Ad-22(e)(3), infra Part VII.
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Existing Rules 17Ad-22(b) and (d) require registered clearing
agencies to establish, implement, maintain and enforce written policies
and procedures reasonably designed to meet several requirements that
address risk management practices by registered clearing agencies that
provide CCP services (Rules 17Ad-22(b)(1) through (4)), certain
requirements regarding access to registered clearing agencies that
provide CCP services (Rules 17Ad-22(b)(5) through (7)), and certain
minimum standards for the operations of registered clearing agencies
providing CCP or CSD services.\134\ Consistent with these requirements
and the Exchange Act requirements discussed above, \135\ the Commission
preliminarily believes that proposed Rule 17Ad-22(e)(3) is appropriate
and would require a covered clearing agency's policies and procedures
to take a broader, more comprehensive approach to risk management,
which the Commission believes is fundamental to a covered clearing
agency's functioning given its size, operation, and importance in the
U.S. securities markets. While existing rules under the Exchange Act
already target certain aspects of risk management, the Commission
preliminarily believes that comprehensive risk management policies and
procedures established pursuant to proposed Rule 17Ad-22(e)(3) would
further support the examination of risks, the assessment of their
probability and impact, and the
[[Page 29523]]
identification of linkages to other entities that in turn pose risks to
the covered clearing agency. The Commission also believes that
comprehensive risk management policies and procedures would facilitate
the development of mechanisms to better prioritize, manage, and monitor
risks, and to measure the covered clearing agency's risk tolerance and
capacity. In proposing Rule 17Ad-22(e)(3), the Commission is
emphasizing a comprehensive approach to risk management that would
require risk management policies and procedures be designed
holistically, be consistent with each other, and work effectively
together in order to mitigate the risk of financial losses to covered
clearing agencies' members and participants in the markets they serve.
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\134\ See 17 CFR 240.17Ad-22(b), (d); see also Clearing Agency
Standards Release, supra note 5, at 66230-43, 66244-58.
Specifically, as examples, Rule 17Ad-22(d)(4) requires a registered
clearing agency to have policies and procedures reasonably designed
to address certain aspects of operational risk, and Rule 17Ad-
22(d)(7) requires a registered clearing agency to have policies and
procedures reasonably designed to address certain aspects of risks
relating to linkages. See 17 CFR 240.17Ad-22(d)(4), (7).
\135\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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In addition, policies and procedures for the comprehensive
management of risks have the potential to play an important role in
making sure that covered clearing agencies better fulfill the Exchange
Act requirements that the rules of a clearing agency be designed to
protect investors and the public interest.\136\ Similarly, these
requirements may promote the effectiveness of a covered clearing
agency's risk management procedures by fostering a focus on the
critical role that risk management plays in promoting prompt and
accurate clearance and settlement. Accordingly, the Commission
preliminarily believes that it is important that covered clearing
agencies have policies and procedures that enable them to identify,
monitor, and manage the range of risks that arise in or are borne by
all aspects of their clearance and settlement activities.
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\136\ See 15 U.S.C. 78q-1(a)(2).
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In addition, the Commission is proposing the requirements described
below, which do not appear in existing Rules 17Ad-22(b) or (d). The
Commission preliminarily believes these requirements would be
appropriate for covered clearing agencies given the risks that their
size, operation, and importance pose to the U.S. securities markets.
a. Policies and Procedures Requirements, Periodic Review, and Annual
Board Approval
Proposed Rule 17Ad-22(e)(3)(i) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to provide for risk management
policies, procedures, and systems designed to identify, measure,
monitor, and manage the range of risks that arise in or are borne by
the covered clearing agency, and subject them to review on a specified
periodic basis and approval by the board of directors annually.\137\
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\137\ See id.
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The Commission preliminarily believes periodic review of the risk
management policies and procedures would allow covered clearing
agencies to assess whether the risk management policies and procedures
should be updated to account for changing factors in the market and to
address and codify in a uniform way the approach to new risks taken
since the last periodic review. The Commission preliminarily believes
that the board of directors of a covered clearing agency should be
required to approve the risk management policies and procedures. The
Commission preliminarily believes that, in complying with this
requirement, a board of directors may want to subject all material
components of the covered clearing agency's risk management policies
and procedures to review pursuant to Rule 17Ad-22(e)(3)(i) due to the
critical role that risk management plays in promoting prompt and
accurate clearance and settlement.
b. Recovery and Orderly Wind-Down Plans
Proposed Rule 17Ad-22(e)(3)(ii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it establishes plans for
the recovery and orderly wind-down of the covered clearing agency
necessitated by credit losses, liquidity shortfalls, losses from
general business risk, or any other losses.\138\
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\138\ See proposed Rule 17Ad-22(e)(3), infra Part VII.
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Securities exchanges, market participants, and investors rely upon
the safe, sound, and efficient operations of covered clearing agencies,
and accordingly the Commission preliminarily believes that a disorderly
wind-down of a covered clearing agency would have systemic
consequences.\139\ The Commission preliminarily believes that a
recovery plan designed to deal with possible scenarios that may
threaten or potentially prevent a covered clearing agency from being
able to provide its critical operations and services as a going concern
and that assesses a full range of options for recovery could mitigate
the impact of a near failure of a covered clearing agency.
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\139\ See generally Clearing Agency Standards Release, supra
note 5, at 66283 (noting, in discussing Rule 17Ad-22(d)(11), that
having policies and procedures ``allow[s] a clearing agency to wind
down positions in an orderly way and continue to perform its
obligations in the event of a participant default, assuring
continued functioning of the securities market in times of stress
and reducing systemic risk'').
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Based on its supervisory experience, the Commission recognizes that
covered clearing agencies operating in the market today each have
relevant standards and practices relating to recovery and orderly wind-
down with differing degrees of formality. The Commission therefore
preliminarily expects that Rule 17Ad-22(e)(3)(ii) would require covered
clearing agencies to review such standards and practices for
sufficiency with respect to the safe operation of the covered clearing
agency and revise such practices in a manner consistent with the
findings of such review consistent with the proposed rule, if adopted,
and the requirements of the Exchange Act.
c. Risk Management and Internal Audit
Proposed Rule 17Ad-22(e)(3)(iii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to provide risk management and
internal audit personnel with sufficient authority, resources,
independence from management, and access to the board of directors. The
Commission preliminarily believes that a covered clearing agency could
satisfy the policies and procedures requirement for independence from
management by, for example, providing reporting lines for risk
management functions that are clear and separate from those for other
operations and providing for direct reporting to the board of directors
or a relevant committee of the board. In that regard, proposed Rule
17Ad-22(e)(3)(iv) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide risk management and internal audit
personnel with oversight by and a direct reporting line to a risk
management committee and an audit committee of the board of directors,
respectively. Furthermore, proposed Rule 17A-22(e)(3)(v) would require
a covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for an
independent audit committee.
The Commission preliminarily believes that a covered clearing
agency should have an effective internal audit function in order to
provide, among other things, a rigorous and independent assessment of
the effectiveness of the clearing agency's
[[Page 29524]]
risk management and control processes, and should have an independent
audit committee overseeing the internal audit function in order to help
promote the integrity and efficiency of the audit process and
strengthen internal controls. In order to satisfy the independence
requirement for an audit committee under proposed Rule 17Ad-22(e)(2), a
covered clearing agency could use such independence criteria as are
established by its board of directors. The Commission further
preliminarily believes that policies and procedures for risk management
are important to the effective operation of a covered clearing agency.
d. Request for Comments
The Commission generally requests comments on all aspects of
Proposed Rule 17Ad-22(e)(3). In addition, the Commission requests
comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to maintain a sound risk management framework
for comprehensively managing legal, credit, liquidity, operational,
general business, investment, custody, and other risks that arise in or
are borne by the covered clearing agency? Why or why not?
Should the Commission require a covered clearing agency's
policies and procedures include plans for the recovery and orderly
wind-down of the covered clearing agency necessitated by credit losses,
liquidity shortfalls, losses from general business risk, or any other
losses? Why or why not?
How and to whom should the board of directors communicate
the results of its review of the risk management framework, if at all?
Are there any other requirements that should be included
in the rule to facilitate policies and procedures that maintain a sound
risk management framework, including the proposed requirements for
policies and procedures regarding board review and approval of risk
management policies and policies and procedures with respect to
recovery and orderly wind-down plans? Why or why not? For example,
should the Commission require a covered clearing agency's policies and
procedures to identify, measure, monitor, and manage the material risks
that it poses to other entities, such as other financial market
utilities, settlement banks, liquidity providers, or service providers,
as a result of interdependencies? Why or why not?
The Commission is not proposing at this time to require a
covered clearing agency's policies and procedures to, in its
comprehensive risk management framework, provide for criteria for the
independence of audit committee members. Should the Commission consider
requirements that specify such criteria? Why or why not? If so, should
those criteria be similar to the audit committee independence
requirements for listed companies in Rule 10A-3 under the Exchange Act?
\140\ In order to satisfy the policies and procedures requirement for
independence of the audit committee under proposed Rule 17Ad-22(e)(3),
should a covered clearing agency be allowed to use such independence
criteria as are established by its board of directors?
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\140\ See 17 CFR 240.10A-3.
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4. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk Management
a. Overview of Financial Risks Faced by Clearing Agencies
Covered clearing agencies face a variety of financial risks from
their participants and service providers, including credit or
counterparty default risk, market risk, and liquidity risk. For
example, for clearing agencies that provide CSD services, credit risk
arises from the potential that a participant will not pay what it owes
for securities that it has purchased or will not deliver securities
that it has sold. For clearing agencies that clear and settle
derivatives contracts, credit risk arises from the potential that a
participant will not meet its margin or settlement obligations or pay
any other amounts owed to the covered clearing agency.\141\ Credit risk
also arises for clearing agencies of any type from commercial banks or
custodians that the covered clearing agency uses to effect money
transfers among participants, to hold overnight deposits, or to
safeguard cash or other collateral.
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\141\ In this context, the clearing agency's credit risk is
closely related to the participant's market risk. A participant's
ability to meet its obligations to the clearing agency may be
affected by the participant's exposure to fluctuations in the market
value of the participant's open positions. In addition, fluctuations
in the market value of the collateral posted by the participant may
require the clearing agency to obtain additional margin from the
participant.
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Clearing agencies that provide CCP services take offsetting
positions as the substituted counterparty to a transaction and,
therefore, do not ordinarily face market risk except in the event of a
participant default. In such an event, market risk takes two forms.
First, the clearing agency may need to liquidate collateral posted by
the defaulting participant. The clearing agency is therefore exposed to
volatility in the market price of the defaulting participant's non-cash
collateral that could result in the clearing agency having insufficient
financial resources to cover the losses in the defaulting participant's
open positions. Second, a clearing agency providing CCP services is
subject to volatility in the market price of the defaulting
participant's open positions during the interval between the point at
which the clearing agency takes control of those positions and the
point at which the clearing agency is able to offset, transfer, or
liquidate those positions. A clearing agency faces the risk that its
exposure to a participant can change as a result of a change in prices,
positions, or both.
A clearing agency must be able to measure the counterparty credit
exposures that it is expected to manage effectively. A clearing agency
can ascertain its current credit exposure to each participant by
marking each participant's outstanding positions to current market
prices and (to the extent permitted by a clearing agency's rules and
supported by law) netting any gains against any losses.
In addition to credit risk and market risk, clearing agencies also
face liquidity or funding risk. Currently, to complete the settlement
process, clearing agencies generally rely on incoming payments from
participants in net debit positions in order to make payments to
participants in net credit positions. If a participant does not have
sufficient funds to make an incoming payment immediately when it is due
(even though it may be able to pay at some future time), or if a
settlement bank is unable to make an incoming payment on behalf of a
participant, the clearing agency faces a funding shortfall. A clearing
agency typically holds additional financial resources to cover
potential funding shortfalls such as margin collateral or lines of
credit. However, if collateral cannot be liquidated within a short
time, or if lines of credit are unavailable, liquidity risk would be
exacerbated.
b. Current Financial Risk Management Requirements for CCPs
Rules 17Ad-22(b)(1) through (4) concern risk management
requirements for clearing agencies that perform CCP services
(hereinafter ``CCPs'' in this part). Rule 17Ad-22(b)(1) requires that
CCPs establish, implement, maintain and enforce written policies and
procedures reasonably designed to measure their credit exposures at
least once per day.\142\ Rule 17Ad-22(b)(2) requires that CCPs
establish, implement, maintain and enforce written policies
[[Page 29525]]
and procedures reasonably designed to use margin requirements to limit
their exposures to participants.\143\ This margin can also be used to
reduce a CCP's losses in the event of a participant default. Rule 17Ad-
22(b)(3) requires that CCPs establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
sufficient financial resources to withstand, at a minimum, a default by
the participant family to which a CCP has the largest exposure in
extreme but plausible market conditions, except that CCPs clearing
security-based swap transactions must maintain additional financial
resources sufficient to withstand the simultaneous default by the two
participant families to which a CCP has the largest exposures.\144\
Finally, Rule 17Ad-22(b)(4) requires that CCPs establish, implement,
maintain and enforce written policies and procedures reasonably
designed to provide for an annual model validation that consists of
evaluating the performance of a clearing agency's margin models and the
related parameters and assumptions associated with such models and that
is performed by a qualified person who is free from influence from the
persons responsible for development or operation of the models being
validated.\145\
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\142\ See 17 CFR 240.17Ad-22(b)(1).
\143\ See 17 CFR 240.17Ad-22(b)(2).
\144\ See 17 CFR 240.17Ad-22(b)(3).
\145\ See 17 CFR 240.17Ad-22(b)(4).
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c. Proposed Rule 17Ad-22(e)(4): Credit Risk
Proposed Rule 17Ad-22(e)(4) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
exposures arising from its payment, clearing, and settlement
processes.\146\ The Commission preliminarily believes the proposed rule
is consistent with the requirements of the Exchange Act discussed
above.\147\
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\146\ See proposed Rule 17Ad-22(e)(4), infra Part VII.
\147\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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Proposed Rule 17Ad-22(e)(4)(i) would require a covered clearing to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain sufficient financial
resources to cover its credit exposure to each participant fully with a
high degree of confidence. The Commission's intention in proposing the
term ``high degree of confidence'' is to refer to the statistical
meaning of this term.\148\ The proposed rule would require a covered
clearing agency to use statistical methods to develop models in order
to estimate the financial resources required under proposed Rule 17Ad-
22(e)(4)(ii) and (iii),\149\ and to comply with the requirements of
proposed Rule 17Ad-22(e)(4)(ii) and (iii), while recognizing that such
an approach is necessarily imprecise to at least some degree.
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\148\ See, e.g., Arthur S. Goldberger, A Course in Econometrics
122-23 (Harvard Univ. Press, 2003) (defining confidence intervals
for parameter estimates).
\149\ See supra Part II.B.4.a (noting that a clearing agency
must be able to measure the counterparty credit exposures in order
to manage risk effectively).
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Proposed Rule 17Ad-22(e)(4)(ii) would require a covered clearing
agency that provides CCP services, and that is ``systemically important
in multiple jurisdictions'' or ``a clearing agency involved in
activities with a more complex risk profile,'' to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain additional financial resources, to the extent not
already maintained pursuant to proposed Rule 17Ad-22(e)(4)(i), at a
minimum level necessary to enable it to cover a wide range of
foreseeable stress scenarios, including but not limited to the default
of the two participant families that would potentially cause the
largest aggregate credit exposure for the covered clearing agency in
extreme but plausible market conditions (hereinafter the ``cover two''
requirement).
Proposed Rule 17Ad-22(e)(4)(iii) would require a covered clearing
agency that is not subject to proposed Rule 17Ad-22(e)(4)(ii) to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain additional financial
resources, to the extent not already maintained pursuant to proposed
Rule 17Ad-22(e)(4)(i), at the minimum to enable it to cover a wide
range of foreseeable stress scenarios, including the default of the
participant family that would potentially cause the largest aggregate
credit exposure for the covered clearing agency in extreme but
plausible market conditions (hereinafter the ``cover one''
requirement).\150\ The Commission notes that the requirement in
proposed Rules 17Ad-22(e)(4)(ii) and (iii) to examine exposure under
foreseeable stress scenarios including extreme but plausible market
conditions means the covered clearing agency may need to use models to
determine how its estimated exposure under such conditions differs from
its actual exposure to positions of such participants, which it would
be required to measure under proposed Rule 17Ad-22(e)(4)(i).
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\150\ The Commission notes that, with the exception of security-
based swap clearing agencies, all registered clearing agencies
providing CCP services are all currently required to meet a ``cover
one'' standard under Rule 17Ad-22(b)(3), and therefore the
Commission anticipates that covered clearing agencies may need to
make only limited changes to policies and procedures to satisfy the
proposed requirement, if adopted. See infra Parts IV.B.3.b.i and
IV.C.3.a.iv(1) (discussing current practices at registered clearing
agencies relating to credit risk and the anticipated economic effect
of the proposed requirement, respectively).
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Also, as previously discussed, the Commission is proposing Rule
17Ad-22(a)(4) to define ``clearing agency involved in activities with a
more complex risk profile.'' \151\ The Commission is also proposing
Rule 17Ad-22(a)(19) to define ``systemically important in multiple
jurisdictions'' to mean a covered clearing agency that has been
determined by the Commission to be systemically important in more than
one jurisdiction pursuant to Rule 17Ab2-2.\152\
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\151\ See supra Part II.A.1 (discussing the scope of proposed
Rule 17Ad-22(e)); supra notes 79-80 and accompanying text.
\152\ See proposed Rule 17Ad-22(a)(19), infra Part VII; see also
infra Parts II.C and VII (discussing the determinations process
under proposed Rule 17Ab2-2 and providing proposed rule text).
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Like the ``cover two'' requirement in Rule 17Ad-22(b)(3), which
applies to registered clearing agencies that provide CCP services for
security-based swaps,\153\ proposed Rule 17Ad-22(e)(4)(ii) would impose
a ``cover two'' requirement to address credit risk of certain covered
clearing agencies: Those systemically important in multiple
jurisdictions and those involved in activities with a more complex risk
profile. The Commission notes that the set of complex risk profile
clearing agencies subject to this requirement would include, as of the
date of this proposal, only registered clearing agencies that provide
CCP services for security-based swaps, which are already subject to the
``cover two'' requirement in Rule 17Ad-22(b)(3). In addition, the
Commission notes that no covered clearing agency would be systemically
important in multiple jurisdictions unless and until the Commission
made such a determination pursuant to
[[Page 29526]]
proposed Rule 17Ab2-2.\154\ For any covered clearing agency not
currently subject to a ``cover two'' requirement that could be
determined by the Commission in the future to be either systemically
important in multiple jurisdictions or involved in activities with a
more complex risk profile, the Commission believes that requiring such
entities to improve their resilience to offset increased risk and to
prepare for extreme but plausible market conditions is appropriate
because it could decrease the likelihood that systemic events in other
jurisdictions or extreme volatility in more complex financial
instruments would result in interruptions to the provision of clearance
and settlement services in the U.S. securities markets.
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\153\ See 17 CFR 240.17Ad-22(b)(3); see also infra Part II.A.1
(discussing the scope of proposed Rule 17Ad-22(e)); Clearing Agency
Standards Release, supra note 5, at 66233-36 (discussing proposed
Rule 17Ad-22(b)(3)).
\154\ See infra Parts II.C and VII (discussing the
determinations process under proposed Rule 17Ab2-2 and providing
proposed rule text).
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In addition, the Commission is proposing the requirements described
below. In discussing these requirements, the below sections describe
how they differ from existing requirements in Rules 17Ad-22(b)(1)
through (4) applicable to security-based swap clearing agencies,
previously discussed above.\155\
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\155\ See supra Part II.B.4.b.
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i. Prefunded Financial Resources
Proposed Rule 17Ad-22(e)(4)(iv) would require a covered clearing
agency providing CCP services that is either systemically important in
multiple jurisdictions or a complex risk profile clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to include prefunded financial
resources, excluding assessments for additional guaranty fund
contributions or other resources that are not prefunded, when
calculating the financial resources available to meet the standards
under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable.\156\ The Commission preliminarily believes that prefunding
default obligations is appropriate because of the importance of the
ability of a covered clearing agency to meet its default resource
obligations to the clearance and settlement system, given the risks
that its size, operation, and importance pose to the U.S. securities
markets.\157\ Immediately available financial resources are necessary
to ensure that a covered clearing agency can meet its financial
obligations on an ongoing basis. Without prefunded financial resources,
a covered clearing agency may be unable to meet its financial
obligations in stressed market conditions, when clearing members may be
unwilling or unable to contribute to the clearing agency's guaranty
fund in the event of a member default.
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\156\ See proposed Rule 17Ad-22(e)(4)(iv), infra Part VII.
\157\ See generally 12 U.S.C. 5461 (Congress finding, among
other things, that enhancements to the regulation and supervision of
systemically important FMUs and the conduct of systemically
important PCS activities by financial institutions are necessary,
under Title VIII, to provide consistency, to promote robust risk
management and safety and soundness, to reduce systemic risks, and
to support the stability of the broader financial system).
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The Commission notes that while the ability to assess participants
for contributions under applicable covered clearing agency governing
documents, rules, or agreements could not be included in this
calculation, previously paid-in participant contributions into a
covered clearing agency default fund could be counted to the extent the
clearing agency's rules, policies, or procedures permit such resources
to be used in a manner equivalent to other financial resources in the
default fund. Other sources of prefunded resources, such as margin
previously posted to the clearing agency by participants, could also be
treated in this manner. In addition, while the ability to draw down
under a revolving loan facility could not be counted towards prefunded
resources because funds from such loan facility would not be in the
covered clearing agency's immediate possession, the covered clearing
agency could count borrowed funds already drawn down, such as under a
term loan or other credit facility.
Existing requirements under Rule 17Ad-22 do not include
requirements for prefunded financial resources at registered clearing
agencies. The proposed requirement reflects the Commission's
recognition of the importance of a covered clearing agency meeting its
default resource obligations, given the risks that its size, operation,
and importance pose to the U.S. securities markets.
ii. Combined or Separately Maintained Clearing or Guaranty Funds
Proposed Rule 17Ad-22(e)(4)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain the financial resources
required under proposed Rules 17Ad-22(e)(4)(i) through (iii) in
combined or separately maintained clearing or guaranty funds.\158\ The
proposed rule makes clear that a covered clearing agency may choose to
maintain a separate default fund for purposes of complying with
proposed Rules 17Ad-22(e)(4)(i) through (iii).
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\158\ See proposed Rule 17Ad-22(e)(4)(v), infra Part VII.
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This requirement would be similar to the requirement in Rule 17Ad-
22(b)(3) requiring a security-based swap clearing agency to have
policies and procedures reasonably designed to maintain financial
resources generally or in separately maintained funds.\159\ The
Commission believes that this approach facilitates the operations of
clearing agencies. For example, clearing agencies may maintain separate
default funds for each product or asset type cleared, in order to more
appropriately tailor risk management requirements or contain losses
from a default to that fund.
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\159\ Rule 17Ad-22(b)(3) currently also permits a security-based
swap clearing agency to have policies and procedures reasonably
designed to maintain financial resources generally or in separately
maintained funds. See 17 CFR 240.17Ad-22(b)(3); see also Clearing
Agency Standards Release, supra note 5, at 66233-236.
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iii. Testing the Sufficiency of Financial Resources
Proposed Rule 17Ad-22(e)(4)(vi) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to test the sufficiency of its total
financial resources available to meet the minimum financial resource
requirements under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable, by conducting a stress test of its total financial
resources at least once each day using standard predetermined
parameters and assumptions.\160\ Registered clearing agencies are not
subject to requirements for testing the sufficiency of their financial
resources under existing Rule 17Ad-22.
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\160\ See proposed Rule 17Ad-22(e)(4)(vi), infra Part VII.
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The proposed rule would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to conduct a comprehensive analysis on
at least a monthly basis of the existing stress testing scenarios,
models, and underlying parameters and assumptions, and consider
modifications to ensure they are appropriate for determining the
covered clearing agency's required level of default protection in light
of current market conditions. When the products cleared or markets
served by a covered clearing agency display high volatility, become
less liquid, or when the size or concentration of positions held by the
entity's participants increases
[[Page 29527]]
significantly, the proposed rule would specifically require a covered
clearing agency to have policies and procedures for conducting
comprehensive analyses of stress testing scenarios, models, and
underlying parameters and assumptions more frequently than monthly. The
Commission preliminarily believes that what constitutes ``high
volatility'' and ``low liquidity'' would vary across asset classes that
a covered clearing agency might clear. Accordingly, the Commission
preliminarily believes that a clearing agency would need flexibility to
address changing circumstances and is therefore not proposing to
prescribe triggers for any particular circumstance.
The proposed rule would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for the reporting of the
results of this analysis to the appropriate decision makers at the
covered clearing agency, including its risk management committee or
board of directors, and to require the use of the results to evaluate
the adequacy of and to adjust its margin methodology, model parameters,
and any other relevant aspects of its credit risk management policies
and procedures, in supporting compliance with the minimum financial
resources requirements discussed above.
The Commission is also proposing to add Rule 17Ad-22(a)(18) to
define ``stress testing'' to mean the estimation of credit and
liquidity exposures that would result from the realization of extreme
but plausible price changes or changes in other valuation inputs and
assumptions.\161\ The Commission preliminarily believes that stress
testing is an important component of the proposed rules because stress
testing may enable a covered clearing agency to be prepared for an
extreme event that may not be anticipated or expected based solely on
current market conditions or from a sample of historical data.
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\161\ See proposed Rule 17Ad-22(a)(18), infra Part VII.
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The Commission preliminarily believes that the requirements in
proposed Rule 17Ad-22(e)(4)(vi) are appropriate for testing the
sufficiency of the financial resources of covered clearing agencies
because, in certain market conditions, such as periods of high
volatility or diminished liquidity, existing stress scenarios, models,
or underlying parameters may no longer be valid or appropriate. Based
on its supervisory experience, the Commission believes that certain,
but not all, covered clearing agencies adjusted their stress testing
scenarios following the 2008 financial crisis to incorporate larger
debt, equity, and credit market shocks similar to those experienced
during the crisis. Accordingly, the Commission preliminarily believes
that specific policies and procedures contemplating actions to be taken
by all covered clearing agencies in such circumstances are necessary to
ensure the safe functioning of the covered clearing agencies as
required by the Exchange Act,\162\ and that requiring periodic feedback
and analysis on the strength of credit risk management policies and
procedures would improve the reliability of those policies and
procedures. The Commission also preliminarily believes that the rule
would provide a covered clearing agency with the flexibility to use
stress scenarios that are appropriately tailored to current market
conditions and that can be revised over time as markets change and
believes that such flexibility is appropriate to achieve the objectives
of the Exchange Act.
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\162\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
---------------------------------------------------------------------------
iv. Annual Conforming Model Validation
Proposed Rule 17Ad-22(e)(4)(vii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to require a conforming model
validation for its credit risk models to be performed not less than
annually or more frequently as may be contemplated by the covered
clearing agency's risk management policies and procedures.\163\ The
Commission preliminary believes that an annual cycle is appropriate for
the reasons described in Part II.A.3. The Commission notes that other
important reviews such as auditing of the financial statements of
registered clearing agencies and their disclosure are required to occur
on an annual basis as well.\164\
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\163\ See proposed Rule 17Ad-22(e)(4)(vii), infra Part VII.
\164\ See 17 CFR 240.17Ad-22(c)(2).
---------------------------------------------------------------------------
The Commission is proposing to add Rule 17Ad-22(a)(5) to define
``conforming model validation'' to mean an evaluation of the
performance of each material risk management model used by a covered
clearing agency, along with the related parameters and assumptions
associated with such models.\165\ Such model validation would apply to
models that would include initial margin models, liquidity risk models,
and models used to generate clearing or guaranty fund requirements. A
conforming model validation would also require that the model
validation be performed by a qualified person who is free from
influence from the persons responsible for the development or operation
of the models or policies being validated so that credit risk models
can be candidly assessed.\166\ Generally, the Commission considers that
a person is free from influence when that person does not perform
functions associated with the clearing agency's models (except as part
of the annual model validation) and does not report to a person who
performs these functions. The Commission generally would not expect
that it would be necessary for policies and procedures adopted pursuant
to this proposed requirement to require the clearing agency to separate
organizationally model review from model development or to maintain two
separate quantitative teams.
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\165\ See proposed Rule 17Ad-22(a)(5), infra Part VII.
\166\ See Clearing Agency Standards Release, supra note 5, at
66238.
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The proposed rule differs from the existing requirement for
security-based swap clearing agencies in Rule 17Ad-22(b)(4) by defining
in explicit terms the requirements for a conforming model validation
and by requiring it for credit risk models.\167\ The proposed rule
would also apply to any covered clearing agency, and not only security-
based swap clearing agencies. The Commission preliminarily believes,
because credit risk models play an important role in limiting systemic
risk, that it is important to create a consistent, clear, and uniformly
applied minimum standard for model validation across all covered
clearing agencies.\168\ The Commission also preliminarily believes that
annual conforming model validation would provide unbiased feedback on
the performance of such models and policies, and therefore could
improve their reliability.
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\167\ Rule 17Ad-22(b)(4) requires a security-based swap clearing
agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for an annual
model validation consisting of evaluating the performance of the
clearing agency's margin models and the related parameters and
assumptions associated with such models by a qualified person who is
free from influence from the persons responsible for the development
or operation of the models being validated. See 17 CFR 240.17Ad-
22(b)(4); see also Clearing Agency Standards Release, supra note 5,
at 66236-238.
In contrast to proposed Rules 17Ad-22(a)(5) and (e)(4)(vii),
Rule 17Ad-22(b)(4) requires only a model validation for margin
models and does not specify the general elements of a model
validation.
\168\ See generally Clearing Agency Standards Release, supra
note 5, at 66238.
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[[Page 29528]]
d. Proposed Rule 17Ad-22(e)(5): Collateral
Proposed Rule 17Ad-22(e)(5) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to limit the assets it accepts as
collateral to those with low credit, liquidity, and market risks, and
also require policies that set and enforce appropriately conservative
haircuts and concentration limits if the covered clearing agency
requires collateral to manage its own or its participants' credit
exposures.\169\ The proposed rule includes requirements similar to
those applicable to registered clearing agencies under Rule 17Ad-
22(d)(3) but would, in addition, require a covered clearing agency's
policies and procedures to set and enforce appropriately conservative
haircuts and concentration limits if the covered clearing agency
requires collateral to manage its own or its participants' credit
exposures.\170\
---------------------------------------------------------------------------
\169\ See proposed Rule 17Ad-22(e)(5), infra Part VII.
\170\ Registered clearing agencies are currently subject to
requirements under Rule 17Ad-22(d)(3), which requires registered
clearing agencies to hold assets in a manner that minimizes risk of
loss or risk of delay in access to them and invest assets in
instruments with minimal credit, market, and liquidity risk. See 17
CFR 240.17Ad-22(d)(3); see also Clearing Agency Standards Release,
supra note 5, at 66247-48; infra Part II.B.13 (discussing proposed
Rule 17Ad-22(e)(16)).
Similarly, the Commission preliminarily believes that
appropriately conservative haircuts and concentration limits would
require a covered clearing agency to value assets in a manner that
minimizes risk of loss or risk of delay in access to them.
---------------------------------------------------------------------------
The Commission is proposing Rule 17Ad-22(e)(5) to require policies
and procedures with respect to specific practices to be followed by a
covered clearing agency when managing collateral to ensure the
safeguarding of funds, consistent with the requirements under the
Exchange Act discussed above.\171\ In doing so, proposed Rule 17Ad-
22(e)(5) would promote confidence that covered clearing agencies are
able to meet their settlement obligations by reducing the likelihood
that assets securing participant obligations to the covered clearing
agency would be unavailable or insufficient when the covered clearing
agency needs to draw on them. Specifically, such requirements recognize
the role played by system-wide asset price deterioration in generating
systemic risk and the vulnerability a covered clearing agency could
face if posted collateral were concentrated in assets that subsequently
experience such deterioration in price.\172\ The Commission
preliminarily believes the proposed rule is appropriate given the risks
that its size, operation, and importance pose to the U.S. securities
markets, thereby promoting stability in the national system for
clearance and settlement by increasing the likelihood collateral
holdings will function as designed when faced with stressed market
conditions.
---------------------------------------------------------------------------
\171\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\172\ See, e.g., Mark Roe, Clearinghouse Overconfidence (Aug.
11, 2013), available at http://ssrn.com/abstract=2224305 (discussing
the risks posed to clearing agencies by asset price deterioration).
---------------------------------------------------------------------------
In addition, the Commission is proposing that a covered clearing
agency establish, implement, maintain and enforce written policies and
procedures reasonably designed to include a not-less-than-annual review
of the sufficiency of a covered clearing agency's collateral haircuts
and concentration limits.\173\ Rule 17Ad-22(d) does not impose a
similar requirement on registered clearing agencies. The Commission
preliminarily believes that the proposed approach is appropriate
because of the importance of collateral haircuts and concentration
limits to a covered clearing agency's risk management policies and
procedures. Because of the role collateral plays in a default, a
covered clearing agency needs assurance of its value in the event of
liquidation, as well as the capacity to draw upon that collateral
promptly. The Commission preliminarily believes, given the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets, that it is important to require policies and
procedures for a not-less-than-annual review of the sufficiency of its
collateral haircuts and concentration limits.\174\
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\173\ See proposed Rule 17Ad-22(e)(5), infra Part VII.
\174\ See supra Part II.A.3 (discussing the Commission's
rationale for imposing varying frequencies of review under certain
policies and procedures requirements of the proposed rules).
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e. Proposed Rule 17Ad-22(e)(6): Margin
Generally, proposed Rule 17Ad-22(e)(6) would require a covered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to cover its credit exposures to its participants by
establishing a risk-based margin system that is monitored by management
on an ongoing basis and regularly reviewed, tested, and verified.\175\
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\175\ See proposed Rule 17Ad-22(e)(6), infra Part VII.
---------------------------------------------------------------------------
Rule 17Ad-22(b)(2) currently requires registered clearing agencies
that provide CCP services to use risk-based models and parameters to
set margin requirements, and to review such margin requirements and the
risk-based models and parameters at least monthly,\176\ and the
proposed rule would impose substantially the same requirements.\177\
Rule 17Ad-22(b)(4) also currently requires a registered clearing agency
that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to provide
for an annual model validation consisting of evaluating the performance
of the clearing agency's margin models and the related parameters and
assumptions associated with such models by a qualified person who is
free from influence from the persons responsible for the development or
operation of the models being validated.
---------------------------------------------------------------------------
\176\ See 17 CFR 240.17Ad-22(b)(2).
\177\ Similar to Rule 17Ad-22(b)(2), proposed Rule 17Ad-
22(e)(6)(vi) would require a covered clearing agency to conduct on
at least a monthly basis a conforming sensitivity analysis of its
margin resources and its parameters and assumptions for backtesting.
See infra Parts II.B.4.e.vi and VII.
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The Commission notes that proposed Rule 17Ad-22(e)(6) is different
from these existing requirements under Rule 17Ad-22, as discussed
below. The proposed requirements reflect more specific recognition by
the Commission of the importance margin plays in risk management by
covered clearing agencies. The Commission preliminarily believes that
these requirements for a covered clearing agency to periodically verify
and modify margin requirements in light of changing market conditions
would be appropriate to mitigate the risks posed by a covered clearing
agency to financial markets in periods of financial stress considering
the risks that its size, operation, and importance pose to the U.S.
securities markets.
i. Active Management of Model Risk
Proposed Rule 17Ad-22(e)(6)(i) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to result
in a margin system that at a minimum considers, and produces margin
levels commensurate with, the risks and particular attributes of each
relevant product, portfolio, and market.\178\ The complexity and
product risk
[[Page 29529]]
characteristics of the cleared product and underlying instrument can
influence the margin requirements necessary to manage the credit
exposures posed by a covered clearing agency's participants.
Additionally, the volume of trading may also influence the margin
requirements necessary to manage the credit exposures proposed by a
covered clearing agency's participants. The Commission preliminarily
believes that expressly requiring policies and procedures regarding the
active management of a covered clearing agency's margin system to
account for those factors and differences would help ensure the
effectiveness of a covered clearing agency's risk management practices.
---------------------------------------------------------------------------
\178\ See proposed Rule 17Ad-22(e)(6)(i), infra Part VII.
---------------------------------------------------------------------------
ii. Collection of Margin
Proposed Rule 17Ad-22(e)(6)(ii) would require a covered clearing
agency that provides CCP services to establish implement, maintain and
enforce written policies and procedures reasonably designed to ensure
that the margin system would mark participant positions to market and
collect margin, including variation margin or equivalent charges if
relevant, at least daily, and include the authority and operational
capacity to make intraday margin calls in defined circumstances.\179\
The Commission preliminarily believes that marking each participant's
outstanding positions to current market prices is an important feature
of an effective margin system because adverse price movements can
rapidly increase a covered clearing agency's exposures to its
participants. Rule 17Ad-22(b)(2) requires registered clearing agencies
that provide CCP services to calculate margin requirements daily. The
Commission preliminarily believes that requiring a covered clearing
agency to have the authority and operational capacity to make intraday
margin calls in defined circumstances will benefit covered clearing
agencies by covering settlement risk created by intraday price
movements. By being more specific with respect to its expectations for
collecting sufficient margin and having other liquid resources at its
disposal, the Commission expects that a covered clearing agency will be
better able to organize its practices accordingly, to limit its
exposures to potential losses from defaults by clearing members in
normal market conditions considering the risks that its size,
operation, and importance pose to the U.S. securities markets.\180\
---------------------------------------------------------------------------
\179\ See proposed Rule 17Ad-22(e)(6)(ii), infra Part VII.
\180\ See Clearing Agency Standards Release, supra note 5, at
66231.
---------------------------------------------------------------------------
iii. Ninety-Nine Percent Confidence Level
Proposed Rule 17Ad-22(e)(6)(iii) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to
calculate margin sufficient to cover its potential future exposure to
participants in the interval between the last margin collection and the
close out of positions following a participant default.\181\ The
Commission is proposing to add Rule 17Ad-22(a)(14) to define
``potential future exposure'' to mean the maximum exposure estimated to
occur at a future point in time with an established single-tailed
confidence level of at least 99% with respect to the estimated
distribution of future exposure.\182\ The Commission preliminarily
believes that a 99% confidence level is an appropriately conservative
setting that is also consistent with the international standard for
bank capital requirements, which requires banks to measure market risks
at a 99% confidence interval when determining regulatory capital
requirements.\183\
---------------------------------------------------------------------------
\181\ See proposed Rule 17Ad-22(e)(6)(iii), infra Part VII.
\182\ See proposed Rule 17Ad-22(a)(14), infra Part VII.
\183\ See Clearing Agency Standards Release, supra note 5, at
66226 (describing the history of usage for a 99% confidence
interval). A 99% confidence level would represent one day of actual
trading losses that exceeded the results predicted by the model (as
revealed by backtesting) for every 100 days that trading occurred.
See id. Requiring a covered clearing agency to have policies and
procedures with a higher or lower confidence level than that
currently used by its clearing members could potentially create
incentives or disincentives for clearing members to clear based on
the statistical confidence level alone.
---------------------------------------------------------------------------
The Commission preliminarily believes that, rather than establish
specific criteria in advance, it is more appropriate to address
liquidation periods separately with respect to each covered clearing
agency through the Commission's supervisory process under Sections 17A
and 19 of the Exchange Act,\184\ so that the length of the liquidation
period can be appropriately tailored to the characteristics of the
products cleared by the covered clearing agency as financial markets
evolve.
---------------------------------------------------------------------------
\184\ See supra Part I.A (discussing the regulatory framework
under Section 17A of the Exchange Act); supra note 96 (describing
the requirements in Section 19(b) of the Exchange Act).
---------------------------------------------------------------------------
iv. Price Data Source
Proposed Rule 17Ad-22(e)(6)(iv) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to ensure
that it uses reliable sources of timely price data and procedures and
sound valuation models for addressing circumstances in which pricing
data are not readily available or reliable.\185\ The Commission
preliminarily believes that a covered clearing agency should use
reliable sources of timely price data because its margin system needs
such data to operate with a high degree of accuracy and reliability,
given the risks that the covered clearing agency's size, operation, and
importance pose to the U.S. securities markets.\186\ Based on its
supervisory experience, the Commission preliminarily believes that
reliable data sources may include the following features, among other
things: (i) Provision of data by the data source that is accurate,
complete, and timely; (ii) capability of the data source to provide
broad data sets to the covered clearing agency; and (iii) limited need
for manual intervention by the clearing agency. In some situations,
price data may not be available or reliable, such as in instances where
third party data providers experience lapses in service or where
limited liquidity otherwise makes price discovery difficult.
Establishing appropriate procedures and sound valuation models is a
useful step a covered clearing agency can take to help protect itself
in such situations. The Commission preliminarily believes, in selecting
price data sources, a covered clearing agency should consider the
likelihood of the data being provided under a variety of market
conditions and not select price data sources based on their cost alone.
---------------------------------------------------------------------------
\185\ See proposed Rule 17Ad-22(e)(6)(iv), infra Part VII.
\186\ Cf. PFMI Report, supra note 1, at 51 (discussing Principle
6, margin).
---------------------------------------------------------------------------
v. Method for Measuring Credit Exposure
Proposed Rule 17Ad-22(e)(6)(v) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to ensure
the use of an appropriate method for measuring credit exposure that
accounts for relevant product risk factors and portfolio effects across
products. Measuring such portfolio effects means a covered clearing
agency may take into account certain netting procedures or
[[Page 29530]]
offsets through which credit exposure may be reduced in measuring
credit exposure, including the use of portfolio margining procedures
across products where applicable.\187\ The Commission preliminarily
believes that this proposed requirement that covered clearing agencies
contemplate both product level and portfolio level effects when
considering and measuring their credit exposure is appropriate, given
that the method for measuring credit exposure will determine the
accuracy of a covered clearing agency's measurements in practice.
---------------------------------------------------------------------------
\187\ See proposed Rule 17Ad-22(e)(6)(v), infra Part VII.
---------------------------------------------------------------------------
vi. Backtesting and Sensitivity Analysis
Under proposed Rule 17Ad-22(e)(6)(vi), in addition to the
requirement discussed above in relation to monitoring by management on
an ongoing basis, a covered clearing agency that provides CCP services
would be required to establish, implement, maintain and enforce written
policies and procedures reasonably designed to regularly review, test,
and verify its risk-based margin system by conducting backtests at
least once each day and conducting a conforming sensitivity analysis of
its margin resources and its parameters and assumptions for backtesting
at least monthly, and consider modifications to ensure the backtesting
practices are appropriate for determining the adequacy of its margin
resources.\188\ The Commission preliminarily believes that, since
margin positions must be calculated at least daily, policies and
procedures should also provide for daily backtesting. The Commission
preliminarily believes that requiring, on at least a monthly basis, a
conforming sensitivity analysis of margin resources and parameters and
assumptions for backtesting would appropriately balance cost concerns
with the interest of assuring that risk margin methodologies continue
to reflect current conditions. The Commission notes that, based on its
supervisory experience, risk management committees of the board and
similar management committees of registered clearing agencies commonly
meet on a monthly basis, and therefore the proposed requirement of a
monthly sensitivity analysis would be consistent with such meeting
frequency.
---------------------------------------------------------------------------
\188\ See proposed Rule 17Ad-22(e)(6)(vi), infra Part VII.
---------------------------------------------------------------------------
Backtesting is a technique used to compare the potential losses
forecasted by a model with the actual losses that participants
incurred, and is intended to reveal the accuracy of models.
Misspecified or miscalibrated models may lead to errors in decision
making. The Commission is proposing to require policies and procedures
that provide for backtesting the margin models used by covered clearing
agencies to help uncover and address possible errors in model design,
misapplication of models, or errors in the inputs to, and assumptions
underlying, margin models. The Commission is also proposing to add Rule
17Ad-22(a)(1) to define ``backtesting'' to mean an ex-post comparison
of actual outcomes with expected outcomes derived from the use of
margin models.\189\ Additionally, the Commission is proposing to add
Rule 17Ad-22(a)(17) to define ``sensitivity analysis'' to mean an
analysis that involves analyzing the sensitivity of a model to its
assumptions, parameters, and inputs.\190\ The Commission preliminarily
understands that these terms and definitions are commonly accepted
among, and employed by, market participants.\191\
---------------------------------------------------------------------------
\189\ See proposed Rule 17Ad-22(a)(1), infra Part VII.
\190\ See proposed Rule 17Ad-22(a)(17), infra Part VII.
\191\ See, e.g., Alexander J. McNeil, R[uuml]diger Frey & Paul
Embrechts, Quantitative Risk Management: Concepts, Techniques, and
Tools, at 35 (Princeton Univ. Press, 2005) (defining ``factor-
sensitivity measures'' as a change in portfolio value given a
predetermined change in one of the underlying risk factors).
---------------------------------------------------------------------------
The Commission is also proposing to add Rule 17Ad-22(a)(6) to
define ``conforming sensitivity analysis'' to mean a sensitivity
analysis that considers the impact on the model of both moderate and
extreme changes in a wide range of inputs, parameters, and assumptions,
including correlations of price movements or returns if relevant, which
reflect a variety of historical and hypothetical market conditions and
actual and hypothetical portfolios of proprietary positions and, where
applicable, customer positions. The Commission notes that ``sensitivity
analysis'' is a commonly understood term among industry
participants,\192\ and the Commission intends for the proposed
definition to ensure that the specified minimum requirements are met in
performing sensitivity analyses. Under the proposed definition, a
conforming sensitivity analysis, when performed by or on behalf of a
covered clearing agency involved in activities with a more complex risk
profile, would consider the most volatile relevant periods, where
practical, that have been experienced by the markets served by the
clearing agency. Under the proposed definition, a conforming
sensitivity analysis would also test the sensitivity of the model to
stressed market conditions, including the market conditions that may
ensue after the default of a member and other extreme but plausible
conditions as defined in a covered clearing agency's risk
policies.\193\
---------------------------------------------------------------------------
\192\ See id.
\193\ See proposed Rule 17Ad-22(a)(6), infra Part VII.
---------------------------------------------------------------------------
Under proposed Rule 17Ad-22(e)(6)(vi), the policies and procedures
for model review, testing, and verification requirements would include
policies and procedures for conducting a conforming sensitivity
analysis more frequently than monthly when the products cleared or
markets served display high volatility, become less liquid, or when the
size or concentration of positions held by participants increases or
decreases significantly.\194\ The proposed rule would also require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to report the
results of such conforming sensitivity analysis to appropriate decision
makers at the covered clearing agency, including its risk management
committee or board of directors, and use these results to evaluate the
adequacy of and adjust its margin methodology, model parameters, and
any other relevant aspects of its credit risk management policies and
procedures. The Commission preliminary believes that the requirement to
report to appropriate decision makers at the covered clearing agency,
including its risk management committee or board of directors, is
important to ensure that such risk management requirements and
compliance therewith are addressed at the most senior levels of the
governance framework of the covered clearing agency, commensurate with
the importance of said requirements.
---------------------------------------------------------------------------
\194\ See proposed Rule 17Ad-22(e)(6)(vi), infra Part VII.
---------------------------------------------------------------------------
By proposing the requirement for conducting a conforming
sensitivity analysis, the Commission expects that feedback generated by
these analyses would improve the performance of risk-based margin
systems used by covered clearing agencies and therefore better ensure
the safe functioning of covered clearing agencies. Additionally, the
Commission preliminarily believes that conforming sensitivity analysis
may help a covered clearing agency discover and address shortcomings in
its margin models that would not otherwise be revealed through
backtesting and is accordingly appropriate given the risks
[[Page 29531]]
that its size, operation, and importance pose to the U.S. securities
markets.\195\
---------------------------------------------------------------------------
\195\ Cf. PFMI Report, supra note 1, at 56 (discussing Principle
6, margin).
---------------------------------------------------------------------------
vii. Annual Conforming Model Validation
Rule 17Ad-22(b)(4) currently requires a registered clearing agency
that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to provide
for an annual model validation consisting of evaluating the performance
of the clearing agency's margin models and the related parameters and
assumptions associated with such models by a qualified person who is
free from influence from the persons responsible for the development or
operation of the models being validated. Under proposed Rule 17Ad-
22(e)(6)(vii), a covered clearing agency that provides CCP services
would be required to establish, implement, maintain and enforce written
policies and procedures reasonably designed to require not less than
annually a conforming model validation of the covered clearing agency's
margin system and related models.\196\ As previously discussed, the
model validation would be required to include initial margin models,
liquidity risk models, and models used to generate clearing or guaranty
fund requirements. Also, for a model validation to be considered a
conforming model validation under the proposed rule, it would have to
be performed by a qualified person who is free from influence from the
persons responsible for the development or operation of the models or
policies being validated.\197\
---------------------------------------------------------------------------
\196\ See proposed Rule 17Ad-22(e)(6)(vii), infra Part VII; see
also supra Part II.B.4.c.iv and infra Part VII (defining
``conforming model validation'' under proposed Rule 17Ad-22(a)(5)
and providing the definition text, respectively).
\197\ See supra Part II.B.4.c.iv (describing a person who is
free from influence in the context of the policy and procedure
requirement for an annual conforming model validation addressing
credit risk).
---------------------------------------------------------------------------
The Commission preliminarily believes the proposed approach of
requiring policies and procedures that subject a covered clearing
agency's models to review by such parties would be relevant to ensuring
the safe operation of covered clearing agencies and will help to ensure
that covered clearing agencies have the opportunity to benefit from the
views of a qualified person free from influence and incorporate
alternative risk management methodologies into their models as
appropriate. The Commission preliminarily believes this is important
for covered clearing agencies given the risks that a covered clearing
agency's size, operation, and importance pose to the U.S. securities
markets.
f. Proposed Rule 17Ad-22(e)(7): Liquidity Risk
Proposed Rule 17Ad-22(e)(7) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively measure, monitor, and
manage the liquidity risk that arises in or is borne by it, by meeting,
at a minimum, the ten requirements specified below.\198\
---------------------------------------------------------------------------
\198\ See proposed Rule 17Ad-22(e)(7), infra Part VII; see also
infra Parts II.B.4.f.i-x.
---------------------------------------------------------------------------
Liquidity risk describes the risk that an entity will be unable to
meet financial obligations on time due to an inability to deliver funds
or securities in the form required though it may possess sufficient
financial resources in other forms. Although Rule 17Ad-22(d)(11)
currently requires, among other things, that a registered clearing
agency establish, implement, maintain and enforce written policies and
procedures reasonably designed to take timely action to contain
liquidity pressures and to continue to meet obligations in the event of
a participant default, the Commission does not currently have
requirements for policies and procedures of registered clearing
agencies regarding the management of liquidity risk with the level of
specificity proposed in Rule 17Ad-22(e)(7). Given the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets, the proposed requirements would require a
covered clearing agency to maintain sufficient liquidity resources to
ensure they are prepared to meet their payment obligations in order to
facilitate the prompt and accurate clearance and settlement of
securities transactions.
i. Sufficient Liquid Resources
Proposed Rule 17Ad-22(e)(7)(i) would require that a covered
clearing agency's policies and procedures be reasonably designed to
ensure that it maintains sufficient liquid resources in all relevant
currencies to effect same-day and, where appropriate, intraday and
multiday settlement of payment obligations with a high degree of
confidence under a wide range of potential stress scenarios that
includes the default of the participant family that would generate the
largest aggregate payment obligation for it in extreme but plausible
market conditions. As noted above, maintaining sufficient liquidity
resources helps ensure that a covered clearing agency is prepared to
meet its payment obligations in order to facilitate the prompt and
accurate clearance and settlement of securities transactions
ii. Qualifying Liquid Resources
Proposed Rule 17Ad-22(e)(7)(ii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it holds qualifying liquid
resources sufficient to meet the minimum liquidity resource requirement
in each relevant currency for which the covered clearing agency has
payment obligations owed to clearing members.\199\ The Commission is
also proposing to add Rule 17Ad-22(a)(15) to define ``qualifying liquid
resources.'' \200\ For any covered clearing agency, in each relevant
currency, qualifying liquid resources would include three types of
assets:
---------------------------------------------------------------------------
\199\ See proposed Rule 17Ad-22(e)(7)(ii), infra Part VII. In
other words, if payment obligations were denominated in U.S.
dollars, the minimum liquidity resource requirement would refer to a
U.S. dollar amount.
\200\ See proposed Rule 17Ad-22(a)(15), infra Part VII.
---------------------------------------------------------------------------
Cash held either at the central bank of issue or at
creditworthy commercial banks; \201\
---------------------------------------------------------------------------
\201\ The Commission preliminarily believes that the
creditworthiness of commercial banks should be considered by a
covered clearing agency after considering its particular
circumstances and those of its members and the markets which it
services. Accordingly, in complying with the requirements of
proposed Rule 17Ad-22(e)(7) and proposed Rule 17Ad-22(a)(15), a
covered clearing agency's policies and procedures for determining
whether a commercial bank is creditworthy may reflect such
circumstances.
---------------------------------------------------------------------------
assets that are readily available and convertible into
cash through either:
[cir] Prearranged funding arrangements without material adverse
change limitations, such as committed lines of credit, foreign exchange
swaps, and repurchase agreements, or
[cir] other prearranged funding arrangements determined to be
highly reliable even in extreme but plausible market conditions by the
board of directors of the covered clearing agency following a review
conducted for this purpose not less than annually; and
other assets that are readily available and eligible for
pledging to (or conducting other appropriate forms of transactions
with) a relevant central bank, if the covered clearing agency has
access to routine credit at such central bank.\202\
---------------------------------------------------------------------------
\202\ See id. The Commission notes that such access to routine
credit at a relevant central bank and the collateral required by
such central bank to be posted to secure a loan may be determined at
the discretion of the central bank, and accordingly the practical
application of the definition of qualifying liquid resources would
be subject to variation based on those decisions. The Commission
preliminarily believes that inclusion of assets eligible for
pledging to any central bank, as opposed to only to a Federal
Reserve Bank, is appropriate because, in practice, a covered
clearing agency may need access to liquid resources in currencies
other than U.S. dollars.
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[[Page 29532]]
The Commission preliminarily believes that this requirement is
appropriate, given the risks that its size, operation, and importance
pose to the U.S. securities markets, and will help ensure that a
covered clearing agency has sufficient liquid resources, as determined
by stress testing, to effect settlement of payment obligations with a
high degree of confidence under a wide range of potential stress
scenarios.\203\ Furthermore, the Commission preliminarily believes this
requirement is appropriate given the specific circumstances of the U.S.
securities markets. U.S. securities markets are among the largest and
most liquid in the world, and CCPs operating in the United States are
also among the largest in the world.\204\ The resulting peak liquidity
demands of CCPs are therefore proportionately large on both an
individual and an aggregate basis, and the ability of CCPs to satisfy a
requirement limiting qualifying liquid resources to committed
facilities could be constrained by the capacity of traditional
liquidity sources in the U.S. banking sector in certain circumstances.
Therefore, the Commission is proposing to include in the definition of
qualifying liquid resources other prearranged funding arrangements
determined to be highly reliable even in extreme but plausible market
conditions.
---------------------------------------------------------------------------
\203\ Cf. PFMI Report, supra note 1, at 60 (discussing Principle
7, liquidity risk).
\204\ See infra notes 561-562 and accompanying text (discussing
the volume of transactions processed by U.S. clearing agencies).
---------------------------------------------------------------------------
For similar reasons, the Commission preliminarily believes it is
appropriate to include in the definition of qualifying liquid resources
assets that a central bank would permit a covered clearing agency to
use as collateral, to the extent such covered clearing agency has
access to routine credit at such central bank.\205\ The Commission
preliminarily notes that, although covered clearing agencies do not
currently have access to routine credit at Federal Reserve Banks,
potential registrants that could be determined to be covered clearing
agencies in the future may be operating in a jurisdiction where access
to routine credit is provided to the potential registrant by that
jurisdiction's central bank.\206\
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\205\ See ICMA Eur. Repo Council, The Interconnectivity of
Central and Commercial Bank Money in the Clearing and Settlement of
the European Repo Market, at 10-11 (Sept. 2011) (indicating that
access to central bank credit is important and may cause banks to
use either central bank settlement services or cash settlement
banking services of a commercial bank, depending on availability of,
and the terms of, central bank credit).
\206\ See Peter Allsopp, Bruce Summers & John Veale, The
Evolution of Real-Time Gross Settlement: Access, Liquidity and
Credit, and Pricing, at 15 (World Bank, Feb. 2009) (indicating that
CCPs in the Eurozone have access to central bank settlement account
services and routine credit).
---------------------------------------------------------------------------
With regard to assets convertible into cash, the Commission
preliminarily notes that the mere ownership of assets that a covered
clearing agency may consider readily available and also may consider
readily convertible into cash, based on factors such as the historical
volume of trading in a particular market for such asset, may not be
sufficient alone to make the assets count towards qualifying liquid
resources unless one of the above-referenced prearranged funding
arrangements is in place under which the covered clearing agency would
receive cash in a timely manner. The prearranged funding arrangements
would be in place to cover any shortfall. The Commission, however,
preliminarily considers committed funding arrangements to be reasonably
capable of being established by covered clearing agencies in the
relevant commercial lending markets and other funding arrangements to
be reasonably capable of being assessed for reliability by the boards
of directors of covered clearing agencies following consideration of
the relevant circumstances, and therefore preliminarily believes the
standard to be sufficiently clear to allow for it to be interpreted and
applied in practice by covered clearing agencies. Further, the
Commission preliminarily notes that, in complying with proposed Rule
17Ad-22(e)(7), covered clearing agencies should consider the lower of
the value of the assets capable of being pledged and the amount of the
commitment (or the equivalent availability under a highly reliable
prearranged facility) as the amount that counts towards qualifying
liquid resources in the event there is any expected difference between
the two.\207\ This may occur, for example, where the terms of the
arrangement provide for over-collateralization or where the covered
clearing agency lacks sufficient qualifying assets to make full use of
an otherwise qualifying liquidity facility.
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\207\ The Commission notes that, based on the types of assets
that may be considered qualifying liquid resources, for purposes of
complying with proposed Rule 17Ad-22(e)(7)(ii), factors that may be
relevant for a covered clearing agency to take into account include
(i) the portion of its default fund that is held as cash, (ii) the
portion of its default fund that is held as securities, (iii) the
portion of any excess default fund contributions held as cash that
could be used by the covered clearing agency to meet liquidity
needs, (iv) the portion of any excess default fund contributions
held as securities that could be used by the covered clearing agency
to meet liquidity needs, (v) the amount at any given time of
securities or cash delivered by members that a covered clearing
agency may be able to use to meet liquidity needs upon the default
of a member, and (vi) the borrowing limits under any committed
funding arrangement.
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In defining the proposed requirements for qualifying liquid
resources, the Commission preliminarily believes that it would be
appropriate to provide covered clearing agencies with the flexibility
to use highly reliable funding arrangements in addition to committed
arrangements for purposes of using assets other than cash to meet the
proposed requirements of Rule 17Ad-22(e)(7).\208\ The Commission
preliminarily believes that limiting the funding arrangements that are
included within the definition of qualifying liquid resources to
committed funding arrangements may not be necessary or appropriate in
determining liquidity requirements for a covered clearing agency
operating in the U.S. securities markets and expanding the concept of
qualifying liquid resources to include other highly reliable funding
arrangements is necessary and appropriate to ensure the proper
functioning of covered clearing agencies as required by the Exchange
Act.
---------------------------------------------------------------------------
\208\ Cf. PFMI Report, supra note 1, at 57 (discussing Principle
7, liquidity risk, at Key Consideration 5).
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For similar reasons, the Commission preliminarily believes it is
appropriate to include in the definition of qualifying liquid resources
assets that a central bank would permit a covered clearing agency to
use as collateral.\209\ The Commission notes that, although routine
discount window borrowing at a Federal Reserve Bank is currently not
available to covered clearing agencies, this provision will provide
covered clearing agencies with additional flexibility in meeting the
liquidity requirements of proposed Rule 17Ad-22(e)(7), should routine
credit at a Federal Reserve Bank become available in the future.\210\
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\209\ The Commission also preliminarily notes that the term
``central bank'' in the proposed definition of ``qualifying liquid
resources'' is not limited to a Federal Reserve Bank, and
accordingly covered clearing agencies based in or operating outside
of the United States that have access to routine credit at other
central banks would be able to take that into consideration when
assessing the amount of their qualifying liquid resources.
\210\ See infra Part IV.C.3.a.iv(4) (discussing the relative
cost of central bank credit). Section 806(b) of the Clearing
Supervision Act states that the Board may authorize a Federal
Reserve Bank to provide to a designated FMU discount and borrowing
privileges only in unusual and exigent circumstances, subject to
certain conditions. See 12 U.S.C. 5465(b).
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[[Page 29533]]
iii. Access to Account Services at a Federal Reserve Bank or Other
Relevant Central Bank
Proposed Rule 17Ad-22(e)(7)(iii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it uses accounts and
services at a Federal Reserve Bank, pursuant to Section 806(a) of the
Clearing Supervision Act,\211\ or other relevant central bank, when
available and where determined to be practical by the board of
directors of the covered clearing agency, in order to enhance its
management of liquidity risk.\212\ The Commission notes that the
proposed rule would not require using Federal Reserve Bank or other
relevant central bank account services; it would only require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to consider and determine
when and in what circumstances it chooses to do so, when the services
are available and when considered to be practical. The Commission
preliminarily believes that covered clearing agencies should be
encouraged to actively consider using Federal Reserve Bank or other
central bank accounts and services, as this is a valuable new tool made
available under the Clearing Supervision Act.\213\ The Commission
preliminarily believes, however, that it should also permit the use of
commercial banks by covered clearing agencies holding cash as
collateral or for other services related to clearance and settlement
activity, even when comparable services are available from a central
bank.
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\211\ See 12 U.S.C. 5465(a).
\212\ See proposed Rule 17Ad-22(e)(7)(iii), infra Part VII.
\213\ See Clearing Agency Standards Release, supra note 5, at
66268-69 & n.535.
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iv. Liquidity Providers
Proposed Rule 17Ad-22(e)(7)(iv) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it undertakes due
diligence to confirm that it has a reasonable basis to believe each of
its liquidity providers, whether or not such liquidity provider is a
clearing member, has sufficient information to understand and manage
the liquidity provider's liquidity risks, and the capacity to perform
as required under its commitments to provide liquidity.\214\
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\214\ See proposed Rule 17Ad-22(e)(7)(iv), infra Part VII.
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The Commission preliminarily intends for the term ``due diligence''
to have the same meaning as what this term is commonly understood to
mean by market participants. Consequently, in order to comply with the
requirements of proposed Rule 17Ad-22(e)(7) and to form a reasonable
basis regarding a liquidity provider's understanding and management of
liquidity risks and operational capacity, the Commission expects a
covered clearing agency would ordinarily not rely on representations of
the liquidity provider to this effect and instead conduct its own
investigation into the liquidity provider's business. A covered
clearing agency should consider implementing due diligence procedures
that provide a sufficient basis for its belief, given its business and
the nature of its liquidity providers. Procedures for purposes of
forming a reasonable basis could include, for example, interviewing the
liquidity provider's staff and reviewing both public and non-public
documents that would allow the covered clearing agency to gather
information about relevant factors, including but not limited to the
strength of the liquidity provider's financial condition, its risk
management capabilities, and its internal controls.
The Commission preliminarily believes that proposed Rule 17Ad-
22(e)(7)(iv) is appropriate because a covered clearing agency needs to
soundly manage its relationships with liquidity providers given the
risks posed to the U.S. securities markets by its size, operation, and
importance. In addition, Proposed Rule 17Ad-22(e)(7)(iv) would
reinforce proposed Rule 17Ad-22(e)(7)(ii) and the definition of
qualifying liquid resources in proposed Rule 17Ad-22(a)(15), which
contemplate potential reliance on liquidity providers where a covered
clearing agency would seek to use assets other than cash for purposes
of complying with proposed Rule 17Ad-22(e)(7)(ii) and would need to
transact with a liquidity provider to convert such assets into cash.
Should a committed or prearranged funding arrangement prove to be
unreliable at the time a covered clearing agency needs to utilize it
because of liquidity problems at the lender itself, this failure may
trigger a liquidity problem at the covered clearing agency, which would
raise systemic risk concerns for the U.S. securities markets. These
types of problems at a liquidity provider, by indirectly affecting a
covered clearing agency, could undermine the national system for the
prompt and accurate clearance and settlement of securities
transactions.
v. Maintenance and Annual Testing of Liquidity Provider Procedures and
Operational Capacity
Proposed Rule 17Ad-22(e)(7)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency maintains and, on at least an annual basis,\215\ tests with each
liquidity provider, to the extent practicable, its procedures and
operational capacity for accessing each type of relevant liquidity
resource.\216\
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\215\ The Commission preliminary believes that an annual cycle
is appropriate for the reasons described in Part II.A.3.
\216\ See proposed Rule 17Ad-22(e)(7)(v), infra Part VII.
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In addition, proposed Rule 17Ad-22(e)(7)(v) would reinforce
proposed Rule 17Ad-22(e)(7)(ii) and the definition of qualifying liquid
resources in proposed Rule 17Ad-22(a)(15), which contemplate potential
reliance on liquidity providers where a covered clearing agency would
seek to use assets other than cash for purposes of complying with
proposed Rule 17Ad-22(e)(7)(ii) and would need to transact with a
liquidity provider to convert such assets into cash. If procedures or
operational capacity for accessing liquidity under committed or
prearranged funding arrangements fail to function as planned and in a
timely manner, the covered clearing agency may fail to meet its payment
obligation, which would raise systemic risk concerns for the U.S.
markets and could undermine the national system for the prompt and
accurate clearance and settlement of securities transactions. Proper
preparation for a liquidity shortfall scenario could also promote
members' confidence in the ability of a covered clearing agency to
perform its obligations, which can mitigate the risk of contagion
during stressed market conditions. The Commission preliminarily
believes this is important for covered clearing agencies given the
risks that a covered clearing agency's size, operation, and importance
pose to the U.S. securities markets.
The Commission preliminarily believes that testing of access to
liquidity resources could include efforts by a covered clearing agency
to verify that a liquidity provider is able to provide the relevant
liquidity resource in the manner intended under the terms of the
funding arrangement and without
[[Page 29534]]
undue delay, such as, for example, promptly funding a draw on the
covered clearing agency's credit facility. Testing procedures could
include, for example, test draws funded by the liquidity provider or
tests of electronic connectivity between the covered clearing agency
and the liquidity provider. The Commission recognizes that testing with
liquidity providers may not always be practicable in the absence of
committed liquidity arrangements.
The Commission preliminarily believes the proposed requirement that
testing of a covered clearing agency's access to liquidity be conducted
at least annually with each liquidity provider to be a reasonable step
to ensure the objectives of the Exchange Act are achieved in practice.
The Commission understands such tests are routinely performed currently
by certain registered clearing agencies but are subject to variation
due, in part, to the absence of a regulatory requirement and the
incremental time and attention needed to conduct the tests. The
Commission preliminarily anticipates the effect of the proposed rule
will be to require the development of more uniform liquidity testing
practices by covered clearing agencies, and has accordingly proposed to
allow covered clearing agencies to assess the practicability of such
testing to provide them with reasonable flexibility to design the tests
to suit the circumstances of the covered clearing agency and its
particular liquidity arrangements.
vi. Testing the Sufficiency of Liquid Resources
Proposed Rule 17Ad-22(e)(7)(vi)(A) through (C) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to determine the
amount and regularly test the sufficiency of the liquid resources held
for purposes of meeting the minimum liquid resource requirement of
proposed Rule 17Ad-22(e)(7)(i) by (A) conducting a stress test of its
liquidity resources at least once each day using standard and
predetermined parameters and assumptions; \217\ (B) conducting a
comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources, and considering modifications to ensure
they are appropriate for determining the covered clearing agency's
identified liquidity needs and resources in light of current and
evolving market conditions at least once each month; \218\ and (C)
conducting a comprehensive analysis of the existing stress testing
scenarios, models, and underlying parameters and assumptions used in
evaluating liquidity needs and resources more frequently when products
cleared or markets served display high volatility or become less
liquid, when the size or concentration of positions held by
participants increases significantly, or in other circumstances
described in the covered clearing agency's policies and
procedures.\219\ Proposed Rule 17Ad-22(e)(7)(vi)(D) would also require
a covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to result in
reporting the results of the analyses performed under proposed Rule
17Ad-22(e)(7)(vi)(B) and (C) to appropriate decision makers, including
the risk management committee or board of directors, at the covered
clearing agency for use in evaluating the adequacy of and adjusting its
liquidity risk management framework.
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\217\ The Commission preliminary believes that a daily cycle is
appropriate for the reasons described in Part II.A.3.
\218\ The Commission preliminary believes that a monthly cycle
is appropriate for the reasons described in Part II.A.3.
\219\ See proposed Rule 17Ad-22(e)(7)(vi), infra Part VII.
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The Commission preliminarily believes that proposed Rules 17Ad-
22(e)(7)(vi)(A) through (D) would require a covered clearing agency to
take reasonable steps to ensure the adequacy of liquid resources in
practice. Given the risks that a covered clearing agency's size,
operation, and importance pose to the U.S. securities markets, in
addition to the potential consequences to the U.S. financial system of
a failure of a covered clearing agency, the Commission preliminarily
believes that requiring a covered clearing agency to devote additional
time and attention to testing the sufficiency of its liquid resources,
relative to a registered clearing agency generally, is appropriate. The
Commission preliminarily believes that the requirements in proposed
Rule 17Ad-22(e)(7)(vi) are appropriate for testing the sufficiency of
liquid resources of covered clearing agencies because, in certain
market conditions, such as periods of high volatility or diminished
liquidity, existing stress scenarios, models, or underlying parameters
may no longer be valid or appropriate. For example, covered clearing
agencies may have adjusted their financial resources models following
the 2008 financial crisis to account for larger debt, equity, and
credit market shocks than would have been contemplated by those models
prior to the crisis. Accordingly, the Commission preliminarily believes
that specific policies and procedures specifying actions to be taken by
covered clearing agencies to maintain sufficient liquid resources would
contribute to the safe functioning of the covered clearing agency as
required by the Exchange Act,\220\ and that requiring periodic feedback
and analysis on the strength of liquidity risk management policies and
procedures would improve the reliability of those policies and
procedures. The Commission also preliminarily believes that covered
clearing agencies should have the flexibility to use stress scenarios
that are appropriately calibrated to the markets in which they operate
and that they can be revised over time as those markets change. Proper
preparation for a liquidity shortfall scenario could also promote a
participant's confidence in the ability of a covered clearing agency to
perform its obligations, which can mitigate the risk of undue
disruption during stressed market conditions.
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\220\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
---------------------------------------------------------------------------
One of the appropriate methods of preparation by a covered clearing
agency would be, in the Commission's preliminary view, the testing of
the sufficiency of liquidity that it might need under certain extreme
but plausible parameters and assumptions. The Commission preliminarily
believes that conducting stress testing of liquidity would allow a
covered clearing agency to understand its level of resilience and
adjust its operations accordingly to address areas of inadequacy. The
Commission preliminarily believes that by testing under extreme but
plausible scenarios, covered clearing agencies, and in particular those
designated systemically important, would be better prepared in the
event that equivalent or similar scenarios actually occurred.
vii. Annual Conforming Model Validation
Proposed Rule 17Ad-22(e)(7)(vii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in performing an annual or
more frequent conforming model validation of its liquidity risk
models.\221\
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\221\ See proposed Rules 17Ad-22(a)(5) and (e)(7)(vii), infra
Part VII. The Commission notes that, in contrast to proposed Rules
17Ad-22(a)(5) and (e)(7)(vii), Rule 17Ad-22(b)(4) requires only a
model validation for margin models and does not specify the general
elements of a model validation. See supra note 167 and accompanying
text.
In addition, the Commission preliminary believes that an annual
cycle is appropriate for the reasons described in Part II.A.3.
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[[Page 29535]]
The Commission preliminarily believes that such annual conforming
model validation would provide feedback on the performance of such
liquidity risk models conducted by a qualified person who is free from
influence from the persons responsible for the development or operation
of the liquidity risk model, as contemplated by the definition of
``conforming model validation'' in proposed Rule 17Ad-22(a)(5), and
incorporate alternative liquidity risk management methodologies into
their models as appropriate. Generally, the Commission preliminarily
considers that a person is free from influence when that person does
not perform functions associated with the clearing agency's models
(except as part of the annual model validation) and does not report to
a person who performs these functions. Preliminarily, the Commission
would not expect policies and procedures adopted pursuant to this
proposed requirement to require the clearing agency to detach model
review from model development or to maintain two separate quantitative
teams. By reacting to such feedback, a covered clearing agency may
improve the functioning of its liquidity risk model. The Commission
notes that misspecified or miscalibrated liquidity risk models may lead
to errors in decision making. The Commission preliminarily believes
that the proposed rule is appropriate following consideration of the
Exchange Act requirements discussed above \222\ and the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets.
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\222\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
---------------------------------------------------------------------------
viii. Address Liquidity Shortfalls and Seek To Avoid Unwinding
Settlement
Proposed Rule 17Ad-22(e)(7)(viii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to address foreseeable liquidity
shortfalls that would not be covered by its liquid resources and seek
to avoid unwinding, revoking, or delaying the same-day settlement of
payment obligations.\223\ The Commission preliminarily believes advance
planning by a covered clearing agency with regard to liquidity
shortfalls could further enhance the covered clearing agency's ability
to perform its payment obligations without delay and therefore support
the ability of the clearing agency's participants to function without
disruption. Foreseeable liquidity shortfalls could include, for
example, potential shortfalls that can be identified through testing a
covered clearing agency's financial resources in a manner consistent
with the policies and procedures requirements in proposed Rule 17Ad-
22(e)(7)(vi). The Commission recognizes that foreseeable liquidity
shortfalls could occur even when a covered clearing agency is in
compliance with the proposed requirements of Rule 17Ad-22(e)(7), such
as when, for example, the covered clearing agency is unable to obtain
liquidity pursuant to a prearranged funding arrangements that are
uncommitted. The Commission preliminarily believes the proposed
requirement is appropriate for covered clearing agencies given the
risks that a covered clearing agency's size, operation, and importance
pose to the U.S. securities markets and are consistent with the
Exchange Act requirements discussed above.\224\
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\223\ See proposed Rule 17Ad-22(e)(7)(viii), infra Part VII.
\224\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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ix. Replenishment of Liquid Resources
Proposed Rule 17Ad-22(e)(7)(ix) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to describe its process for
replenishing any liquid resources that it may employ during a stress
event.\225\ The Commission preliminarily believes a covered clearing
agency should specifically contemplate and memorialize its expectations
for replenishing its financial resources when they are depleted so that
its ability to withstand repeated stress events, such as multiple
market shocks or sequential defaults of multiple participants is
clearly understood and reflected in its planning for such events. The
Commission preliminarily believes that the proposed requirement is
appropriate given the risks that a covered clearing agency's size,
operation, and importance pose to the U.S. securities markets and is
consistent with the Exchange Act requirements discussed above.\226\
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\225\ See proposed Rule 17Ad-22(e)(7)(ix), infra Part VII.
\226\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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x. Feasibility Analysis for ``Cover Two''
Proposed Rule 17Ad-22(e)(7)(x) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it, at least once a year,
evaluates the feasibility of maintaining sufficient liquid resources at
a minimum in all relevant currencies to effect same-day and, where
appropriate, intraday and multiday settlement of payment obligations
with a high degree of confidence under a wide range of foreseeable
stress scenarios that includes, but is not limited to, the default of
the two participant families that would potentially cause the largest
aggregate credit exposure for the covered clearing agency in extreme
but plausible market conditions if the covered clearing agency provides
CCP services and is either systemically important in multiple
jurisdictions or a clearing agency involved in activities with a more
complex risk profile.\227\
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\227\ See proposed Rule 17Ad-22(e)(7)(x), infra Part VII.
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Rule 17Ad-22 does not currently provide specific requirements
regarding the sizing and testing of liquid resources or what types of
financial resources would qualify as liquid. However, the financial
crisis of 2008 demonstrated the plausibility of the default of two
large participants in a clearing agency over a brief period.\228\
Accordingly, the Commission preliminarily believes that its proposed
approach is appropriate, given the need for more stringent financial
resource requirements for a covered clearing agency due to the risks
that its size, operation, and importance pose to the U.S. securities
markets, and is consistent with the Exchange Act requirements discussed
above.\229\ The Commission also believes that such financial resources
must be robust enough to accommodate the risks that are particular to
each market served and accordingly believes that a covered clearing
agency should have the flexibility to determine that different
standards are appropriate in different markets, given the variable
nature and
[[Page 29536]]
risks associated with the products cleared.\230\
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\228\ See Clearing Agency Standards Release, supra note 5, at
66235-36 (noting that the financial crisis of 2008 demonstrated the
plausibility of the default of two large participants in a clearing
agency over a brief period).
\229\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\230\ See generally Clearing Agency Standards Release, supra
note 5, at 66234-36 (describing a ``cover two'' requirement for
credit risk).
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The Commission also preliminarily believes that, with greater
emphasis being placed on the role of CCPs in the financial system, the
requirement in proposed Rule 17Ad-22(e)(7)(x) for CCPs to review and
consider the feasibility of meeting a higher liquidity risk management
standard is appropriate. While Rule 17Ad-22(e)(7)(x) would impose on
certain covered clearing agencies' policies and procedures requirements
to conduct an annual analysis of the feasibility of maintaining ``cover
two'' for liquidity, such covered clearing agencies would not be
mandated to adopt a ``cover two'' approach regarding liquidity risk
management. The responsibility for such a determination would remain
with the boards of directors of covered clearing agencies following a
review of the information produced pursuant to proposed Rule 17Ad-
22(e)(7)(x).
The Commission preliminarily believes that it may be appropriate
for a covered clearing agency that provides CCP services to maintain
liquidity coverage at levels higher than other clearing agencies due to
the heightened need to ensure the safe operation of covered clearing
agencies given their importance to the U.S. financial markets and the
risks attributable to the products they clear, but also that covered
clearing agencies not subject to a ``cover two'' requirement should
have flexibility to evaluate the results of an annual feasibility study
and to make their own determinations as to whether a ``cover two''
approach to liquidity risk management is necessary or appropriate.
Furthermore, the Commission notes that if, following completion of a
feasibility study as contemplated in proposed Rule 17Ad-22(e)(7)(x), a
covered clearing agency makes a determination to move beyond ``cover
one'' for liquidity that would be required under proposed Rule 17Ad-
22(e)(7)(i), such covered clearing agency would not be limited to
sizing its qualifying liquid resources to cover the default of its two
largest participant families. In such case, the covered clearing agency
could select a level of liquid resources exceeding ``cover one'' that
it deems most appropriate to the management of liquidity risk, which
could be either less than, equal to, or more than ``cover two.''
Based on its supervisory experience, the Commission also
preliminarily believes that, in sizing its liquid resources to exceed
``cover one,'' a covered clearing agency may take into account a
variety of factors, including, but not limited to, (i) the business
model of the covered clearing agency, such as a utility model (which
may be also referred to as an ``at cost'' model) versus a for-profit
model; (ii) diversification of its members' business models as they
impact the members' ability to supply liquidity to the covered clearing
agency; (iii) concentration of membership of the covered clearing
agency, as the breadth of the membership may affect the ability to draw
liquidity from members; (iv) levels of usage of the covered clearing
agency's services by members, as the concentration of demand on the
covered clearing agency's services may bear upon potential liquidity
needs; (v) the relative concentration of members' market share in the
cleared products; (vi) the degree of alignment of interest between
member ownership of the covered clearing agency and the provision of
funding to the covered clearing agency; and (vii) the nature of, and
risks associated with, the products cleared by the covered clearing
agency.
g. Request for Comments
The Commission generally requests comments on all aspects of
proposed Rules 17Ad-22(e)(4), (5), (6), and (7) and proposed Rules
17Ad-22(a)(5), (6), (14), (15), (17), (18), and (19). In particular,
the Commission requests comments on the following issues:
Has the Commission provided sufficient guidance for Rule
17Ad-22(e)(4) regarding the meaning of the requirement to cover credit
exposures to each participant ``fully with a high degree of
confidence''? Has the Commission provided sufficient guidance regarding
the meaning of the requirement to maintain the financial resources
required under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable, ``in combined or separately maintained clearing or guaranty
funds''? Has the Commission provided sufficient guidance regarding the
use of ``high volatility'' and ``become less liquid''? Why or why not?
Is the Commission's proposed requirement to cover credit
exposures to each participant ``fully with a high degree of
confidence'' in proposed Rule 17Ad-22(e)(4) appropriate? Why or why
not?
Should a covered clearing agency's policies and procedures
provide for the measurement of credit exposures more frequently than
once per day? Why or why not? If so, how frequently? What factors
should be considered in determining the minimum frequency?
Should the Commission require a covered clearing agency's
policies and procedures to limit the assets it accepts as collateral to
those with low credit, liquidity, and market risks? Why or why not? Has
the Commission provided sufficient guidance regarding what constitutes
``low credit, liquidity, and market risks''? Why or why not? If not,
what additional guidance should the Commission consider providing?
Should the Commission require a covered clearing agency's
policies and procedures to set and enforce appropriately conservative
haircuts and concentration limits if the covered clearing agency
requires collateral to manage its or its participants' credit exposure?
Why or why not? Has the Commission provided sufficient guidance on what
would constitute ``appropriately conservative haircuts and
concentration limits''? Why or why not? Should the Commission adopt
different standards? If so, what should those standards be? Please
explain in detail.
Are there any other requirements that should be included
in proposed Rule 17Ad-22(e)(5) to facilitate policies and procedures
that address collateral? Why or why not? Are there any requirements
that should be removed? Why or why not? For instance, should the
Commission require policies and procedures that avoid concentrated
holdings of any particular kind of asset, such as those that would
significantly impair the covered clearing agency's ability to liquidate
such assets quickly without significant adverse price effects? Should
the Commission require policies and procedures that avoid concentrated
holdings under certain conditions?
Has the Commission provided sufficient guidance for Rule
17Ad-22(e)(6) regarding ``margin levels commensurate with, the risks
and particular attributes of each relevant product, portfolio, and
market''? Has the Commission provided sufficient guidance regarding
what a ``reliable'' source of timely price data is? Why or why not?
Should the Commission use a different standard? If so, what should that
standard be? Please explain in detail.
Is the requirement in proposed Rule 17Ad-22(e)(6)(i)
regarding policies and procedures reasonably designed to result in a
margin system that at a minimum considers, and produces margin levels
commensurate with, the risks and particular attributes of each relevant
product, portfolio, and market appropriate? Why or why not?
Is the Commission's approach in proposed Rule 17Ad-
22(e)(6)(iii),
[[Page 29537]]
requiring a covered clearing agency's policies and procedures to
calculate margin sufficient to cover its potential future exposure to
participants, and the definition of ``potential future exposure'' in
proposed Rule 17Ad-22(a)(14) to mean the ``maximum exposure estimated
to occur at a future point in time with an established single-tailed
confidence interval of at least 99% with respect to the estimated
distribution of future exposure'' appropriate and sufficiently clear?
Why or why not?
Are there any other requirements that should be included
in proposed Rule 17Ad-22(e)(6) to facilitate policies and procedures
that address margin? Why or why not? For instance, should the
Commission require policies and procedures that address minimum
liquidation periods for products cleared by covered clearing agencies?
Why or why not?
Has the Commission provided sufficient guidance for Rule
17Ad-22(e)(7) regarding what constitutes the ``relevant currency'' in
holding qualifying liquid resources? Has the Commission provided
sufficient guidance regarding the ``due diligence'' with respect to
liquidity providers? Has the Commission provided sufficient guidance
regarding what constitutes ``foreseeable'' liquidity shortfalls? Why or
why not?
Has the Commission provided sufficient guidance regarding
what constitutes ``regularly'' testing the sufficiency of liquid
resources under proposed Rule 17Ad-22(e)(7)(vi)? Why or why not? How
frequently should a covered clearing agency test the sufficiency of its
liquid resources? Please explain.
Does the set of minimum requirements for policies and
procedures under proposed Rule 17Ad-22(e)(7) sufficiently address
liquidity risks? Why or why not? Should the Commission adopt other
requirements for addressing liquidity risk?
Is the proposed definition of ``qualifying liquid
resources'' under Rule 17Ad-22(a)(15) accurate, appropriate, and
sufficiently clear given the requirements proposed? Why or why not?
Should all types of assets be subject to prearranged funding
arrangements? Should the proposed definition distinguish among them by
asset, product type, or liquidity? Are there alternative definitions
the Commission should consider?
Is the meaning of the term ``due diligence'' under Rule
17Ad-22(7)(iv) sufficiently clear? Why or why not?
Is the proposed definition of ``systemically important in
multiple jurisdictions'' under Rule 17Ad-22(a)(19) accurate,
appropriate, and sufficiently clear given the requirements proposed?
Why or why not? Are there alternative definitions the Commission should
consider? How should the Commission assess another regulator or
jurisdiction's determination that a covered clearing agency is
systemically important in multiple jurisdictions? Please explain.\231\
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\231\ For additional requests for comments relating to proposed
Commission determinations under Rule 17Ab2-2, see Part II.C.4.
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Is the Commission's proposed approach to ``cover one'' and
``cover two'' with respect to credit risk appropriate? Should the
Commission expand or contract the scope of covered clearing agencies
subject to a ``cover two'' requirement beyond those systemically
important in multiple jurisdictions or those involved in activities
with a more complex risk profile? Why or why not? Is the ``cover two''
approach, in which the covered clearing agency must have policies and
procedures requiring financial resources sufficient to cover the
default of the two participant families that would potentially cause
the largest aggregate credit exposure for the covered clearing agency
in extreme but plausible market conditions, appropriate? Should the
Commission require policies and procedures that provide for financial
resources in excess of ``cover two''? Why or why not? If so, what would
be the potential costs and benefits?
Is the Commission's proposed approach to ``cover one'' and
``cover two'' with respect to liquidity risk appropriate? Should the
Commission require policies and procedures that would provide for
maintaining qualifying liquid resources equal to ``cover two,'' rather
than policies and procedures for a feasibility analysis with regard to
``cover two''? Why or why not?
Should the Commission include more specific requirements
for policies and procedures regarding stress testing that take into
account, for example, relevant peak historic price volatilities, shifts
in other market factors such as price determinants and yield curves,
multiple defaults over various time horizons, simultaneous pressures in
funding and asset markets, or a spectrum of forward-looking stress
scenarios in a variety of extreme but plausible market conditions? Why
or why not?
Is the requirement to require policies and procedures for
reporting the results of a conforming sensitivity analysis to the
appropriate decision makers at the covered clearing agency appropriate?
Why or why not? Has the Commission sufficiently described who the
appropriate decision makers are? Please explain.
Do any of the proposed rules for financial risk management
differentiate between clearing agencies based on factors that should
not be determinative, i.e. whether a clearing agency is covered or
uncovered, whether a clearing agency is systemically important in
multiple jurisdictions, involved in activities with a more complex risk
profile, or neither, and whether the clearing agency provides CCP
services for security-based swaps or other securities? Should the
Commission consider other factors in determining which clearing
agencies should be subject to the proposed requirements?
5. Proposed Rule 17Ad-22(e)(8): Settlement Finality
Proposed Rule 17Ad-22(e)(8) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to define the point at which settlement
is final no later than the end of the day on which the payment or
obligation is due and, where necessary or appropriate, intraday or in
real time.\232\
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\232\ See proposed Rule 17Ad-22(e)(8), infra Part VII.
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Rule 17Ad-22(d)(12) currently requires registered clearing agencies
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to ensure that final settlement occurs
no later than the end of the settlement day and to require that
intraday or real-time finality be provided where necessary to reduce
risks.\233\ The Commission preliminarily believes that defining
settlement finality with specific reference to the day on which the
payment or obligation is due is appropriate because it better reflects
the prevailing international convention and accordingly helps to ensure
that covered clearing agencies can facilitate transactions
globally.\234\ Because of the similarity between proposed Rule 17Ad-
22(e)(8) and Rule 17Ad-22(d)(12), the Commission anticipates that
covered clearing agencies may need to make only limited changes to
update
[[Page 29538]]
their policies and procedures to comply with the proposed rule.\235\
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\233\ See 17 CFR 240.17Ad-22(d)(12); see also Clearing Agency
Standards Release, supra note 5, at 66255-56. Rule 17Ad-22(d)(12)
focuses on achieving settlement on the particular settlement date
associated with the securities transaction or on an intraday or
real-time basis (i.e., delivery versus payment) where those
additional steps are necessary to reduce risks. See Clearing Agency
Standards Release, supra note 5, at 66256.
\234\ Cf. PFMI Report, supra note 1, at 64.
\235\ See supra Part II.A.4.
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As with Rule 17Ad-22(d)(12), the Commission preliminarily believes
that proposed Rule 17Ad-22(e)(8) is appropriate for covered clearing
agencies, given the risks that a covered clearing agency's size,
operation, and importance pose to the U.S. securities markets, for the
following reasons. First, the Commission preliminarily believes that
defining the point at which settlement is final may assist in the
potential wind-down of a member in the event of insolvency because it
provides the covered clearing agency with information regarding the
member's open positions. As an example, clearly defining the point at
which settlement is final might include establishing a cut-off point
after which unsettled payments, transfer instructions, or other
obligations may not be revoked by a clearing member. Clearly defining
the point at which settlement is final could also provide to clearing
members the necessary guidance from the covered clearing agency to
permit extensions for members with operating problems. For example, the
covered clearing agency may establish rules governing the approval and
duration of such extensions.
Second, the Commission preliminarily believes that a covered
clearing agency's policies and procedures should require completing
final settlement no later than the end of the day on which the payment
or obligation is due and that practices creating material uncertainty
regarding when final settlement will occur or permit the back-dating or
``as of'' dating of a transaction that settles after the end of the day
on which the payment or obligation is due would not comply with this
requirement. The Commission preliminarily believes that final
settlement has the effect of reducing the buildup of exposures between
clearing members and the clearing agency, and final settlement no later
than the end of the day on which the payment or obligation is due
limits these exposures to the change in price between valuation and the
end of the day. Accordingly, deferring final settlement beyond the end
of the day on which the payment or obligation is due would allow these
exposures to increase in size, thereby creating the potential for
credit and liquidity pressures for members and other market
participants and potentially increasing systemic risk.
Third, the Commission preliminarily believes that a covered
clearing agency's policies and procedures, where necessary and
appropriate, should require intraday or real-time finality in order to
reduce risk in circumstances where uncertainty regarding finality may
impede the clearing agency's ability to facilitate prompt and accurate
clearance and settlement, cause the clearing agency's members to fail
to meet their obligations, or otherwise disrupt the securities markets.
The Commission preliminarily believes that such efforts would be
necessary and appropriate when, for example, the risks in question are
material or when the opportunity to require intraday or real-time
finality is available and it would be reasonable, whether in economic
or other terms, to do so.
Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(8). In addition, the Commission
requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to define the point at which settlement is
final no later than the end of the day on which the payment or
obligation is due, as in the proposed rule, or no later than the end of
the settlement date, as in existing Rule 17Ad-22(d)(12) applicable to
registered clearing agencies? Please explain.
What changes, if any, would be created by the proposed
requirements for settlement finality? Does the proposed rule affect
certain, identifiable categories of market participants differently
than others, such as smaller entities or entities with limited
operations in the United States? If so, how?
Are there operational, legal, or regulatory impediments to
intraday or real-time settlement finality? Will the proposed standard
make it harder for covered clearing agencies to conduct certain types
of business for which intraday or real-time finality may be difficult?
Are any additional rules or regulations needed to encourage intraday or
real-time finality to reduce risks?
Are there circumstances when the requirements of intraday,
real-time, or end-of-day settlement finality proposed by the rule are
not feasible or are not beneficial? If so, in what circumstances?
6. Proposed Rule 17Ad-22(e)(9): Money Settlements
Proposed Rule 17Ad-22(e)(9) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to ensure it considers conducting its
money settlements in central bank money, where available and determined
to be practical by the board of directors of the covered clearing
agency, and minimizes and manages credit and liquidity risk arising
from conducting its money settlements in commercial bank money if
central bank money is not used by the covered clearing agency.\236\
Rule 17Ad-22(e)(9) contains requirements similar to those applied to
registered clearing agencies under Rule 17Ad-22(d)(5), but would
additionally require a covered clearing agencies to have policies and
procedures for conducting money settlement in central bank money.\237\
Because this is the only requirement that differs between proposed Rule
17Ad-22(e)(9) and existing Rule 17Ad-22(d)(5), the Commission
anticipates that covered clearing agencies may need to make only
limited changes to update their policies and procedures.\238\
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\236\ See proposed Rule 17Ad-22(e)(9), infra Part VII.
The Commission notes that, in some cases, for example, the use
of central bank money may not be practical, as direct access to all
central bank accounts and payment services may not be available to
certain clearing agencies or members, and, for clearing agencies
working under different currencies, certain central bank accounts
may not be operational at the time money settlements occur.
\237\ In full, Rule 17Ad-22(d)(5) requires registered clearing
agencies to establish, implement, maintain and enforce written
policies and procedures reasonably designed to employ money
settlement arrangements that eliminate or strictly limit the
clearing agency's settlement bank risks, such as credit and
liquidity risks from the use of banks to effect money settlements
with its participants. See 17 CFR 240.17Ad-22(d)(5); see also
Clearing Agency Standards Release, supra note 5, at 66249-50.
\238\ See supra Part II.A.4 (noting the anticipated effect of
the proposed rule) and infra Part IV.B.3.c (describing the current
practices at registered clearing agencies regarding settlement).
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As with Rule 17Ad-22(d)(5), the Commission is proposing Rule 17Ad-
22(e)(9) to provide assurance that funds transfers are final when
effected.\239\ The Commission preliminarily believes that the proposed
requirement for policies and procedures for conducting money settlement
in central bank money would, in addition, help to further reduce the
risk that financial obligations related to the activities of a covered
clearing agency are not settled in a timely manner or discharged with
finality because settlement in central bank money eliminates settlement
risk within the jurisdiction of the central bank.\240\
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\239\ See proposed Rule 17Ad-22(e)(9), infra Part VII.
\240\ See ICMA Eu. Repo Council, supra note 205, at 8-9 (noting
that central bank money ``can be regarded as completely safe in the
jurisdiction of the central bank'' and listing a number of
advantages attributable to central bank money).
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The Commission notes that there are a number of arrangements that a
covered
[[Page 29539]]
clearing agency could employ to meet the requirements under the
proposed rule. For example, pursuant to the Clearing Supervision Act,
designated clearing agencies may obtain access to account services at a
Federal Reserve Bank.\241\ The Commission preliminarily believes,
however, that it may be appropriate for covered clearing agencies to
use commercial banks for conducting money settlements even when
comparable services are available from a central bank, and therefore
the proposed rule would permit a covered clearing agency to decide for
itself which service to use in those circumstances. If central bank
account services are not available or used, then the covered clearing
agency should consider establishing criteria for use of commercial
banks to effect money settlements with its participants that address
such commercial banks' regulation and supervision, creditworthiness,
capitalization, access to liquidity, and operational reliability. In
addition, a covered clearing agency also could seek to ensure that its
legal agreements with such commercial settlement banks support such
risk-reduction principles and commercial settlement bank criteria,
including through provisions providing that funds transfers to the
covered clearing agency are final when effected.
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\241\ See 12 U.S.C. 5465(a); see also supra Parts II.B.4.d and
II.B.4.f.iii (discussing access to account services at a Federal
Reserve Bank, or other relevant central bank, pursuant to proposed
Rules 17Ad-22(e)(5) and (7), respectively).
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The proposed rule would also permit a covered clearing agency to
use multiple settlement banks in order to monitor and manage
concentration of payments among its commercial settlement banks. In
those circumstances, policies and procedures would be required to
consider the degree to which concentration of a covered clearing
agency's exposure to a commercial settlement bank is affected or
increased by multiple relationships with the settlement bank, including
(i) where the settlement bank is also a participant in the covered
clearing agency, or (ii) where the settlement bank provides back-up
liquidity resources to the covered clearing agency.
Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(9). In addition, the Commission
requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to conduct its money settlements in central
bank money, where available and determined to be practical by the board
of directors of the covered clearing agency? Why or why not? Has the
Commission provided sufficient guidance on what would be ``practical''
in this context? Why or why not?
Should the Commission require a covered clearing agency's
policies and procedures to minimize and manage credit and liquidity
risk arising from conducting its money settlements in commercial bank
money if central bank money is not used by the covered clearing agency?
Why or why not?
Are there other requirements that the Commission should
apply to money settlements, such as requiring policies and procedures
with respect to the minimum number of banks that a covered clearing
agency may use to effect money settlements with its participants in
order to avoid reliance on a small number of such banks? Should the
Commission require policies and procedures specifying the
characteristics of financial institutions that may be used by clearing
agencies for settlement purposes? Why or why not?
Should the Commission require a covered clearing agency's
policies and procedures to establish and monitor adherence to criteria
based on high standards for the covered clearing agency's settlement
banks? For example, should the Commission require that criteria to
consider the applicable regulatory and supervisory frameworks,
creditworthiness, capitalization, access to liquidity, and operational
reliability? Why or why not?
Should the Commission require a covered clearing agency's
policies and procedures to monitor and manage the concentration of
credit and liquidity exposures to its commercial settlement banks? Why
or why not?
Should rules for money settlements established by the
Commission be uniform for all types of money settlements, or are there
circumstances in which it would be appropriate for covered clearing
agencies to accept a higher degree of money settlement risk, such as
when transacting in certain product categories or with certain types of
customers? Why or why not?
7. Proposed Rule 17Ad-22(e)(10): Physical Delivery Risks
Proposed Rule 17Ad-22(e)(10) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish and maintain
transparent written standards that state its obligations with respect
to the delivery of physical instruments and operational practices that
identify, monitor, and manage the risk associated with such physical
deliveries.\242\
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\242\ See proposed Rule 17Ad-22(e)(10), infra Part VII.
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The proposed requirement is similar to the requirement applicable
to registered clearing agencies in Rule 17Ad-22(d)(15), but the
proposed rule also requires that such standards be transparent at
covered clearing agencies.\243\ Considering the risks that a covered
clearing agency's size, operation, and importance pose to the U.S.
securities markets, the Commission preliminarily believes that the
proposed new requirement for transparent standards is appropriate.
Physical delivery may require the involvement of multiple parties,
including the clearing agency itself, its members, customers,
custodians, and transfer agents, and failures to deliver physical
instruments can threaten the integrity and smooth functioning of the
financial system. By requiring policies and procedures to include
transparent written standards at covered clearing agencies, the
proposed rule helps to mitigate physical delivery risks.
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\243\ Registered clearing agencies are currently subject to
existing Rule 17Ad-22(d)(15), which requires them to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to state to its participants the clearing
agency's obligations with respect to physical deliveries and
identify and manage the risks from these obligations. See 17 CFR
240.17Ad-22(d)(15); see also Clearing Agency Standards Release,
supra note 5, at 66257-58.
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The Commission preliminarily believes that the proposed requirement
for a covered clearing agency to maintain transparent written standards
that state its obligations with respect to physical deliveries would
help to ensure that members and their customers have information that
is likely to enhance their understanding of their rights and
responsibilities with respect to using the clearance and settlement
services of a covered clearing agency.\244\ The Commission
preliminarily believes that such information, when available to members
and their customers through the covered clearing agency's policies and
procedures, would promote a shared understanding regarding physical
delivery practices between the covered clearing agency and its members.
The requirement for policies and procedures with transparent written
standards may further facilitate prompt and accurate
[[Page 29540]]
clearance and settlement and mitigate physical delivery risks.
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\244\ The Commission is proposing additional requirements
regarding disclosures to participants and disclosure generally,
pursuant to proposed Rules 17Ad-22(e)(1) (legal risk), (e)(2)
(governance), and (e)(23) (disclosure of rules, key procedures, and
market data). See infra Parts II.B.1, 2, and 20, respectively.
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The Commission acknowledges that practices regarding physical
delivery vary based on the types of assets that a covered clearing
agency settles.\245\ A covered clearing agency would be required,
however, to state clearly which asset classes it accepts for physical
delivery and the procedures surrounding the delivery of each. The
Commission notes that there are a number of arrangements that a covered
clearing agency could employ pursuant to the requirements of the
proposed rule. For example, if a covered clearing agency takes physical
delivery of securities from its members in return for payments of cash,
then it should inform its members of the extent of the clearing
agency's obligations to make payment. The Commission envisions that one
possible approach a covered clearing agency could take in fulfillment
of the proposed requirement would be to employ policies and procedures
that clearly state any obligations it incurs to members for losses
incurred in the delivery process. In addition, its policies and
procedures could clearly state rules or obligations regarding
definitions for acceptable physical instruments, the location of
delivery sites, rules for storage and warehouse operations, and the
timing of delivery.
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\245\ The proposed rule would provide covered clearing agencies
with flexibility to achieve clear and transparent standards but
would necessarily require an approach that provides sufficient
notice to its participants regarding the covered clearing agency's
obligations. See infra Parts II.B.20 and VII (discussing a covered
clearing agency's disclosure obligations pursuant to proposed Rule
17Ad-22(e)(23) and providing proposed rule text).
The Commission notes that CDS employing the contractual term
``physical delivery'' or similar language, which upon an event of
default are settled by ``physical delivery'' of the instrument (as
such terms are used in the agreement) to the protection seller by
the protection buyer are not within the scope of this rule merely
because of such contractual terminology where they are not delivered
in paper form (but are delivered through book entry or electronic
transfer).
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The proposed rule would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to identify, monitor, and manage the
risks that arise in connection with their obligations for physical
deliveries.\246\ The Commission notes that this is similar to the
requirement for a registered clearing agency's policies and procedures
to identify and manage the risks from its obligations in Rule 17Ad-
22(d)(15).\247\ As with Rule 17Ad-22(d)(15), the Commission believes
that requiring a clearing agency's policies and procedures to identify,
monitor, and manage these risks facilitates its ability to deal
preemptively with potential issues with physical delivery, in line with
Exchange Act requirements to facilitate prompt and accurate clearance
and settlement and the safeguarding of assets.\248\
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\246\ See proposed Rule 17Ad-22(e)(10), infra Part VII.
\247\ See supra note 243.
\248\ See 15 U.S.C. 78q-1(b)(3)(F).
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The Commission preliminarily notes that certain risks associated
with physical deliveries could stem from operational limitations with
respect to assuring receipt of and processing of physical deliveries.
Other operational risks may relate to personnel, which can be mitigated
by having policies and procedures designed to review and assess the
qualifications of potential employees, including reference and
background checks and employee training, among other things. Further
operational risks include theft, loss, counterfeiting, and
deterioration of or damage to assets.\249\ Insurance coverage may be
one way to mitigate such risk of theft, loss, counterfeiting, fraud,
and damage to assets. Other appropriate methods to identify, monitor,
and manage risks related to delivery and storage of physical assets may
include ensuring records of physical assets received and held
accurately reflect holdings and that employee duties for such
recordkeeping for and holding of physical assets are separated.
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\249\ In addition, the Commission is proposing Rule 17Ad-
22(e)(17) to establish minimum requirements for operational risk
management. See infra Parts IV.C.3.a.xii and VII (further discussing
the proposed requirements and providing proposed rule text).
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(10). In addition, the
Commission requests comments on the following specific issue:
Should the Commission require a covered clearing agency's
policies and procedures to establish and maintain transparent written
standards that state its obligations with respect to the delivery of
physical instruments? Why or why not? Are there physical delivery
obligations that a covered clearing agency's policies and procedures
should not be required to state through transparent written standards?
If so, please explain.
8. Proposed Rule 17Ad-22(e)(11): Central Securities Depositories
Proposed Rule 17Ad-22(e)(11) would apply only to a covered clearing
agency providing CSD services (hereinafter a ``covered CSD'' in this
part).\250\ Proposed Rule 17Ad-22(e)(11)(i) would require a covered CSD
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain securities in an immobilized
or dematerialized form for their transfer by book entry, ensure the
integrity of securities issues, and minimize and manage the risks
associated with the safekeeping and transfer of securities.\251\ While
Rule 17Ad-22(d)(10) similarly requires registered clearing agencies
that provide CSD services to have policies and procedures reasonably
designed to immobilize or dematerialize securities certificates and
transfer them by book entry to the greatest extent possible, \252\
proposed Rule 17Ad-22(e)(11) would also require a covered CSD to have
policies and procedures that ensure the integrity of securities issues,
and minimize and manage the risks associated with the safekeeping and
transfer of securities. The Commission preliminarily believes these
additional requirements are appropriate for covered CSDs given the
risks that a covered CSD's size, operation, and importance pose to the
U.S. securities markets.
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\250\ See proposed Rule 17Ad-22(a)(3), infra Part VII (defining
``central securities depository services''). In the United States,
DTC is currently the only registered clearing agency that provides
CSD services.
This definition is currently codified at 17 CFR 240.17Ad-
22(a)(2). See supra note 61 (noting that 17 CFR 240.17Ad-22(a) is
being revised to incorporate additional terms).
\251\ See proposed Rule 17Ad-22(e)(11), infra Part VII.
\252\ In full, existing Rule 17Ad-22(d)(10) requires registered
clearing agencies that provide CSD services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to immobilize or dematerialize securities certificates and
transfer them by book entry to the greatest extent possible. See 17
CFR 240.17Ad-22(d)(10); see also Clearing Agency Standards Release,
supra note 5, at 66253-54.
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Like existing Rule 17Ad-22(d)(10), proposed Rule 17Ad-22(e)(11)(i)
would, among other things, require a covered CSD to have policies and
procedures to maintain securities in an immobilized or dematerialized
form for transfer by book entry.\253\ The Commission
[[Page 29541]]
preliminarily believes this approach would continue to promote a
reduction in securities transfer processing costs, as well as the risks
associated with securities settlement and custody, such as destruction
or theft, by removing the need to hold and transfer many, if not most,
physical certificates.\254\ In addition, the Commission preliminarily
believes the requirement would continue to promote prompt and efficient
settlement processes through the potential for increased automation and
may also help reduce the risk of error and delays in securities
processing. The Commission also preliminarily believes the proposed
rule would, like Rule 17Ad-22(d)(10), further the objectives in Section
17A of the Exchange Act requiring the Commission to end the physical
movement of securities certificates in connection with settlement among
brokers and dealers.\255\ Further, the Commission preliminarily
believes that the proposed rule, by continuing to facilitate book-entry
transfer, may also continue to facilitate the use of exchange-of-value
settlement systems, which help to reduce settlement risk pursuant to
proposed Rule 17Ad-22(e)(12).\256\
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\253\ Immobilization refers to any circumstance where an
investor does not receive a physical certificate upon the purchase
of shares or is required to physically deliver a certificate upon
the sale of shares. Dematerialization is the process of eliminating
physical certificates as a record of security ownership.
The Commission notes that, while registered clearing agencies
that provide CSD services are already subject to this requirement
under Rule 17Ad-22(d)(10), the Commission is proposing Rule 17Ad-
22(e)(10) as part of a comprehensive set of rules for regulating
covered clearing agencies. Because Rule 17Ad-22(d)(10) already
contains this requirement, however, the Commission anticipates that
covered clearing agencies may need to make only limited changes to
update their policies and procedures to comply with this requirement
under the proposed rule. See supra Part II.A.4.
\254\ By concentrating the location of physical securities in a
CSD, clearing agencies are able to achieve efficiencies in clearance
and settlement by streamlining transfer. Virtually all mutual fund
securities, government securities, options, and municipal bonds in
the United States are dematerialized and most of the equity and
corporate bonds in the U.S. market are either immobilized or
dematerialized. While the U.S. markets have made great strides in
achieving immobilization and dematerialization for institutional and
broker-to-broker transactions, many industry representatives believe
that the small percentage of securities held in certificated form
imposes unnecessary risk and expense to the industry and to
investors. See Exchange Act Release No. 34-49405 (Mar. 11, 2004), 69
FR 12922, 12933 (Mar. 18, 2004).
\255\ See 15 U.S.C. 78q-1(e).
\256\ See infra Parts II.B.9 (discussing proposed Rule 17Ad-
22(e)(12) for exchange-of-value settlement systems) and IV.C.3.a.vi
(noting that the economic effect of book-entry transfer in a
delivery versus payment system is to allow securities to be credited
to an account immediately upon debiting the account for the payment
amount and that it thereby helps reduce trade failures).
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As with Rule 17Ad-22(d)(10), the Commission notes that the proposed
requirement for policies and procedures to cover maintaining securities
in an immobilized form is not intended to prohibit a covered CSD from
holding physical securities certificates on behalf of its members for
purposes other than to facilitate immobilization where such securities
currently continue to exist in paper form. In this regard, the
Commission believes it would be useful to describe three relevant
features of the current U.S. market. First, in order for securities to
be offered and sold publicly, the offer or sale of the securities
generally must be registered with the Commission or subject to an
exemption from registration.\257\ Securities sold in an exempt
transaction may be subject to restrictions. For example, securities
acquired from the issuer in a transaction not involving any public
offering are restricted securities,\258\ are subject to restrictions on
resale, often bear legends that discuss such restrictions, and often
are in paper certificate form in current market practice. The
restrictions on such securities may make more complex the
immobilization or ultimate dematerialization of these paper
certificates. For instance, registered CSDs in the United States
currently do not provide book-entry transfer for all restricted
securities.\259\
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\257\ See 15 U.S.C. 77e.
\258\ See 17 CFR 230.144(a)(3).
\259\ See 17 CFR 230.144A; see also Exchange Act Release No. 34-
59384 (Feb. 11, 2009), 74 FR 7941 (Feb. 20, 2009); DTC, Operational
Arrangements, Secs. I.A.2 & I.B.5 (Jan. 2012), available at http://www.dtcc.com/.
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Second, U.S. law generally does not provide for a federal corporate
law or corporate charter. Instead, states currently permit corporations
to issue stock certificates to registered owners. While the market in
the United States has made advances in immobilizing and dematerializing
securities, no federal statute or regulation prohibits the issuance of
paper certificates to registered owners of a class of securities
registered under the Exchange Act or companies that file periodic
reports with the Commission. Accordingly, the Commission's rules do not
prohibit, and in some respects contemplate, the issuance of securities
certificates.\260\ As a result, some registered owners may hold
securities in paper certificate form.
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\260\ In the absence of a federal or state requirement, an
issuer could limit its issuance of certain types of securities to
book-entry only form through its own charter, bylaws, or policies.
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Third, some broker-dealers in the United States no longer operate
vaults in which to hold securities certificates registered in the names
of their customers where such customers seek a third-party to
physically hold their certificates. In such cases, broker-dealers
(without an in-house vault) may utilize the vault services of the CSD
of which they are a participant in order to be able to offer such
custody service to their customers.
The Commission also notes that the proposed rule is not intended to
alter the following practices in the U.S. market. Proposed Rule 17Ad-
22(e)(11) would not prohibit a covered CSD from providing custody-only
services for purposes not intended to promote immobilization to
facilitate street name transfer but solely to hold these securities for
third parties. Likewise, proposed Rule 17Ad-22(e)(11) would not
prohibit a covered CSD from holding American depositary shares in
custody.\261\
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\261\ Issuers of American depositary receipts (``ADRs''),
whether in programs sponsored or unsponsored by a foreign issuer,
may hold the underlying shares of the foreign issuer (which may be
in paper certificate form and are commonly referred to as American
depositary shares) to which the ADRs relate in the ultimate custody
of a covered CSD.
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In addition, the Commission preliminarily believes that the
policies and procedures of a covered CSD should be required to ensure
the integrity of securities issues and minimize and manage the risks
associated with the safekeeping and transfer of securities, given the
risks that a covered CSD's size, operation, and importance pose to the
U.S. securities markets, for the following reasons. First, the
preservation of the rights of issuers and holders of securities is
necessary for the orderly functioning of the securities markets.\262\
The integrity of a securities issue can be undermined, for instance, if
a covered CSD does not prohibit overdrafts and debit balances in
securities accounts, which can create unauthorized issuances of
securities that undermine the integrity of the covered CSD's services.
Second, minimizing and managing the risks associated with the
safekeeping and transfer of securities promotes risk management
policies and procedures that address custody risk.\263\
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\262\ The Commission is proposing additional requirements under
Rule 17Ad-22(e)(11) to further address the integrity of securities
issues. See infra Part II.B.8.a.
\263\ The Commission is proposing additional requirements under
Rule 17Ad-22(e)(11) to further address custody risk at covered CSDs.
See infra Part II.B.8.c.
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In addition, the Commission is proposing the requirements described
below. Although Rule 17Ad-22(d)(10) does not include similar
requirements, the Commission anticipates that, based on the current
practices of registered CSDs in the United States, a registered CSD may
need to make only limited changes to update its policies and procedures
to comply with the below proposed requirements.\264\
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\264\ See infra Parts IV.B.3.d.i (discussing the current
practices of registered CSDs in the United States) and IV.C.3.a.vi
(discussing the anticipated economic effect of the proposed rule).
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[[Page 29542]]
a. Controls To Safeguard the Rights of Securities Issuers and Holders
and Prevent the Unauthorized Creation or Deletion of Securities
Proposed Rule 17Ad-22(e)(11)(ii) would require a covered CSD to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to implement internal auditing and other
controls to safeguard the rights of securities issuers and holders and
prevent the unauthorized creation or deletion of securities.
The Commission preliminarily believes that the proposed requirement
to safeguard the rights of issuers and holders is appropriate because,
while issuers and holders may not be participants in a covered CSD,
they access its services through covered CSD immobilization or
dematerialization of securities and thus a failure to safeguard
securities by the CSD may adversely affect issuers or holders,
including for example by creating legal problems related to
unauthorized issuance of securities, dilution of a holder's ownership
interest or the holder's claim on the security as beneficial owner
where holding indirectly through a member of the CSD.
As noted above, the preservation of the rights of securities
issuers and holders is necessary for the orderly functioning of the
securities markets. Accordingly, the Commission preliminarily believes
the proposed rule is appropriate to help ensure that a covered clearing
agency can verify that its records are accurate and provide a complete
accounting of its securities issues.
b. Periodic and at Least Daily Reconciliation of Securities Maintained
Proposed Rule 17Ad-22(e)(11)(ii) would require a covered CSD to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to conduct periodic and at least daily
reconciliation of securities issues it maintains.\265\ The Commission
preliminarily believes that the proposed requirement to reconcile on a
daily basis securities maintained would (i) support the safeguarding of
securities because, through such internal control procedures, accurate
record-keeping is promoted and thereby safe, accurate, and effective
clearing and settlement is also promoted, and (ii) further benefit
issuers and holders, as discussed above, by potentially preventing
unauthorized issuance of securities, dilution of a holder's positions,
or the holder's claim on the security as beneficial owner where holding
indirectly through a member of the CSD.
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\265\ See proposed Rule 17Ad-22(e)(11), infra Part VII. The
Commission preliminary believes that daily reconciliation is
appropriate for the reasons described in Part II.A.3.
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The Commission notes that CSDs in the United States currently do
not provide registrar or transfer agent services to record name owners
of securities. CSD services that facilitate book-entry transfer are
limited to holding jumbo/global certificates in custody or, through
sub-custodian relationships with the transfer agent for a particular
issuer via the Fast Automated Securities Transfer (``FAST'') system,
which is used to maintain jumbo/global record ownership position
balances of the CSD's holdings in a particular issue.\266\ In both
cases, custody or sub-custody facilitates book-entry transfer for
ultimate beneficial owners as the CSD credits and debits the accounts
of its members, which then maintain records of ownership and send
account statements to their customers that are the ultimate beneficial
owners. Since the registrar maintaining the security holder list for an
issuer is not the CSD, the daily reconciliation requirement applicable
to a covered CSD reconciling CSD ownership positions (that facilitate
book-entry transfer for ultimate beneficial owners) against the record
of such CSD ownership positions on the security holder list could not
be done solely in-house but would require the CSD to coordinate with
the registrar maintaining the security holder list for each issue that
has been immobilized.\267\
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\266\ For a description of DTC's rules relating to FAST, see
Exchange Act Release Nos. 34-64191 (Apr. 5, 2011), 76 FR 20061 (Apr.
11, 2011); 34-61800 (Mar. 30, 2010), 75 FR 17196 (Apr. 5, 2010); 34-
60196 (Jun. 30, 2009), 74 FR 33496 (Jul. 13, 2009); 34-46956 (Dec.
2, 2002), 67 FR 77115 (Dec. 16, 2002); 34-31941 (Mar. 3, 1993); 34-
21401 (Oct. 16, 1984); 34-14997 (Jul. 26, 1978); and 34-13342 (Mar.
8, 1977).
\267\ Commonly, the entity performing the registrar and transfer
services for an issue would be the same. Both functions are
functions that place an entity within the definition of ``transfer
agent'' pursuant to Section 3(a)(25) of the Exchange Act and the
related regulatory regime for transfer agents. See 15 U.S.C.
78c(a)(25).
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c. Protect Assets Against Custody Risk
Proposed Rule 17Ad-22(e)(11)(iii) would require a covered CSD to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to protect assets against custody risk
through appropriate rules and procedures consistent with relevant laws,
rules, and regulations in jurisdictions where it operates.\268\ The
Commission preliminarily believes the proposed requirement to address
custody risk is appropriate because a covered CSD faces risks of
negligence, misuse of assets, fraud, record-keeping or administrative
failures, loss, destruction, damage, natural disaster, and theft or
other crime regarding assets held in custody. The Commission
preliminarily believes that the proposed rule would further support
Section 17A(b)(3)(F) of the Exchange Act, which requires the rules of a
clearing agency to assure the safeguarding of securities and funds that
are in the custody or control of the clearing agency or for which it is
responsible.\269\
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\268\ See proposed Rule 17Ad-22(e)(11), infra Part VII. For
example, in the United States, additional safekeeping requirements
may apply under state law. See, e.g., N.Y. UCC Law 8-504 (requires
securities intermediaries, including clearing corporations, to
exercise due care in accordance with reasonable commercial standards
to obtain and maintain the financial asset).
\269\ See 15 U.S.C. 78q-1(b)(3)(F).
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Such custody risk may be related to physical delivery risk, which
proposed Rule 17Ad-22(e)(10) would require a covered clearing agency's
policies and procedures to identify, monitor, and manage.\270\
Operational risks may also be implicated, including those relating to
personnel, which can be mitigated by having policies and procedures
designed to review and assess the qualifications of potential
employees, including reference and background checks and employee
training, among other things. Additional operational risks include
theft, loss, counterfeiting, and deterioration of or damage to
assets.\271\ Insurance coverage may be one way to mitigate such risk of
theft, loss, counterfeiting, fraud, and damage to assets. Other
appropriate methods to monitor and manage custody risks may include
ensuring records of securities held in custody accurately reflect
holdings and that employee duties for such recordkeeping for and
holding of securities are separated.\272\
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\270\ See supra Part II.B.7 and infra Part VII (discussing the
requirements under proposed Rule 17Ad-22(e)(10) and providing
proposed rule text).
\271\ The Commission is also proposing Rule 17Ad-22(e)(17) to
establish minimum standards for operational risk management. See
infra Parts II.B.14 and VII.
\272\ The Commission is also proposing Rule 17Ad-22(e)(16) to
establish minimum standards for custody and investment risk. See
infra Parts II.B.13 and VII.
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The Commission also preliminarily notes that increased
dematerialization would not eliminate the applicability of the
requirement to protect assets against custody risk. When held in
electronic custody through accounting entries, such as through
electronic sub-custody
[[Page 29543]]
of the CSD global/jumbo record ownership position with a transfer agent
via FAST, assets may nevertheless remain subject to operational risks
and may be subject to variations of such risks, such as hacking or
digital piracy, that are different from those risks faced with respect
to paper certificates.
d. Request for Comments
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-22(e)(11). In addition, the Commission requests
comments on the following specific issues:
Should the Commission require a covered CSD's policies and
procedures to maintain securities in an immobilized or dematerialized
form for their transfer by book entry? Why or why not? Are there any
circumstances under which this would be inappropriate? Please explain.
Should the Commission require a covered CSD's policies and
procedures to ensure the integrity of securities issues? Why or why
not?
Should the Commission require a covered CSD's policies and
procedures to protect assets against custody risk through appropriate
rules and procedures consistent with relevant laws, rules, and
regulations in jurisdictions where it operates? Why or why not?
Are there any other requirements that should be included
in the proposed rule to promote sound practices at covered CSDs? For
instance, should the Commission require a covered CSD's policies and
procedures to include provisions to identify, measure, monitor, and
manage its risks from other activities that it may perform? Should the
Commission require a covered CSD's policies and procedures to employ a
robust system that ensures segregation between the CSD's own assets and
the securities of its participants and segregation among the securities
of participants? Why or why not?
9. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems
Proposed Rule 17Ad-22(e)(12) would apply to transactions cleared by
a covered clearing agency that involve the settlement of two linked
obligations.\273\ The proposed rule would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to eliminate principal risk by
conditioning the final settlement of one obligation upon the final
settlement of the other, regardless of whether the covered clearing
agency settles on a gross or net basis and when finality occurs.\274\
The Commission preliminarily believes that the proposed rule is
appropriate to help reduce the potential that delivery of a security is
not appropriately matched with payment for the security, thereby
impairing a covered clearing agency's ability to facilitate prompt and
accurate clearance and settlement.
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\273\ See proposed Rule 17Ad-22(e)(12), infra Part VII.
\274\ See id.
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Rule 17Ad-22(d)(13) similarly requires that a registered clearing
agency's policies and procedures be reasonably designed to eliminate
principal risk by linking securities transfers to funds transfers in a
way that achieves delivery versus payment (``DVP''),\275\ though it
does not specify that settlement should occur regardless of whether the
clearing agency settles on a gross or net basis and when finality
occurs. Because this is the only provision that differs between
proposed Rule 17Ad-22(e)(12) and existing Rule 17Ad-22(d)(13), the
Commission anticipates that covered clearing agencies may need to make
only limited changes to update their policies and procedures.\276\
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\275\ See 17 CFR 240.17Ad-22(d)(13); see also Clearing Agency
Standards Release, supra note 5, at 66256.
\276\ See supra Part II.A.4.
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The Commission notes that ensuring settlement finality only when
settlement of the corresponding obligation is final--regardless of
whether a covered clearing agency settles on a gross or net basis--may
require corresponding policies and procedures that address legal,
contractual, operational, and other risks.\277\ Given the risks that
the size, operation, and importance of covered clearing agencies pose
to the U.S. securities markets, the Commission preliminarily believes
that this requirement is appropriate for covered clearing agencies.
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\277\ See supra Parts II.B.1-3 and infra Parts II.B.14 and VII
(discussing proposed rules establishing minimum standards for legal
risk and governance arrangements, requiring a comprehensive risk
management framework, requiring minimum standards for operational
risk management, and providing proposed rule text in each case,
respectively).
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Market confidence, in addition to public confidence more generally,
hinges in large part on the dependability and promptness of the
clearing and settlement systems underlying a given market. If CCPs are
unable to promptly and fully give to clearing members access to funds
due, they and other market participants may lose confidence in the
settlement process.\278\
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\278\ See Arthur Levitt, Chairman, U.S. Securities and Exchange
Commission, Speeding Up Settlement: The Next Frontier, Remarks
before the Symposium on Risk Reduction in Payments, Clearance and
Settlement Systems (Jan. 26, 1996), available at http://www.sec.gov/news/speech/speecharchive/1996/spch071.txt.
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As under Rule 17Ad-22(d)(13), a covered clearing agency can link
securities transfers to funds transfers and mitigate principal risk in
connection with settlement through DVP settlement mechanisms. DVP is
achieved in the settlement process when the mechanisms facilitating
settlement ensure that delivery occurs only if payment occurs.\279\ DVP
eliminates the risk that a party would lose some or its entire
principal because securities were delivered without payments being
confirmed. The Commission notes that DVP settlement mechanisms are
prevalent among registered clearing agencies because they eliminate
principal risk and reduce the settlement risk that arises in a
securities transaction. A counterparty default absent a DVP settlement
mechanism may cause substantial losses and liquidity pressures.
Further, a settlement default could result in high replacement costs
because the unrealized gain on an unsettled contract or the cost of
replacing the original contract at market prices may change rapidly
during periods of market stress.
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\279\ See BIS, Delivery Versus Payment in Securities Settlement
Systems (Sept. 1992), available at http://www.bis.org/publ/cpss06.pdf. Three different DVP models can be differentiated
according to whether the securities and/or funds transfers are
settled on a gross (trade-by-trade) basis or on a net basis.
Proposed Rule 17Ad-22(e)(10), supra Part II.B.7 and infra Part VII,
would establish minimum requirements for physical deliveries.
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(12). In addition, the
Commission requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to, if the covered clearing agency settles
transactions that involve the settlement of two linked obligations,
eliminate principal risk by conditioning the final settlement of one
obligation upon the final settlement of the other? Should the
Commission impose this policy and procedure requirement regardless of
whether the covered clearing agency settles on a gross or net basis, as
proposed? Should the Commission impose this policy and procedure
requirement regardless of when finality occurs, as proposed? Why or why
not?
Does the proposed rule affect certain identifiable
categories of covered clearing agencies differently than others, such
as clearing agencies with more
[[Page 29544]]
diversified post-trade services as compared to clearing agencies that
specialize in fewer activities? If so, how? How should the proposed
rule account for these differences?
Are there operational or legal impediments to implementing
the proposed rule? Would the proposed rule make it more difficult for
covered clearing agencies to conduct certain types of business that may
require a longer settlement cycle, for reasons outside of their
control? Are any additional rules or regulations needed to support
achievement of the proposed rule?
Are there circumstances when ensuring that the settlement
of an obligation is final if and only if the settlement of the
corresponding obligation is final is not feasible or practicable? If
so, when?
10. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and
Procedures
Proposed Rule 17Ad-22(e)(13) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency has the authority and operational capacity to take timely action
to contain losses and liquidity demands and continue to meet its
obligations in the event of a participant default.\280\ Because Rule
17Ad-22(d)(11) currently requires a registered clearing agency's
policies and procedures to meet substantially the same
requirements,\281\ the Commission anticipates that covered clearing
agencies may need to make only limited changes to update their policies
and procedures to comply with the proposed rule.\282\
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\280\ See proposed Rule 17Ad-22(e)(13), infra Part VII. The
Commission is proposing Rule 17Ad-22(e)(13) as part of a
comprehensive set of rules for regulating covered clearing agencies
that is consistent with and comparable to other domestic and
international standards for FMIs.
\281\ Rule 17Ad-22(d)(11) requires a registered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to establish default procedures that
ensure that the clearing agency can take timely action to contain
losses and liquidity pressures and to continue meeting its
obligations in the event of a participant default. See 17 CFR
240.17Ad-22(d)(11); see also Clearing Agency Standards Release,
supra note 5, at 66254-55.
\282\ See supra Part II.A.4.
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As with Rule 17Ad-22(d)(11), the Commission believes that proposed
Rule 17Ad-22(e)(13) is appropriate given the importance of having
established procedures in the event a covered clearing agency faces a
member default. The proposed rule would continue to provide certainty
and predictability to market participants about the measures a clearing
agency will take in the event of a participant default as default
procedures, among other things, are meant to reduce the likelihood that
a default by one or more participants will disrupt the clearing
agency's operations. By establishing, implementing, maintaining and
enforcing such policies and procedures, a covered clearing agency
should be in a better position to continue providing its services in a
manner that promotes prompt and accurate clearance and settlement
during times of market stress.\283\ Accordingly, a covered clearing
agency that has financial and operational triggers for default would
need to ensure these are clearly defined.\284\ In addition, where
triggers are not automatic through the application of objective
standards or thresholds, the discretion afforded a covered clearing
agency to declare defaults would need to be clearly defined.\285\ For
example, a clear definition may include defining which person or group
exercises discretionary authority in the event of default and providing
specific examples of when the exercise of discretion is appropriate.
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\283\ The Commission is also proposing Rule 17Ad-22(e)(23) to
require disclosure of rules, key procedures, and market data to
members, market participants, and in certain circumstances the
public. See infra Parts II.B.20 and VII (discussing the proposed
rule and providing rule text, respectively).
\284\ An operational default may occur when a participant is not
able to meet its obligations due to an operational problem, such as
a failure in information technology systems. The Commission is
proposing Rule 17Ad-22(e)(17) to establish minimum standards for
operational risk management. See infra Parts II.B.14 and VII
(discussing the proposed rule and providing rule text,
respectively).
\285\ In this regard, the Commission notes that policies and
procedures regarding participant default must satisfy the
requirement for legal certainty in proposed Rule 17Ad-22(e)(1). See
supra Part II.B.1.
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The proposed rule would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to ensure that it can take timely action
to contain losses and liquidity pressures and to continue meeting its
obligations when due in the event of a member default.\286\ Default
procedures are meant to reduce the likelihood that a default by a
member, or multiple members, will disrupt the covered clearing agency's
operations. Based on its supervisory experience, the Commission
preliminarily believes such policies and procedures would address,
among other things, the following: (i) Accessing credit facilities,
(ii) managing (which may include hedging open positions and funding
collateral positions it is not prudent to close out immediately),
transferring (such as through allocation or auction to other members)
and/or closing out a defaulting member's positions; and (iii)
transferring and/or liquidating applicable collateral. By employing
policies and procedures that are designed to permit a covered clearing
agency to take actions to contain losses and liquidity pressures it
faces in the event of a participant default while continuing to meet
its obligations, a covered clearing agency should be in a better
position to continue providing its services in a manner that promotes
accurate clearance and settlement during times of market stress.
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\286\ See proposed Rule 17Ad-22(e)(13), infra Part VII. A
clearing agency may be able to contain liquidity pressures it faces
by taking actions to secure additional sources of liquidity or
limiting transactions that potentially serve to drain liquidity
resources.
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A covered clearing agency should also have the operational capacity
to comply with the proposed requirements to contain losses. The
Commission preliminarily believes that the following measures would
help promote such operational capacity: (i) Establishing training
programs for employees involved in default matters to ensure policies
are well implemented; (ii) developing a communications strategy for
communicating with stakeholders, including the Commission, concerning
defaults; and (iii) making sure the proper tools and resources (whether
these are personnel or other) required are available to close out,
transfer, or hedge open positions of a defaulting member promptly even
in the face of rapid market movements.\287\
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\287\ See supra note 284 and accompanying text. The Commission
has also proposed Regulation Systems Compliance and Integrity
(``Regulation SCI'') to establish requirements for operational
capacity. See infra note 326 and accompanying text.
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In addition, based on its supervisory experience, the Commission
preliminarily believes that a covered clearing agency's default
procedures would generally include the following: (i) The action that
may be taken (e.g., exercising mutualization of losses); (ii) who may
take those actions (e.g., the division of responsibilities when
clearing agencies operate links to other clearing agencies); (iii) the
scope of the actions that may be taken (e.g., any limits on the total
losses that would be mutualized); (iv) potential changes to the normal
settlement practices, should these changes be necessary in extreme
circumstances, to ensure timely settlement; (v) the management of
transactions at different stages of processing; (vi) the sequencing of
actions; (vii) the roles, obligations, and
[[Page 29545]]
responsibilities of the various parties, including non-defaulting
members; (viii) the mechanisms to address a covered clearing agency's
obligations to non-defaulting members (e.g., the process for clearing
trades guaranteed by the covered clearing agency to which a defaulting
member is a party); and (ix) the mechanisms to address the defaulting
member's obligations to its customers (e.g., the process for dealing
with a defaulting member's accounts).
In addition, proposed Rule 17Ad-22(e)(13) would include the
requirements described below, for which no comparable requirements
under Rule 17Ad-22(d) are applicable to registered clearing agencies.
The Commission preliminarily believes the proposed requirements are
appropriate for covered clearing agencies given the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets.
a. Address Allocation of Credit Losses
Proposed Rule 17Ad-22(e)(13)(i) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to address the allocation of credit
losses it may face if its collateral and other resources are
insufficient to fully cover its credit exposures, including the
repayment of any funds the covered clearing agency may borrow from
liquidity providers.\288\
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\288\ See proposed Rule 17Ad-22(e)(13), infra Part VII.
---------------------------------------------------------------------------
The Commission preliminarily believes that this requirement is
appropriate because requiring that policies and procedures address key
aspects of the allocation of credit losses would provide certainty and
predictability about the measures available to a covered clearing
agency in the event of a default. Such certainty and predictability
would facilitate the orderly handling of member defaults and would
enable members to understand their obligations to the covered clearing
agency in extreme circumstances. In some instances, managing a member
default may involve hedging open positions, funding collateral so that
the positions can be closed out over time, or both. A covered clearing
agency may also decide to auction or allocate open positions to its
participants. To the extent possible, the Commission believes a covered
clearing agency would allow non-defaulting members to continue to
manage their positions in the ordinary course. By addressing the
allocation of credit losses, the covered clearing agency would have
policies and procedures intended to address the resolution of a member
default where its collateral and other financial resources are
insufficient to cover credit losses.
b. Describe Replenishment of Financial Resources
Proposed Rule 17Ad-22(e)(13)(ii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to describe its process to replenish
any financial resources it may use following a member default or other
event in which use of such resources is contemplated.\289\
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\289\ See proposed Rule 17Ad-22(e)(13), infra Part VII.
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The Commission preliminarily believes this requirement is
appropriate because the absence of procedures to replenish resources
may undermine a covered clearing agency's ability to contain losses and
liquidity pressures. The Commission also preliminarily believes that a
covered clearing agency's rules and procedures to draw on financial
resources will support the proposed rule's other requirements to
contain losses and liquidity pressures. Such procedures commonly
specify the order of use of different types of resources, including (i)
assets provided by the defaulting member (such as margin or other
collateral), (ii) the guaranty fund of the covered clearing agency,
(iii) capital calls on members, and (iv) credit facilities. In
addition, the Commission preliminarily believes a covered clearing
agency could satisfy the proposed requirement by having policies and
procedures that describe (i) how resources that have been depleted as a
result of a member default would be replenished over time and (ii) what
burdens a non-defaulting member may bear.
c. Test Default Procedures Annually and Following Material Changes
Proposed Rule 17Ad-22(e)(13)(iii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to require its members and, when
practicable, other stakeholders to participate in the testing and
review of its default procedures, including any close out procedures.
The proposed rule would also require policies and procedures providing
for such testing and review to occur at least annually and following
material changes thereto.\290\ The Commission preliminarily expects
that covered clearing agencies would make efforts to secure the
participation of all stakeholders in such testing and review of default
procedures but recognizes that covered clearing agencies may have
limited ability to require said participation by all such stakeholders,
and therefore the proposed rule requires such participation by other
stakeholders only when practicable.
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\290\ See proposed Rule 17Ad-22(e)(13), infra Part VII. The
Commission preliminary believes that an annual testing cycle is
appropriate for the reasons described in Part II.A.3.
---------------------------------------------------------------------------
The Commission preliminarily believes that including members and
other stakeholders in such testing will help to ensure that procedures
will be practical and effective in the face of an actual default. In
addition to the relevant employees, members, and other stakeholders
that would be involved in testing default procedures, a covered
clearing agency may determine, as appropriate, to include members of
its board of directors or similar governing body, and to invite linked
clearing agencies, significant indirect participants, providers of
credit facilities, and other service providers to participate. The
Commission preliminarily believes requiring member and, where
practicable, stakeholder participation in periodic testing is
appropriate because successful default management will require
coordination among these parties, particularly during periods of market
stress.
d. Request for Comments
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-22(e)(13). In addition, the Commission requests
comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to ensure the covered clearing agency has the
authority and operational capacity to take timely action to contain
losses and liquidity demands and continue to meet its obligations?
Should the proposed rule include minimum requirements, as proposed? Why
or why not?
Should the Commission require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require its members and, when
practicable, other stakeholders to participate in the testing and
review of its default procedures? Why or why not? Is it appropriate for
stakeholders other than a covered clearing agency's participants to
participate in the testing and review of its default procedures? Why or
why not? Should the Commission require policies and procedures that
would require stakeholders to be included in testing unless a
determination is made by the
[[Page 29546]]
covered clearing agency that it would be impracticable to do so?
Should the Commission require policies and procedures
regarding specific default procedures for covered clearing agencies, or
should they have discretion to create their own default procedures
consistent with the proposed rule? If the latter, how much flexibility
should a covered clearing agency have in its policies and procedures
regarding the time it takes to manage a default and liquidate
positions?
11. Proposed Rule 17Ad-22(e)(14): Segregation and Portability
Proposed Rule 17Ad-22(e)(14) would apply to a covered clearing
agency that is either a security-based swap clearing agency or a
complex risk profile clearing agency.\291\ The proposed rule would
require such a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to enable the segregation and portability of positions of a
member's customers and the collateral provided to the covered clearing
agency with respect to those positions, and effectively protect such
positions and related collateral from the default or insolvency of that
member.\292\ The Commission notes that security-based swap clearing
agencies are currently not subject to rules regarding segregation and
portability under existing Rule 17Ad-22.
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\291\ See proposed Rule 17Ad-22(e)(14), infra Part VII.
\292\ See id.
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The Commission preliminarily believes that proposed Rule 17Ad-
22(e)(14) is appropriate because it facilitates the protection of
customer collateral and positions by requiring a covered clearing
agency's policies and procedures to prescribe means for holding or
accounting for them separately from the assets of the clearing agency
member providing services to the customer.
The Commission preliminarily believes that proposed Rule 17Ad-
22(e)(14) should apply only to security-based swap clearing agencies
and complex risk profile clearing agencies because existing rules
applicable to broker-dealers address customer security positions and
funds in cash securities and listed option markets, thereby promoting
segregation and portability and protecting customer positions and
funds.\293\ The Commission considered certain international standards,
which recognize that cash market CCPs operate in legal regimes that
achieve protection of customer assets by alternate means, in proposing
Rule 17Ad-22(e)(14).\294\ The Commission further notes that customer
security positions and funds in cash securities and listed options
markets are further protected under the Securities Investor Protection
Act of 1970 (``SIPA'').\295\
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\293\ Exchange Act Rule 15c3-3 requires broker-dealers that
maintain custody of customer securities and cash (a ``carrying
broker-dealer'') to take two primary steps to safeguard these
assets. The steps are designed to protect customers by segregating
their securities and cash from the broker-dealer's proprietary
business activities. If the broker-dealer fails financially, the
securities and cash should be readily available to be returned to
customers. In addition, if the failed broker-dealer is liquidated in
a formal proceeding under the Securities Investor Protection Act of
1970, the securities and cash would be isolated and readily
identifiable as ``customer property'' and, consequently, available
to be distributed to customers ahead of other creditors.
The first step required by Rule 15c3-3 is that a carrying broker
must maintain physical possession or control of all fully paid and
excess margin securities of their customers. See 17 CFR 240.15c3-3.
Physical possession or control means the broker-dealer must hold
these securities in one of several locations specified in Rule 15c3-
3 and free of liens or any other interest that could be exercised by
a third party to secure an obligation of the broker-dealer.
Permissible locations include a bank, as defined in section 3(a)(6)
of the Exchange Act, and a clearing agency. As described herein,
holding jumbo/global positions in the record name and custody of a
clearing agency is a fundamental part of current U.S. market
structure in which many holders hold indirectly through ``street
name.''
The second step is that a carrying broker-dealer must maintain a
reserve of cash or qualified securities in an account at a bank that
is at least equal in value to the net cash owed to customers,
including cash obtained from the use of customer securities. The
account must be titled ``Special Reserve Bank Account for the
Exclusive Benefit of Customers.'' The amount of net cash owed to
customers is computed pursuant to a formula set forth in Exhibit A
to Rule 15c3-3. Under the customer reserve formula, the broker-
dealer adds up customer credit items (e.g. cash in customer
securities accounts and cash obtained through the use of customer
margin securities) and then subtracts from that amount customer
debit items (e.g. margin loans). If credit items exceed debit items,
the net amount must be on deposit in the customer reserve account in
the form of cash and/or qualified securities. A broker-dealer cannot
make a withdrawal from the customer reserve account until the next
computation and then even only if the computation shows that the
reserve requirement has decreased. The broker-dealer must make a
deposit into the customer reserve account if the computation shows
an increase in the reserve requirement. See 17 CFR 240.15c3-3.
In addition, records of customer positions are subject to
broker-dealer recordkeeping rules. Exchange Act Rules 17a-3 and 17a-
4 require records be kept for certain periods of time, such as three
or six year periods depending upon the type of record. See 17 CFR
240.17a-3, 17a-4.
See also 15 U.S.C. 78c-5 (providing for segregation with respect
to security-based swaps pursuant to Section 3E of the Exchange Act);
Exchange Act Release No. 34-68071 (Oct. 18, 2012), 77 FR 70213,
(Nov. 23, 2012) (proposing Rule 18a-4 under the Exchange Act for
segregation with respect to security-based swaps). The Commission
has also granted conditional relief under Sections 3E(b), (d), and
(e) of the Exchange Act to, among others, clearing entities dually
registered with the Commission and the CFTC as registered clearing
agencies and DCOs, respectively. See Exchange Act Release No. 34-
68433 (Dec. 14, 2012), 77 FR 75211 (Dec. 19, 2012).
\294\ International standards recognize that regimes providing
the same degree of protection as segregation and portability of
customer positions at a CCP include the following features, in the
event of a participant failure: (a) The customer positions can be
identified timely, (b) customers will be protected by an investor
protection scheme designed to move customer accounts from the failed
participant to another participant in a timely manner, and (c)
customer assets can be restored. See PFMI Report, supra note 1, at
83 (discussing Principle 14, Explanatory Note 3.14.6). The
Commission preliminarily believes that the customer protections
existing under the Commission's regulatory regime for broker-dealers
include each of these three features and that limiting the
application of proposed Rule 17Ad-22(e)(14) in the manner described
above is appropriate.
The Commission also notes that, separately, it has proposed Rule
18a-4 to apply customer protection rules to security-based swap
dealers and major security-based swap participants. The approach in
proposed Rule 18a-4 was modeled on the customer protection scheme
under Rule 15c3-3 for broker-dealers. See Exchange Act Release No.
34-68071 (Oct. 18, 2012), 77 FR 70213 (Nov. 23, 2012).
\295\ See 15 U.S.C. 78eee et seq. Pursuant to SIPA, when a
broker-dealer that is a member of the Securities Investor Protection
Corporation (``SIPC'') fails and customer assets are missing, SIPC
seeks to return customer cash and securities, and supplements the
distribution of the remaining customer assets at the broker-dealer
with SIPC reserve funds of up to $500,000 per customer, including a
maximum of $250,000 for cash claims.
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In addition, in so limiting the scope of proposed Rule 17Ad-
22(e)(14), the Commission intends to avoid requiring changes to the
existing structure of cash securities and listed options markets in the
United States where registered clearing agencies that provide CSD or
CCP services play a central role. Transactions in the U.S. cash
security and listed options markets are characterized by the following
features: (i) Customers of members generally do not have an account at
a clearing agency; \296\ and (ii) the clearing agency is not able to
identify which participants' customers beneficially own the street name
positions registered in the record name of the clearing agency (or its
nominee) and the clearing agency has no recourse to funds of customers
of members. Therefore, in part because neither portability nor
segregation could occur as a practical matter under the
[[Page 29547]]
current cash securities and listed options markets structure, the
Commission preliminarily believes that Proposed Rule 17Ad-22(e)(14)
should apply only to a covered clearing agency that is either a
security-based swap clearing agency or a complex risk profile clearing
agency.
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\296\ A customer of a member also would not have an account at
the clearing agency where holding in record name (rather than
through street name ownership). This is the case even where such
record name owner-customer does not receive a paper security
certificate but holds in book-entry form through the direct
registration system, as direct registration system accounts are
maintained by a transfer agent and not by the clearing agency. See
Exchange Act Release No. 34-63320 (Nov. 16, 2010), 75 FR 71473,
71474 (Nov. 23, 2010) (discussing the ability of registered owners
to hold their assets on the records of transfer agents in book-entry
form through the direct registration system).
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The Commission notes that segregation can be achieved either
through an omnibus account structure, as is common in the U.S.
securities markets today, or an individual account structure. An
omnibus account structure, where all collateral belonging to all
customers of a particular member is commingled and held in a single
account segregated from that of the member, might not be as
operationally intensive as an individual account structure. Omnibus
accounts may expose a customer to ``fellow-customer risk'' (i.e. the
risk that another customer of the same member will default) in the
event of a loss that exceeds the amount of available collateral posted
by the fellow customer who has defaulted and the available resources of
the member, in which case the remaining commingled collateral of the
member's non-defaulting customers may be exposed to the loss. Fellow-
customer risk is of particular concern because customers may have
limited ability to monitor or to manage the risk of their fellow
customers. To mitigate this risk, omnibus account structures can be
designed in a manner that operationally commingles collateral related
to customer positions while protecting customers legally on an
individual basis.\297\ This may require a covered clearing agency to
rely on the records of its members or maintain its own books reflecting
customer-level interest in the customer's portion of collateral.
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\297\ See, e.g., Protection of Cleared Swaps Customer Contracts
and Collateral; Conforming Amendments to the Commodity Broker
Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012) (CFTC adopting
rules imposing on DCOs legal segregation with operational
commingling (``LSOC'') for cleared swaps).
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An omnibus account structure may be more efficient when porting
positions and collateral for a group of customers subject to a
defaulting member (where there has been no customer default or where
customer collateral is legally protected on an individual basis).
Omnibus accounts may also foster portability depending on whether the
covered clearing agency collects margin on a gross or net basis. Margin
calculated on a gross basis to support individual customer portfolios
may result in less efficient netting with respect to members; however,
it may eliminate the possibility of under-margined customer positions
when ported. As a result, a clearing agency may be able to port in bulk
or piecemeal the positions of a customer of a member that has
defaulted. When margin is collected on a net basis, there may be a risk
that full portability cannot be achieved if under-margining means that
porting will depend on the ability and willingness of customers to
provide additional collateral where transferee members are unwilling to
accept the porting to them of under-margined positions.
Alternatively, an individual account structure may also provide a
high degree of protection from the default of another customer of a
member, as a customer's collateral is intended to be used to cover
losses associated solely with the default of that customer. In the
event of a member failure (whether or not due to a customer default),
clear and reliable identification of a customer's collateral may
promote portability of an individual customer's positions and
collateral or, alternatively, expedite their return to the customer.
Maintaining individual accounts, however, can be operationally and
resource intensive for a covered clearing agency and could impact the
overall efficiency of its clearing operations. An individual account
structure may also impact margin collection practices at a covered
clearing agency, as the individual account structure may be
inconsistent with net collection of margin because it may be
impractical for the covered clearing agency to allocate the net margin
to individual customers rather than among omnibus accounts.
The Commission preliminarily notes that a covered clearing agency
subject to the proposed rule would be required to structure its
portability arrangements in a way that makes it highly likely that the
positions and collateral of a defaulting member's customers will be
effectively transferred to one or more other members. The Commission
also preliminarily notes that the following methods may assist a
covered clearing agency in achieving portability: (i) Identifying
positions that belong to customers; (ii) identifying and asserting
rights to related collateral held by or through the covered clearing
agency; (iii) identifying potential members to accept the positions and
collateral; (iv) disclosing relevant information to such members so
that they can evaluate the counterparty credit and market risk
associated with the customers and positions, respectively; (v)
transferring positions and related collateral to one or more members;
and (vi) carrying out default management procedures in an orderly
manner.
Finally, where a covered clearing agency's policies and procedures
facilitating portability permit a transfer of specific positions and
collateral that is not performed with the consent of the member to whom
they are transferred, the Commission preliminarily believes that a
covered clearing agency could satisfy this requirement by having
policies and procedures that set out the circumstances where this may
occur. In addition, the Commission preliminarily notes that the
portability requirement does not apply only upon default of a member; a
covered clearing agency should have policies and procedures that
facilitate porting in the normal course of business, such as when a
customer ends its relationship with a member to start a new
relationship with a different member, or as a result of other events,
such as a merger involving the member.\298\
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\298\ In this regard, the Commission notes that policies and
procedures regarding segregation and portability must satisfy the
requirement for legal certainty in proposed Rule 17Ad-22(e)(1). See
supra Part II.B.1.
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(14). In addition, the
Commission requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to enable the segregation and portability of
positions of a participant's customers and the collateral provided to
the covered clearing agency with respect to those positions? Why or why
not?
Should the Commission require a covered clearing agency's
policies and procedures to effectively protect the positions of a
participant's customers and related collateral from the default or
insolvency of that participant? Why or why not?
Does the proposed rule affect certain identifiable
categories of covered clearing agencies differently than others in ways
not discussed in this proposing release? If so, how? Should the
requirements under the proposed rule apply to certain identifiable
categories of covered clearing agencies in addition to security-based
swap and complex risk profile clearing agencies, as proposed? Please
explain.
12. Proposed Rule 17Ad-22(e)(15): General Business Risk
Proposed Rule 17Ad-22(e)(15) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage its
general
[[Page 29548]]
business risk and hold sufficient liquid net assets funded by equity to
cover potential general business losses so that the covered clearing
agency can continue operations and services as a going concern if those
losses materialize.\299\ Registered clearing agencies are not subject
to rules regarding general business risk under existing Rule 17Ad-22,
but the Commission preliminarily believes the proposed rule is
appropriate for covered clearing agencies given the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets.
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\299\ See proposed Rule 17Ad-22(e)(15), infra Part VII.
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Proposed Rule 17Ad-22(e)(15) is designed to help mitigate the
potential impairment of a covered clearing agency's status as a going
concern resulting from general business losses, such as a decline in
revenues or an increase in expenses resulting in expenses that exceed
revenues and a loss that must be charged against the covered clearing
agency's capital.\300\ The Commission preliminarily believes that
proposed Rule 17Ad-22(e)(15) is appropriate because it would help to
mitigate the risk of a disruption in clearance and settlement services
that might result from general business losses. The Commission
preliminarily believes that such impairment could be caused by a
variety of business factors, including poor execution of business
strategy, negative cash flows, or unexpected and/or excessively large
operating expenses. The Commission preliminarily believes that general
business losses should be considered separately in the covered clearing
agency's risk management policies and procedures to promote effective
and efficient measuring, monitoring, and management of general business
risk. The risk of general business losses may require a firm to take
into account past loss events and financial projections, events
distinct from the risks that arise from member default, credit losses,
or liquidity shortfalls.\301\ Proposed Rule 17Ad-22(e)(15) would
require a covered clearing agency to establish implement, maintain and
enforce written policies and procedures reasonably designed to address
the management of general business risk and the development of a
business risk profile to address these concerns.\302\
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\300\ General business risk is the risk of potential losses
arising from the covered clearing agency's administration and
operation as a business enterprise. Such losses are not related to
member default under proposed Rule 17Ad-22(e)(13) nor covered by the
financial resources required for credit and liquidity risk
management under proposed Rules 17Ad-22(e)(4) and (7). See supra
Parts II.B.4.c, II.B.4.f, and II.B.10 and infra Part VII (proposing
rules for managing credit risk, liquidity risk, and participant
default, and providing proposed rule text, respectively).
\301\ See id.
\302\ See proposed Rule 17Ad-22(e)(15), infra Part VII.
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In addition, the Commission is proposing the requirements described
below. Registered clearing agencies are not subject to similar rules
under Rule 17Ad-22, but the Commission preliminarily believes the
proposed requirements are appropriate for covered clearing agencies
given the risks that a covered clearing agency's size, operation, and
importance pose to the U.S. securities markets and are consistent with
the Exchange Act requirements discussed above.\303\
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\303\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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a. Determining Liquid Net Assets for Recovery and an Orderly Wind-Down
Proposed Rule 17Ad-22(e)(15)(i) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to determine the amount of liquid
net assets funded by equity based upon its general business risk
profile and the length of time required to achieve a recovery or
orderly wind-down, as appropriate, of its critical operations and
services if such action is taken.\304\ The Commission preliminarily
believes that plans for orderly recovery and wind-down are critical to
maintain functioning U.S. securities markets, particularly in times of
market stress. Because of the reliance of securities markets, market
participants, and investors on the safe, sound, and efficient
operations of covered clearing agencies, the Commission believes that a
disorderly failure of a covered clearing agency would have systemic
consequences. Accordingly, the Commission is proposing to require
liquid net assets funded by equity to ensure that the covered clearing
agency can continue operations and services as a going concern in the
event of general business losses. Equity allows a covered clearing
agency to absorb losses on an ongoing basis and should therefore be
permanently available for this purpose. The specific amount of liquid
net assets funded by equity that a covered clearing agency should hold
is discussed in more detail below.
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\304\ See proposed Rule 17Ad-22(e)(15)(i), infra Part VII.
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b. Requirements for Liquid Net Assets
Proposed Rule 17Ad-22(e)(15)(ii) would require a clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for holding liquid net assets
funded by equity equal to the greater of either six months of its
current operating expenses or the amount determined by the board of
directors to be sufficient to ensure a recovery or orderly wind-down of
critical operations and services of the covered clearing agency, as
contemplated by the plans established under proposed Rule 17Ad-
22(e)(3)(ii).\305\ A clearing agency's policies and procedures would
require these liquid net assets to be held in addition to resources
held to cover participant defaults or other risks covered under the
credit risk standard in proposed Rules 17Ad-22(e)(4)(i) through (iii)
and the liquidity risk standard in proposed Rules 17Ad-22(e)(7)(i) and
(ii).\306\
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\305\ See proposed Rule 17Ad-22(e)(15)(ii), infra Part VII; see
also supra Part II.B.3.b (discussing recovery and wind-down plans
under proposed Rule 17Ad-22(e)(3)(ii)).
\306\ See supra Parts II.B.4.c and f and infra Part VII
(discussing requirements under proposed Rules 17Ad-22(e)(4) and
(e)(7), respectively, and providing proposed rule text).
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The Commission preliminarily believes that the requirements for a
covered clearing agency's policies and procedures regarding liquid net
assets are necessary to ensure that a covered clearing agency's general
business risk management is sufficiently robust to facilitate either
its orderly recovery or wind-down. The Commission is proposing these
requirements to ensure that a covered clearing agency's policies and
procedures clearly define what liquid net assets are sufficient under
Rule 17Ad-22(e)(15) and to require a covered clearing agency to
maintain, pursuant to its policies and procedures, liquid net assets
appropriate to cover general business risk in addition to those
resources appropriate for managing participant default, credit losses,
or liquidity shortfalls. Based on its supervisory experience, the
Commission preliminarily believes that a covered clearing agency could
satisfy this requirement by having policies and procedures that limit
appropriate liquid net assets to cash or cash equivalents because these
types of assets would best facilitate continued operations if a
clearing agency experienced general business losses.\307\ Further, the
[[Page 29549]]
Commission preliminarily believes that a covered clearing agency could
satisfy this requirement by having policies and procedures that fund
liquid net assets by common stock, disclosed reserves, or other
retained earnings in order to ensure that a covered clearing agency has
a permanent source of capital from which to draw in order to continue
as a going concern in the case of general business losses for at least
a six month period or in accord with a determination of the board of
directors of the covered clearing agency.\308\ Assets funded by debt or
other less permanent sources of capital would not achieve this result
and in some circumstances could further complicate the resolution
process of a covered clearing agency.
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\307\ Regarding marketable securities that may be included as
cash equivalents within liquid net assets, the Commission has not
proposed to require such assets to be readily available and
convertible into cash through certain funding arrangements as it has
proposed under Rule 17Ad-22(e)(7)(ii) (which incorporates proposed
Rule 17Ad-22(a)(15) defining ``qualifying liquid resources''). The
Commission preliminarily believes the amount of liquidity needed to
cover participant defaults in the context of proposed Rule 17Ad-
22(e)(7) may be significantly greater than the amount of liquidity
needed to cover general business losses, and it is therefore
appropriate to permit the use of such assets in the context of
proposed Rule 17Ad-22(e)(7)(ii), in order to provide greater
flexibility to covered clearing agencies regarding liquidity risk
management.
\308\ The Commission preliminarily believes it is appropriate to
apply the limitation that liquid net assets be funded by equity in
proposed Rule 17Ad-22(e)(15) but has not proposed such limitation in
Rule 17Ad-22(e)(4) (regarding financial resources required to manage
credit risk) or Rule 17Ad-22(e)(7)(ii) (regarding qualifying liquid
resources in relevant currencies required to manage liquidity risk)
because equity allows a covered clearing agency to absorb losses on
an ongoing basis so that it can continue operations as a going
concern. Cf. PFMI Report, supra note 1, at 90 & n.137.
In addition, the Commission preliminarily believes a covered
clearing agency may exclude depreciation and amortization expenses
from its calculation of current operating expenses because
depreciation and amortization expenses are non-cash expenses and
accordingly would not have an effect on a covered clearing agency's
cash flow, which might affect its ability to continue operations as
a going concern.
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The Commission also preliminarily believes that a backward-looking
calculation of operating expenses based on the income statement for the
most recently ended fiscal year would not be the type of policy and
procedure sufficient to comply with the proposed requirements regarding
current operating expense.\309\ While reviewing past losses and past
levels of operating expense may be a useful reference point, the
Commission envisions that one possible approach a covered clearing
agency could take in fulfillment of the proposed requirement would be
to consider projected operating expense expected over some time period,
as well as potential changes to the business environment of the covered
clearing agency over that time period. Based on its supervisory
experience, the Commission also believes that the following factors may
materially affect current operating expenses, as compared to operating
expense experienced in the past, that a covered clearing agency may
need to take into account and therefore are likely to be important to
the covered clearing agency's forward-looking projections: (i)
Expectations regarding expansion of its business including as a result
of offering new services or clearing and settling new types of
securities, (ii) expectations regarding contraction of its business
including due to reduction in or loss of certain types of clearing and
settlement activity or clearing members, (iii) potential risk of any
large one-time or non-recurring types of losses, and (iv) the degree to
which expected future losses may be covered by insurance or an
indemnity provided by a third-party unaffiliated with the covered
clearing agency.
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\309\ See id. at 90.
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The proposed rule also requires a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for monitoring its business
operations and reducing the likelihood of losses, which the Commission
believes furthers the requirements of the Exchange Act discussed
above.\310\
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\310\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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Because of the integral role that liquid net assets play in
supporting the recovery or orderly wind-down of a covered clearing
agency in the event of a business loss, the Commission is proposing
requirements for a clearing agency's policies and procedures to require
liquid net assets, funded by equity, equal to the greater of six months
of operating expenses or an amount determined by the board of directors
to be sufficient to facilitate an orderly recovery or wind-down of
critical operations and services. The Commission preliminarily believes
this is appropriate because liquid net assets allow the covered
clearing agency to continue operations as a going concern by acting as
a cushion while the covered clearing agency is in recovery or wind-
down.
c. Plan for Raising Additional Equity
Proposed Rule 17Ad-22(e)(15)(iii) would further require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for maintaining
a viable plan, approved by the board of directors and updated at least
annually, for raising additional equity should its equity fall close to
or below the amount required by the proposed rule as discussed
above.\311\
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\311\ See proposed Rule 17Ad-22(e)(15)(ii), infra Part VII.
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As noted above, because of the reliance of securities markets,
market participants, and investors on the safe, sound, and efficient
operations of covered clearing agencies, a disorderly failure of a
covered clearing agency would have systemic consequences. The proposed
rule requires a covered clearing agency to maintain a viable plan to
raise additional equity in the event that its liquid net assets funded
by equity fall close to or below the amount required by the proposed
rule.\312\ The Commission preliminarily believes that the proposed rule
is necessary to facilitate ongoing management of a covered clearing
agency's general business risk and to provide a covered clearing agency
with a mechanism for maintaining or replenishing appropriate levels of
equity following business losses.
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\312\ See proposed Rule 17Ad-22(e)(15)(iii), infra Part VII.
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d. Request for Comments
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-22(e)(15). In addition, the Commission requests
comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to identify, monitor, and manage the covered
clearing agency's general business risk? Why or why not? Are there
other requirements that the Commission should include in proposed Rule
17Ad-22(e)(15) to address the general business risk management at
covered clearing agencies?
Is the proposed requirement for a covered clearing
agency's policies and procedures to hold liquid net assets funded by
equity equal to the greater of either (x) six months of the covered
clearing agency's current operating expenses or (y) the amount
determined by the board of directors to be sufficient to ensure a
recovery or orderly wind-down of critical operations and services of
the covered clearing agency appropriate? Why or why not? Under the
proposed requirement for policies and procedures, is six months of
operating expenses appropriate? Should the Commission adopt a different
standard, such as three, nine, or twelve
[[Page 29550]]
months? Please explain in detail why using an alternative standard
would be appropriate.
Should the Commission require a covered clearing agency's
policies and procedures to hold liquid net assets in addition to
resources held to cover participant defaults or other risks covered
under the credit risk standard in Rule 17Ad-22(b)(3)? Under the credit
risk standard in proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable? Under the liquidity risk standard in proposed Rules 17Ad-
22(e)(7)(i) and (ii), as applicable? Why or why not? Has the Commission
provided sufficient guidance regarding what constitutes ``liquid net
assets''? Why or why not?
Should a covered clearing agency be required to provide
notice to the Commission at any time before its liquid net assets reach
the minimum required amount? If so, at what amount should the
requirement apply, e.g. at 110% of the minimum, 120% of the minimum, or
some other amount? \313\
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\313\ See, e.g., Commission Delegated Regulation No. 152/2013 of
19 December 2012, 2013 O.J. (L 52), at art. 1(3) (European Union
requiring that, if the required amount of capital held by a CCP is
lower than 110% of the capital requirements or lower than 110% of
[pound]7.5 million (the ``notification threshold''), the CCP shall
immediately notify the competent authority and keep it updated at
least weekly, until the amount of capital held by the CCP returns
above the notification threshold).
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Regarding securities that are cash equivalents and
therefore liquid net assets, should the Commission establish
requirements for policies and procedures that discount the value of
these securities compared to their fair value?
13. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks
Proposed Rule 17Ad-22(e)(16) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to safeguard its own and its
participants' assets and minimize the risk of loss and delay in access
to these assets.\314\ It also requires a clearing agency to invest its
own and its participants' assets in instruments with minimal credit,
market, and liquidity risks.\315\ Rule 17Ad-22(d)(3) currently requires
similar policies and procedures of registered clearing agencies, but
the proposed rule would further require a covered clearing agency to
have policies and procedures designed to safeguard its own and its
participants' assets.\316\ The Commission preliminarily believes this
additional specificity is appropriate for covered clearing agencies
given the risks that a covered clearing agency's size, operation, and
importance pose to the U.S. securities markets. Because this is the
only element of Rule 17Ad-22(e)(16) that differs from Rule 17Ad-
22(d)(3), the Commission anticipates that covered clearing agencies may
need to make only limited changes to update their policies and
procedures to comply with the proposed rule.\317\
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\314\ See proposed Rule 17Ad-22(e)(16), infra Part VII.
\315\ See id.
\316\ Registered clearing agencies are currently subject to
existing Rule 17Ad-22(d)(3), which requires them to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to hold assets in a manner that minimizes risk
of loss or of delay in its access to them, and invest assets in
instruments with minimal credit, market, and liquidity risks. See 17
CFR 240.17Ad-22(d)(3); see also Clearing Agency Standards Release,
supra note 5, at 66247-48.
\317\ See supra Part II.A.4.
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Custody risk is the risk of loss on assets held in custody in the
event of a custodian's (or subcustodian's) insolvency, negligence,
fraud, or poor administration. Investment risk is the risk of loss
faced by a clearing agency when it invests its own or its participants'
assets. In each case, the risk is the likelihood that assets securing
participant obligations to the covered clearing agency or otherwise
needed for the clearing agency to meet its own obligations would be
unavailable or insufficient when the covered clearing agency needs to
draw on them. Failure by a clearing agency to hold assets in
instruments with minimal credit, market, and liquidity risk may limit
the clearing agency's ability to retrieve these assets promptly. That,
in turn, can cause the clearing agency to fail to meet its settlement
obligations to its participants or cause the clearing agency's
participants to fail to meet their obligations. Accordingly, as under
Rule 17Ad-22(d)(3), the Commission believes it is appropriate to
continue to limit such risks to ensure the proper functioning of a
covered clearing agency pursuant to Section 17A of the Exchange
Act.\318\ The Commission also preliminarily believes that requiring a
covered clearing agency to have policies and procedures that safeguard
its own and its participants' assets further supports this objective.
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\318\ The Commission preliminarily believes, however, that it
should not indirectly prohibit the use of commercial banks by
covered clearing agencies holding cash as collateral or for other
services related to clearance and settlement activity when
comparable services are available from a central bank.
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Under existing Rule 17Ad-22(d)(3), the members of a registered
clearing agency typically deposit securities with the clearing agency,
or the clearing agency holds assets that secure the participants'
obligations to it and may invest these assets. In such circumstances,
the clearing agency is exposed to custody and investment risk. The
Commission is aware that, currently, clearing agencies ordinarily seek
to minimize the risk of loss or delay in access by holding assets that
are highly liquid (e.g., cash, U.S. Treasury securities, or securities
issued by a U.S. government agency) and by using only supervised and
regulated entities such as banks to act as custodians for the assets
and to facilitate settlement. Steps are also ordinarily taken to ensure
assets held in custody are protected against claims of a custodian's
creditors through trust accounts or other equivalent arrangements. In
addition, the use of individual custodians is subject to periodic
assessment across several risk criteria and should remain within
acceptable concentration limits.
Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(16). In addition, the
Commission requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to invest its own and its participants' assets
in instruments with minimal credit, market, and liquidity risks? Why or
why not?
Should the Commission require a covered clearing agency's
policies and procedures to minimize the risk of loss and delay in
access to its own and its participants' assets? Why or why not?
Has the Commission provided sufficient guidance regarding
what instruments have ``minimal credit, market, and liquidity risks''?
Should the Commission further specify what kinds of assets would be
appropriate under the proposed requirement, such as investments that
are secured by, or are claims on, high-quality obligors and investments
that allow for timely liquidation with little, if any, adverse price
effect? Why or why not?
Should covered clearing agencies ever be permitted to hold
assets in instruments that do not have minimal credit, market, and
liquidity risk? If so, why and under what circumstances? What type of
measures should covered clearing agencies have in place to minimize the
risk of loss from delays in accessing these assets? Should the proposed
rule specify any such requirements? Should the Commission develop more
specific criteria regarding how covered clearing agencies may hold or
invest assets?
[[Page 29551]]
14. Proposed Rule 17Ad-22(e)(17): Operational Risk Management
Proposed Rule 17Ad-22(e)(17) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to manage the covered clearing
agency's operational risk.\319\ Operational risk involves, among other
things, the likelihood that deficiencies in information systems or
internal controls, human errors or misconduct, management failures,
unauthorized intrusions into corporate or production systems, or
disruptions from external events such as natural disasters, would
adversely affect the functioning of a clearing agency. Proposed Rule
17Ad-22(e)(17)(i) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify the plausible sources of operational
risk, both internal and external, and mitigate their impact through the
use of appropriate systems, policies, procedures, and controls.\320\
Proposed Rule 17Ad-22(e)(17)(ii) would require the covered clearing
agency to establish, implement, maintain, and enforce written policies
and procedures reasonably designed to ensure that systems have a high
degree of security, resiliency, operational reliability, and adequate,
scalable capacity.\321\ Proposed Rule 17Ad-22(e)(17)(iii) further
requires a covered clearing agency to establish, implement, maintain
and enforce written policies and procedures reasonably designed to
provide for a business continuity plan that addresses events posing a
significant risk of disrupting operations.\322\ Rule 17Ad-22(d)(4)
currently requires a registered clearing agency to have policies and
procedures that are substantially similar to those in proposed Rules
17Ad-22(e)(17)(i) through (iii).\323\ Although proposed Rules 17Ad-
22(e)(17)(i) through (iii) differ from Rule 17Ad-22(d)(4) in
contemplating both internal and external operational risks, a high
degree of security and operational reliability for systems, and, in the
context of business continuity plans, events posing a significant risk
of disrupting operations, the Commission preliminarily believes that a
covered clearing agency may need to make only limited changes to update
its policies and procedures. The Commission preliminarily believes
these requirements are appropriate for covered clearing agencies given
the risks that a covered clearing agency's size, operation, and
importance pose to the U.S. securities markets.
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\319\ See proposed Rule 17Ad-22(e)(17), infra Part VII.
\320\ See proposed Rule 17Ad-22(e)(17)(i), infra Part VII.
\321\ See proposed Rule 17Ad-22(e)(17)(ii), infra Part VII. By
requiring ``adequate, scalable capacity,'' the Commission
preliminarily believes that a covered clearing agency should have
operational systems that can be extended or expanded based on its
anticipated business needs.
\322\ See proposed Rule 17Ad-22(e)(17)(iii), infra Part VII.
\323\ Rule 17Ad-22(d)(4) requires a registered clearing agency
to establish policies and procedures reasonably designed to identify
sources of operational risk and minimize them through the
development of appropriate systems, controls, and procedures. It
also requires registered clearing agencies to establish policies and
procedures reasonably designed to implement systems that are
reliable and secure, and have adequate, scalable capacity; and have
business continuity plans that allow for timely recovery of
operations and fulfillment of a clearing agency's obligations. See
17 CFR 240.17Ad-22(d)(4); see also Clearing Agency Standards
Release, supra note 5, at 66248-49.
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As with Rule 17Ad-22(d)(4), the Commission preliminarily believes
that the requirements in proposed Rule 17Ad-22(e)(17)(i) through (iii)
should help covered clearing agencies and its participants continue to
address and manage risks posed by potential operational deficiencies.
Specifically, to help limit disruptions that may impede the proper
functioning of a covered clearing agency, the Commission preliminarily
believes it is imperative that covered clearing agencies review their
operations for potential weaknesses and develop appropriate systems,
controls, and procedures to address weaknesses the proposed rule seeks
to mitigate.
The Commission intends for proposed Rule 17Ad-22(e)(17) to
supplement the existing guidance provided by the Commission in its
Automation Review Policy (``ARP'') statements \324\ and the Interagency
White Paper on Sound Practices to Strengthen the Resilience of the U.S.
Financial System.\325\ The Commission also preliminarily believes that
the proposed rules are consistent with the Commission's objectives in
proposed Regulation SCI.\326\
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\324\ See Automated Systems of Self-Regulatory Organizations,
Exchange Act Release No. 34-27445 (Nov. 16, 1989), 54 FR 48703 (Nov.
24, 1989) (``ARP I''); Automated Systems of Self-Regulatory
Organizations (II), Exchange Act Release No. 34-29815 (May 9, 1991),
56 FR 22489 (May 15, 1991) (``ARP II'').
Generally, the guidance in ARP I and ARP II provides for the
following activities by clearing agencies: (1) Performing periodic
risk assessments of its automated data processing (``ADP'') systems
and facilities; (2) providing for the selection of the clearing
agency's independent auditors by non-management directors and
authorizing such non-management directors to review the nature,
scope, and results of all audit work performed; (3) having an
adequately staffed and competent internal audit department; (4)
furnishing annually to participants audited financial statements and
an opinion from an independent public accountant as to the clearing
agency's system of internal control--including unaudited quarterly
financial statements also should be provided to participants upon
request; and (5) developing and maintaining plans to assure the
safeguarding of securities and funds, the integrity of the ADP
system, and recovery of securities, funds, or data under a variety
of loss or destruction scenarios.
\325\ See Exchange Act Release No. 34-47638 (Apr. 7, 2003), 68
FR 17809 (Apr. 11, 2003), available at http://www.sec.gov/news/studies/34-47638.htm.
\326\ Proposed Rule 17Ad-22(e)(17) would not conflict with the
Commission's proposed Regulation SCI, should the Commission
determine at a later date to adopt those rules as proposed. Proposed
Regulation SCI would, however, subject all covered clearing agencies
to certain requirements, including requirements for operational risk
management and business continuity planning, in addition to those
that appear in this proposal. See Exchange Act Release No. 34-69077
(Mar. 8, 2013), 78 FR 18083, 18091-141 (Mar. 25, 2013).
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rules 17Ad-22(e)(17). In addition, the
Commission requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to manage its operational risks by establishing
and maintaining a business continuity plan that addresses events posing
a significant risk of disrupting operations? Why or why not? Has the
Commission provided sufficient guidance on what an event ``posing a
significant risk of disrupting operations'' would be?
Should the Commission's proposal require a specific
methodology to identify and mitigate operational risk? If so, what is
the methodology and why should this methodology be imposed?
Is the Commission's proposed approach with respect to
ensuring that systems have a high degree of security, resiliency, and
operational reliability appropriate and sufficiently clear? Why or why
not?
Are there any other requirements that should be included
in the rule to facilitate policies and procedures for operational risk
management? Why or why not?
Should the Commission adopt additional policies and
procedures requirements for business continuity planning? If so, please
explain in detail.
15. Proposed Rule 17Ad-22(e)(18): Access and Participation Requirements
Proposed Rule 17Ad-22(e)(18) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish objective, risk-based,
and publicly
[[Page 29552]]
disclosed criteria for participation,\327\ which permit fair and open
access by direct and, where relevant, indirect participants and other
FMUs.\328\
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\327\ The Commission notes that, in contrast to other
requirements in Rule 17Ad-22(e) where ``transparent'' is used and
permits disclosure ``where appropriate'' pursuant to Rule 17Ad-
22(a)(20), the requirement here for policies and procedures designed
to ensure ``publicly disclosed'' criteria for participation would
require policies and procedures requiring such disclosure.
\328\ See proposed Rule 17Ad-22(e)(18), infra Part VII.
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In addition to the requirements described above,\329\ Section 17A
of the Exchange Act requires registered clearing agencies to have rules
not designed to permit unfair discrimination in the admission of
participants.\330\ The Commission has historically used its authority
to help ensure fair access and participation requirements.\331\ In this
regard, the Commission notes that Rules 17Ad-22(b)(5) through (7)
impose requirements regarding access and participation for the policies
and procedures of registered clearing agencies that provide CCP
services.\332\ Similarly, Rule 17Ad-22(d)(2) requires a registered
clearing agency to establish policies and procedures for access and
participation that require participants to have sufficient financial
resources and robust operational capacity to meet obligations arising
from participation in the CCP and have procedures in place to monitor
that participation requirements are met on an ongoing basis.\333\
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\329\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\330\ See 15 U.S.C. 78q-1(b)(3)(F).
\331\ See, e.g., 17 CFR 240.17Ad-22(b)(5) through (7), (d)(2);
Clearing Agency Standards Release, supra note 5, at 66238-43, 66246-
47 (adopting minimum access and participation requirements for
registered clearing agencies); Exchange Act Release No. 34-16900
(June 17, 1980), 45 FR 41920 (June 23, 1980) (outlining staff
guidance establishing minimum standards for participation and fair
access necessary for registration as a clearing agency).
\332\ See 17 CFR 240.17Ad-22(b)(5) through (7); Clearing Agency
Standards Release, supra note 5, at 66238-43. The Commission notes
that covered clearing agencies providing CCP services would remain
subject to the requirements under Rule 17Ad-22(b), in addition to
the requirements under proposed Rule 17Ad-22(e)(18).
\333\ Rule 17Ad-22(d)(2) requires a registered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to (i) require participants to have
sufficient financial resources and robust operational capacity to
meet obligations arising from participation in the clearing agency;
(ii) have procedures in place to monitor that participation
requirements are met on an ongoing basis; (iii) have participation
requirements that are objective and publicly disclosed, and permit
fair and open access. See 17 CFR 240.17Ad-22(d)(2); see also
Clearing Agency Standards Release, supra note 5, at 66246-47.
The Commission notes that the elements of Rule 17Ad-
22(d)(2)(i), regarding policies and procedures requiring
participants to have financial resources and robust operational
capacity to meet obligations arising from participation are also
reflected in other proposed rules, including Rules 17Ad-22(e)(4) and
(17). See supra Parts II.B.4.c (requiring under proposed Rule 17Ad-
22(e)(4) policies and procedures for testing the sufficiency of
financial resources) and II.B.14 (requiring under proposed Rule
17Ad-22(e)(17) policies and procedures for operational risk
management).
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Appropriate minimum operational, legal, and capital requirements
for membership that are maintained and enforced through the supervisory
practices of a clearing agency help to ensure all members will be
reasonably capable of meeting their various obligations to the clearing
agency in stressed market conditions and upon member default. Member
defaults challenge the safe functioning of a clearing agency by
creating credit and liquidity risks, which impede a clearing agency's
ability to settle securities transactions in a timely manner. Ensuring
that clearing members meet objective levels of operational and
financial soundness helps to counterbalance the potential for cascading
effects on other participants and limit the potential of a systemic
disruption in the U.S. securities markets. Fair and open access to all
parties meeting the objective criteria for participation similarly
helps to ensure wide participation and thereby increase beneficial risk
mitigating effects.
Accordingly, the Commission preliminarily believes Rule 17Ad-
22(e)(18) is appropriate because it would promote membership standards
at covered clearing agencies that are likely to limit the potential for
member defaults and, as a result, losses to non-defaulting members in
the event of a member default. The proposed rule has similar
requirements to those applied to registered clearing agencies under
Rule 17Ad-22(d)(2) but would also explicitly require a covered clearing
agency's policies and procedures to establish publicly disclosed
criteria for participation, which permit fair and open access by direct
and, where relevant, indirect participants and other FMUs, and also
require that the criteria be risk-based, in addition to objective.\334\
The Commission preliminarily believes the requirement that policies and
procedures for publicly disclosed criteria for participation that
specify fair and open access by both direct and indirect participants
and other FMUs is appropriate because of the size and reach of covered
clearing agencies, which are likely to transact or link with many
participants, both direct and indirect, as well as other FMUs. The
Commission also preliminarily believes that the requirement for risk-
based criteria helps protect investors and facilitates prompt and
accurate clearance and settlement by helping to ensure that covered
clearing agencies accept participants that are less prone to default.
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\334\ The Commission is proposing Rule 17Ad-22(e)(18) as part of
a comprehensive set of rules for regulating covered clearing
agencies that is consistent with and comparable to other domestic
and international standards for FMIs. Because of the similarity
between the existing requirement in Rule 17Ad-22(d)(2)(iii) and
these requirements under proposed Rule 17Ad-22(e)(18), the
Commission anticipates that covered clearing agencies may need to
make only limited changes to update their policies and procedures to
comply with these requirements under the proposed rule. See supra
Part II.A.4.
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In addition, the Commission is proposing a requirement that covered
clearing agencies establish, implement, maintain and enforce written
policies and procedures reasonably designed to require participants to
have sufficient financial resources and robust operational capacity to
meet obligations arising from participation in the clearing agency and
to monitor compliance with participation requirements on an ongoing
basis. Rule 17Ad-22(d)(2)(i) and (ii) also require a registered
clearing agencies to establish, implement, maintain and enforce written
policies and procedures reasonably designed to have procedures in place
to require participants to have sufficient financial resources and
robust operational capacity to meet obligations arising from
participation in the clearing agency and to monitor that participation
requirements are met on an ongoing basis.\335\ Because these other
requirements in proposed Rule 17Ad-22(e)(18) are the same as those for
registered clearing agencies more generally under existing Rule 17Ad-
22(d)(2), the Commission anticipates that covered clearing agencies may
need to make only limited changes to update their policies and
procedures.\336\ As with Rule 17Ad-22(d)(2), the Commission believes
these requirements are appropriate because they would further support
membership standards at covered clearing agencies that are likely to
limit the potential for member defaults and, as a result, losses to
non-defaulting members in the event of a member default.
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\335\ See supra note 333 and accompanying text.
\336\ See supra Part II.A.4 (noting the anticipated effect of
the proposed rule) and infra Part IV.B.3.c (describing the current
practices at registered clearing agencies regarding settlement).
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Request for Comments. The Commission generally requests comments on
all aspects of proposed
[[Page 29553]]
Rule 17Ad-22(e)(18). In addition, the Commission requests comments on
the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to monitor compliance with its participation
requirements on an ongoing basis? Why or why not? Would a more specific
monitoring requirement be appropriate? For example, should this
requirement specify a frequency of review? Why or why not? If so, what
would be the appropriate frequency of review? Please explain.
Would it be appropriate for the Commission to require a
covered clearing agency's policies and procedures to provide for
different categories of participation? If so, please explain in detail
what these different categories would be and why they would be
appropriate.
16. Proposed Rule 17Ad-22(e)(19): Tiered Participation Agreements
Proposed Rule 17Ad-22(e)(19) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage the
material risks to the covered clearing agency arising from arrangements
in which firms that are indirect participants in the covered clearing
agency rely on the services provided by direct participants in the
covered clearing agency to access the covered clearing agency's
payment, clearing, or settlement facilities (hereinafter ``tiered
participation arrangements'').\337\ The Commission preliminarily
believes the proposed rule is appropriate due to the associated
dependencies and risk exposures that tiered participation arrangements
create, as discussed above. Such risks, including credit, liquidity,
and operational risks, can undermine the operations of a covered
clearing agency and pose risks to the operations of a clearing agency's
participants, both direct and indirect, and to the broader securities
markets as well.
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\337\ See proposed Rule 17Ad-22(e)(19), infra Part VII. Because
proposed Rule 17Ad-22(e)(19) only addresses the situation where a
covered clearing agency relies on direct participants, the proposed
rule does not apply to a broker-dealer that is a member of a CSD and
maintains accounts for retail customers.
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Registered clearing agencies are currently not subject to rules
regarding tiered participation arrangements under existing Rule 17Ad-
22. The Commission preliminarily believes the proposed rule is
appropriate for covered clearing agencies, given the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets, and is consistent with the requirements of the
Exchange Act discussed above.\338\
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\338\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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The Commission has previously noted that, in situations where
direct access to clearing agencies is limited by reasonable
participation standards, firms that do not meet these standards may
still be able to access clearing agencies through correspondent
clearing arrangements with direct participants.\339\ Such a process
would involve the non-participant entering into a correspondent
clearing arrangement with a participant so that the transaction may be
submitted by the participant to the clearing agency. The dependencies
and risk exposures, including credit, liquidity, and operational risks,
inherent in tiered participation arrangements present risks to a
clearing agency and its functioning, in addition to the direct
participant. A covered clearing agency with direct participants that
clear transactions on behalf of indirect participants with large values
or volumes faces the risk of default by both the indirect participant
itself and the direct participant through which those transactions are
routed. Accordingly the Commission is proposing Rule 17Ad-22(e)(19) to
promote the ongoing management of risks associated with such tiered
participation arrangements.
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\339\ See Exchange Act Release No. 34-63107 (Oct. 14, 2010), 75
FR 65882 (Oct. 26, 2010) (proposing ownership limitations and
governance requirements for security-based swap clearing agencies,
security-based swap execution facilities, and national securities
exchanges with respect to security-based swaps under Regulation MC).
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In addition, the Commission is proposing to require that a covered
clearing agency establish, implement, maintain and enforce written
policies and procedures reasonably designed to regularly review the
material risks to the covered clearing agency arising from such tiered
participation arrangements.\340\ The Commission preliminarily believes
the proposed requirement is appropriate due to the ongoing dependencies
and risk exposures that tiered arrangements present to the operation of
a covered clearing agency and to the operation of a covered clearing
agency's participants. Registered clearing agencies are currently not
subject to a similar requirement under existing Rule 17Ad-22, and that
the proposed rule is appropriate for covered clearing agencies, given
the risks that a covered clearing agency's size, operation, and
importance pose to the U.S. securities markets, and is consistent with
the requirements of the Exchange Act discussed above.\341\
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\340\ See proposed Rule 17Ad-22(e)(19), infra Part VII.
\341\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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The operational, financial, and other interconnections between
direct and indirect participants to tiered participation arrangements
are subject to market forces and can therefore change over time.
Because direct and indirect participants collectively contribute to the
operational and financial stability of a covered clearing agency, the
Commission preliminarily believes that the requirement to regularly
review a covered clearing agency's tiered participation arrangements
supports the Exchange Act requirements that clearing agencies be able
to facilitate prompt and accurate clearance and settlement, protect
investors and the public interest, and ensure the safeguarding of
securities and funds in the custody or control of the clearing agency
or for which the clearing agency is responsible.\342\
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\342\ See 15 U.S.C 78q-1(b)(3)(A).
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(19). In addition, the
Commission requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to identify, monitor and manage the material
risks to the covered clearing agency arising from arrangements in which
firms that are indirect participants in the covered clearing agency
rely on the services provided by direct participants to access the
covered clearing agency's payment, clearing, or settlement facilities?
Why or why not?
Has the Commission provided sufficient guidance regarding
who would be ``indirect participants'' and ``direct participants''? Why
or why not?
17. Proposed Rule 17Ad-22(e)(20): Links
Proposed Rule 17Ad-22(e)(20) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage
risks related to any link with one or more other clearing agencies,
FMUs, or trading markets.\343\ Rule 17Ad-22(d)(7) requires registered
clearing agencies to have policies and
[[Page 29554]]
procedures for evaluating the potential sources of risks that can arise
from links.\344\ For the purposes of Rule 17Ad-22(e)(20), however, the
Commission would further define ``link'' in proposed Rule 17Ad-
22(a)(10) to mean any set of contractual and operational arrangements
between a covered clearing agency and one or more other clearing
agencies, FMUs, or trading venues that connect them directly or
indirectly for the purposes of participating in settlement, cross
margining, expanding its services to additional instruments and
participants, or for any other purposes material to their
business.\345\ The Commission preliminarily believes this expanded and
more prescriptive approach to defining a link is appropriate for
covered clearing agencies given their size, global operation, and
importance to the U.S. securities markets.
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\343\ See proposed Rule 17Ad-22(e)(20), infra Part VII.
\344\ Rule 17Ad-22(d)(7) requires a registered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to evaluate the potential sources of
risks that can arise when the clearing agency establishes links
either cross-border or domestically to clear or settle trades, and
ensure that the risks are managed prudently on an ongoing basis. See
17 CFR 240.17Ad-22(d)(7); see also Clearing Agency Standards
Release, supra note 5, at 66250-51.
\345\ See proposed Rule 17Ad-22(a)(10), infra Part VII.
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In addition to the requirements discussed above,\346\ Section 17A
of the Exchange Act directs the Commission to facilitate the
establishment of linked or coordinated facilities for clearance and
settlement.\347\ Links between clearing agencies, FMUs, and trading
markets develop in several circumstances for different reasons. A CCP
may establish a link with another CCP to enable a participant in the
first CCP to clear trades with a participant in the second CCP.
Similarly, a CSD may establish a link with another CSD to enable its
participants to access services provided by the other CSD. Clearing
agencies may also generally establish links with trade repositories and
trading markets to fulfill regulatory obligations.
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\346\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\347\ See 15 U.S.C. 78q-1(a)(2)(A)(ii); see also 15 U.S.C. 78q-
1(a)(1)(D) (Congress finding that the linking of all clearance and
settlement facilities and the development of uniform standards and
procedures for clearance and settlement will reduce unnecessary
costs and increase the protection of investors and persons
facilitating transactions by and acting on behalf of investors).
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Accordingly, the Commission is proposing Rule 17Ad-22(e)(20) to
ensure that covered clearing agencies identify and assess the potential
sources of risk arising from a link arrangement and incorporate that
analysis into its risk management policies and procedures. In certain
cases, the creation of a link may raise risks similar to those raised
by tiered participation arrangements and participant requirements,
discussed above: Namely, the interconnections between the clearing
agency and the other entity may increase the risks to the clearing
agency stemming from, among other things, the risks of participant
default, credit losses, or liquidity shortfalls arising through the
linked entity rather than the clearing agency's own operations.\348\
The range of implicated risks is broad; a clearing agency that operates
links may increase its exposure to legal, operational, custody,
settlement, credit, and liquidity risk depending on the nature and
extent of the link involved.
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\348\ See supra Parts II.B.15 and 16 (discussing the access and
participation requirements in proposed Rule 17Ad-22(e)(18) and
requirements for tiered participation arrangements in proposed Rule
17Ad-22(e)(19)).
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Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(20) and 17Ad-22(a)(10). In
addition, the Commission requests comments on the following specific
issue:
Should the Commission require a covered clearing agency's
policies and procedures to identify, monitor, and manage risks related
to any link the covered clearing agency establishes with one or more
other clearing agencies, FMUs, or trading markets? Why or why not?
Is the definition of ``link'' in proposed Rule 17Ad-
22(a)(10) appropriate and sufficiently clear in light of the proposed
requirements? Why or why not? Is there an alternative definition that
the Commission should consider?
18. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness
Proposed Rule 17Ad-22(e)(21) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it is efficient and
effective in meeting the requirements of its participants and the
markets it serves.\349\ Rule 17Ad-22(d)(6) similarly requires
registered clearing agencies to have policies and procedures designed
to be cost-effective in meeting the requirements of participants while
maintaining safe and secure operations.\350\
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\349\ See proposed Rule 17Ad-22(e)(21), infra Part VII.
\350\ Rule 17Ad-22(d)(6) requires a registered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to be cost-effective in meeting the
requirements of participants while maintaining safe and secure
operations. See 17 CFR 240.17Ad-22(d)(6); see also Clearing Agency
Standards Release, supra note 5, at 66250.
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Proposed Rule 17Ad-22(e)(21) would further require a covered
clearing agency's management to regularly review the efficiency and
effectiveness of its (i) clearing and settlement arrangements; (ii)
operating structure, including risk management policies, procedures,
and systems; (iii) scope of products cleared, settled, or recorded; and
(iv) use of technology and communication procedures.\351\ The
Commission preliminarily believes this requirement for regular review
is appropriate for covered clearing agencies given the risks that a
covered clearing agency's size, global operation, and importance pose
to the U.S. securities markets.\352\
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\351\ See proposed Rule 17Ad-22(e)(21), infra Part VII.
\352\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
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For purposes of the proposed rule, efficiency refers generally to
the efficient use of resources by a clearing agency to perform its
functions, and effectiveness refers to its ability to meet its intended
goals and objectives. A covered clearing agency that operates
inefficiently or functions ineffectively may distort financial activity
and market structure, increasing not only the risks borne by its
members, but also the risks of indirect participants, such as the
customers of participants or other buyers and sellers of securities. If
a covered clearing agency is inefficient, a participant may choose not
to trade or may choose to settle bilaterally, which could potentially
result in greater risks to the U.S. financial system than would
otherwise occur in the presence of a more efficiently functioning
covered clearing agency.
In addition to the requirements discussed above,\353\ Section 17A
of the Exchange Act requires that registered clearing agencies have
rules designed to promote the prompt and accurate clearance and
settlement of securities transactions,\354\ following a finding by
Congress that inefficient procedures for clearance and settlement
impose unnecessary costs on investors and persons facilitating
transactions by and acting on behalf of investors.\355\ The
[[Page 29555]]
Commission preliminarily believes that proposed Rule 17Ad-22(e)(21) is
appropriate because a covered clearing agency must be designed and
operated to meet the needs of its participants and the markets it
serves, while remaining sufficiently flexible to respond to changing
demand and new technologies.
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\353\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\354\ See 15 U.S.C. 78q-1(b)(3)(F).
\355\ See 15 U.S.C. 78q-1(a)(1)(B); see also 15 U.S.C. 78q-
1(a)(1)(C) (Congress finding that new data processing and
communications techniques create the opportunity for more efficient,
effective, and safe procedures for clearance and settlement).
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The Commission is also proposing to require that a covered clearing
agency regularly review the items identified in Rule 17Ad-22(e)(21)(i)
through (iv) because the Commission preliminarily believes that they
are reflective of key aspects of a clearing agency's business necessary
for efficient and effective operation. Moreover, because technology,
sound practices, market forces, and the number and characteristics of
participants may change over time, the Commission preliminarily
believes that measures of efficiency and effectiveness must be subject
to policies and procedures for regular review.
Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(21). In addition, the
Commission requests comments on the following specific issues:
Has the Commission provided sufficient guidance on what
policies and procedures would be necessary to ensure that a covered
clearing agency is ``efficient and effective'' in meeting the
requirements of the proposed rule? Why or why not?
Is the proposed requirement for a covered clearing
agency's policies and procedures to regularly review the following
aspects of its business and operations appropriate: Clearing and
settlement arrangements; operating structure, including risk management
policies, procedures, and systems; the scope of products cleared,
settled, or recorded; and the use of technology and communication
procedures? Why or why not? Should the Commission require that other
aspects of a covered clearing agency's business and operations be
subject to regular review?
19. Proposed Rule 17Ad-22(e)(22): Communication Procedures and
Standards
Proposed Rule 17Ad-22(e)(22) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it uses, or at a
minimum accommodates, relevant internationally accepted communication
procedures and standards in order to facilitate efficient payment,
clearing, and settlement.\356\ No comparable requirement exists for
registered clearing agencies under Rule 17Ad-22(d). The Commission
preliminarily believes this proposed requirement is appropriate for
covered clearing agencies given a covered clearing agency's size and
global operation. The Commission understands that covered clearing
agencies currently use the relevant internationally accepted
communication procedures and standards,\357\ so the Commission expects
only limited changes may be necessary to satisfy the requirements of
the proposed rule.
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\356\ See proposed Rule 17Ad-22(e)(22), infra Part VII.
\357\ See generally Finacle, Messaging Standards in Financial
Industry, (Infosys Thought Paper, 2012), available at http://www.infosys.com/finacle/solutions/thought-papers/Documents/messaging-standards-financial-industry.pdf (describing messaging
standards such as SWIFT, FIX, and Fpml).
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The ability of participants to communicate with a covered clearing
agency in a timely, reliable, and accurate manner is important to
achieving prompt and accurate clearance and settlement. The Commission
preliminarily believes that requiring policies and procedures in line
with internationally accepted communication procedures and standards is
appropriate for a covered clearing agency for two reasons. First,
internationally accepted communication procedures and standards,
because they are widely accepted and adopted standards, reduce the
likelihood of errors and technical complexity in the clearance and
settlement process, thereby reducing risks and costs, improving
efficiency, and reducing barriers to entry. Such procedures and
standards would include standardized protocols for exchanging messages
and reference data for identifying financial instruments and
counterparties.
Second, internationally accepted communication procedures and
standards ensure effective communication with direct and indirect
participants, which the Commission preliminarily believes is important
for covered clearing agencies, given the global nature of their
businesses. Securities markets in the United States are among the
largest and most actively traded in the world, with direct and indirect
participants from numerous other countries that necessitate the
development and use of internationally accepted communication
procedures and standards. Accordingly, the Commission preliminarily
believes that covered clearing agencies are likely to be engaged in
transactions across borders, where standardized communications
protocols and mechanisms are essential to ensure prompt and accurate
clearance and settlement.
Request for Comments. The Commission generally requests comments on
all aspects of proposed Rule 17Ad-22(e)(22). In addition, the
Commission requests comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to use, or at a minimum accommodate, relevant
internationally accepted communication procedures and standards in
order to facilitate efficient payment, clearing, and settlement? Why or
why not?
Is the Commission's assumption that covered clearing
agencies are already using internationally accepted communication
procedures correct? Why or why not?
Has the Commission provided sufficient guidance on what
``relevant internationally accepted communication procedures and
standards'' would be appropriate under the proposed policies and
procedures requirement? Why or why not?
20. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures,
and Market Data
Proposed Rule 17Ad-22(e)(23) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for the specific disclosures
enumerated in the rule, as discussed below.\358\ The proposed rule
would require such policies and procedures to specifically require a
covered clearing agency to (i) publicly disclose all relevant rules and
material procedures, including key aspects of its default rules and
procedures; (ii) provide sufficient information to enable participants
to identify and evaluate the risks, fees, and other material costs they
[[Page 29556]]
incur by participating in the covered clearing agency; and (iii)
publicly disclose relevant basic data on transaction volume and
values.\359\ As with public disclosures contemplated under proposed
Rule 17Ad-22(a)(20), a covered clearing agency could comply with the
proposed requirement by posting the relevant documentation to its Web
site. The Commission preliminarily believes the proposed rule is
appropriate to promote continued transparency at covered clearing
agencies and thereby continue to facilitate prompt and accurate
clearance and settlement.
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\358\ See proposed Rule 17Ad-22(e)(23), infra Part VII; see also
Parts II.B.20.a and b (discussing the specific disclosures
enumerated in the proposed rule).
The Commission is proposing Rule 17Ad-22(e)(23) as part of a
comprehensive set of rules for regulating covered clearing agencies
that is consistent with and comparable to other domestic and
international standards for FMIs.
The Commission notes that Rule 17Ad-22(c)(2) currently requires
a registered clearing agency, within 60 days after the end of its
fiscal year, to post on its Web site its annual audited financial
statements. See 17 CFR 240.17Ad-22(c)(2); see also Clearing Agency
Standards Release, supra note 5, at 66244.
\359\ In full, Rule 17Ad-22(d)(9) requires registered clearing
agencies to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide market
participants with sufficient information for them to identify and
evaluate the risks and costs associated with using its services. See
17 CFR 240.17Ad-22(d)(9); see also Clearing Agency Standards
Release, supra note 5, at 66252-53.
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Rule 17Ad-22(d)(9) currently requires registered clearing agencies
to have policies and procedures to facilitate disclosures similar to
proposed Rule 17Ad-22(e)(23)(ii), but does not require policies and
procedures similar to proposed Rules 17Ad-22(e)(23)(i) and (iii). The
Commission preliminarily believes these additional requirements are
appropriate for a covered clearing agency given the risks that a
covered clearing agency's size, operation, and importance pose to the
U.S. securities markets because these disclosures provide the relevant
authorities with information that further facilitates supervision of
the covered clearing agency, including information that may allow the
relevant authorities to better assess the covered clearing agency's
observance of risk management requirements and better identify possible
risks posed by the covered clearing agency, and provide relevant
stakeholders with information regarding risks associated with
participation in a covered clearing agency.
In addition to the Exchange Act requirements described above,\360\
Section 17A of the Exchange Act requires registered clearing agencies
to have rules designed to foster cooperation and coordination with
persons engaged in the clearance and settlement of securities
transactions.\361\ The Commission preliminarily believes that requiring
a covered clearing agency to have policies and procedures reasonably
designed to disclose sufficient information so that participants can
identify risks and costs associated with using the covered clearing
agency would allow participants to make informed decisions about the
use of the covered clearing agency and to take appropriate actions to
mitigate their risks and to better understand the costs associated with
their use of the covered clearing agency. Similarly, the Commission
preliminarily believes that requiring a covered clearing agency to
publicly disclose relevant basic data on transaction volume and values
would allow regulators, market participants, and market observers to
make informed decisions about the activities of the covered clearing
agency and to take appropriate action, if necessary, in response.
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\360\ See notes 54-56 and accompanying text; see also Parts I.A
and B (generally discussing the regulatory framework under Section
17A of the Exchange Act, as amended by the Dodd-Frank Act).
\361\ See 15 U.S.C. 78q-1(b)(3)(F).
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Pursuant to existing Commission regulations, changes to the rules
of an SRO, including clearing agencies, are required to be available on
the SRO's Web site and are published by the Commission.\362\ The
Commission's proposed rule is designed to promote understanding among
market participants of the policies and procedures of covered clearing
agencies, and the Commission believes the proposed rule is consistent
with existing requirements for SROs. Continued and improved
understanding of the risks and costs associated with using a covered
clearing agency's services should promote confidence generally in the
covered clearing agency's ability to set and manage appropriately risks
and costs, such as margin requirements, restrictions on or limitations
of the covered clearing agency's obligations, and conditions used by
the covered clearing agency to test the adequacy of its financial
resources. The Commission preliminarily believes these requirements are
especially important for covered clearing agencies given their size and
importance.
---------------------------------------------------------------------------
\362\ See 17 CFR 240.19b-4(l) (requiring an SRO to post each
proposed rule change, and any amendments thereto, on its Web site
within two business days of filing with the Commission); 17 CFR
240.19b-4(i) (requiring SROs to retain for public inspection and
copying all filings made pursuant to this section and all
correspondence and other communications reduced to writing,
including comment letters, to and from such SRO concerning any such
filing).
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The Commission notes that these policies and procedures
requirements are intended in part to codify disclosure practices
currently undertaken by some registered clearing agencies on an
elective basis.\363\
---------------------------------------------------------------------------
\363\ See, e.g., DTC, Assessment of Compliance With
Recommendations for Securities Settlement Systems (Dec. 2011),
available at http://dtcc.com/legal/policy-and-compliance.aspx.
---------------------------------------------------------------------------
Below is a discussion of the specific disclosures required under
the proposed rule, which are not similarly required of registered
clearing agencies under Rule 17Ad-22(d)(9). The Commission
preliminarily believes that these additions to a covered clearing
agency's disclosure practices are important to ensure clearing members
and the public have access to up-to-date information about the covered
clearing agency's activities, policies, and procedures, which would
promote confidence in its operations and thereby contribute to the
prompt and accurate clearance and settlement of securities
transactions.\364\
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\364\ As noted above, the Commission preliminarily believes that
the proposed requirement for a comprehensive public disclosure is
consistent with the requirements of the Exchange Act, Rule 19b-4,
and the current practices of some clearing agencies that would be
covered clearing agencies. See supra notes 362-363 and accompanying
text; see also Part IV.B.3.i (discussing the current practices of
registered clearing agencies with respect to transparency and
disclosure).
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a. Comprehensive Public Disclosure
Proposed Rule 17Ad-22(e)(23)(iv) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for a comprehensive public disclosure
of its material rules, policies, and procedures regarding governance
arrangements and legal, financial, and operational risk management,
accurate in all material respects at the time of publication, including
(i) a general background of the covered clearing agency, including its
function and the market it serves, basic data and performance
statistics on its services and operations, such as basic volume and
value statistics by product type, average aggregate intraday exposures
to its participants, and statistics on the covered clearing agency's
operational reliability, and a description of its general organization,
legal and regulatory framework, and system design and operations; (ii)
a standard-by-standard summary narrative for each applicable standard
set forth in proposed Rules 17Ad-22(e)(1) through (22) with sufficient
detail and context to enable the reader to understand its approach to
controlling the risks and addressing the requirements in each standard;
(iii) a summary of material changes since the last update of the
disclosure; and (iv) an executive summary of the key points regarding
each.\365\ The Commission is proposing to require that the
comprehensive public disclosure
[[Page 29557]]
provide basic data and performance statistics, such as statistics on
the covered clearing agency's operational reliability so that the
relevant stakeholders and the general public have data regarding, for
example, performance targets for systems and the actual performance of
systems over specified periods and targets for recovery. The Commission
is also proposing to require that the comprehensive public disclosure
include a standard-by-standard summary narrative to elicit a summary
discussion of a covered clearing agency's implementation of policies
and procedures requirements that would need to be established,
implemented, maintained and enforced by a covered clearing agency in
response to proposed Rules 17Ad-22(e)(1) through (23). In addition, the
Commission is proposing to require a summary of material changes and
would expect that a covered clearing agency should consider its
particular circumstances, such as, for example, changes in the scope of
services provided by the covered clearing agency, in satisfying this
requirement.
---------------------------------------------------------------------------
\365\ See proposed Rule 17Ad-22(e)(23)(iv), infra Part VI.
---------------------------------------------------------------------------
The Commission preliminarily believes that disclosure of the above
required information will provide participants with the information
necessary to, at a minimum, identify and evaluate the risks and costs
associated with use of the covered clearing agency, thereby promoting
transparency and enhancing competition and market discipline. The
Commission preliminarily believes it would also provide other
stakeholders, including regulators and the public, with information
that facilitates informed oversight and decision-making regarding
covered clearing agencies.
b. Updates to the Comprehensive Public Disclosure
Proposed Rule 17Ad-22(e)(23)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure the comprehensive public
disclosure required under proposed Rule 17Ad-22(e)(23)(iv) is updated
not less than every two years, or more frequently following changes to
its system or the environment in which it operates to the extent
necessary, to ensure statements previously provided remain accurate in
all material respects.\366\ The Commission preliminarily believes that
ensuring statements previously provided remain accurate would require a
covered clearing agency's comprehensive public disclosure to provide
statements that would provide a market participant with an accurate
representation of the risks and costs of participating in the covered
clearing agency.
---------------------------------------------------------------------------
\366\ See proposed Rule 17Ad-22(e)(23)(v), infra Part VI.
---------------------------------------------------------------------------
The Commission preliminarily believes that this requirement would
help provide participants, regulators, other stakeholders, and the
public with disclosures that are current, accurate, and comprehensive,
thereby promoting transparency and enhancing competition and market
discipline. The Commission preliminarily believes it would also provide
other stakeholders, including regulators and the public, with timely
information that facilitates informed oversight and decision-making
regarding covered clearing agencies, thereby promoting the clearing
agency obligations required under Section 17A of the Exchange Act.\367\
---------------------------------------------------------------------------
\367\ See 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
c. Request for Comments
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-22(e)(23). In addition, the Commission requests
comments on the following specific issues:
Should the Commission require a covered clearing agency's
policies and procedures to maintain clear and comprehensive rules and
procedures that provide for the specific disclosures proposed under
Rule 17Ad-22(e)(23)? Why or why not? Are there rules and procedures
that should not be fully disclosed to participants? Please explain in
detail what such rules and procedures would be and why they should not
be disclosed to participants.
In imposing certain minimum requirements for policies and
procedures regarding the comprehensive public disclosure, has the
Commission provided sufficient guidance regarding what elements must
appear in the disclosure? Should different elements appear? Should the
Commission require policies and procedures to update the comprehensive
public disclosure every two years, as proposed? Should the Commission
require policies and procedures to update the comprehensive public
disclosure more frequently following changes to its system or the
environment in which it operates to the extent necessary to ensure the
statements provided remain accurate in all material respects? Why or
why not?
Are certain ways that covered clearing agencies
communicate information to market participants more effective than
others? For example, does including information in a covered clearing
agency's rulebook or published interpretive materials provide adequate
notice of the risks and costs of being a participant to persons that
are not currently participants in the covered clearing agency? Why or
why not?
Should the types of information that a covered clearing
agency discloses under the proposed rule be generally available to the
public? Should any categories of the information required to be
disclosed under the proposed rule be restricted to certain parties
only, such as clearing members or the Commission itself? Why or why
not?
Should the Commission require covered clearing agencies to
make public disclosures of information contained in their audited
financial statements that would provide a discussion and analysis of
the covered clearing agency's financial condition, in particular with
respect to liquidity, capital resources, and results of operations,
similar to the Management's Discussion and Analysis of Financial
Condition and Results of Operations disclosure required under Items
303(a)(1) through (3) of Regulation S-K?
Should the Commission require that policies and procedures
pursuant to proposed Rule 17Ad-22(e)(23) specify a certain form for the
disclosures (e.g., using tagged or structured data)? Why or why not?
What form should the proposed disclosures take? Please explain.
C. Proposed Rule 17Ab2-2
The Commission is proposing Rule 17Ab2-2 to establish procedures
for the Commission to make determinations affecting covered clearing
agencies.\368\ Under the proposed rule, the Commission would make
determinations in three cases, as discussed below. In each case, under
proposed Rule 17Ab2-2(d), the Commission would publish notice of its
intention to consider such determinations, together with a brief
statement of the grounds under consideration, and provide at least a
30-day public comment period prior to any determination.\369\ The
Commission may provide the clearing agency subject to the proposed
determination opportunity for hearing regarding the proposed
determination. Under proposed Rule 17Ab2-2(e), notice of determinations
in each case would be given by prompt publication thereof, together
with a
[[Page 29558]]
statement of written reasons supporting the determination.\370\
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\368\ See proposed Rule 17Ab2-2, infra Part VII.
\369\ See proposed Rule 17Ab2-2(d), infra Part VII.
\370\ See proposed Rule 17Ab2-2(e), infra Part VII.
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The Commission notes that under proposed Rule 17Ad-22(e), five
active registered clearing agencies would meet the definition of a
covered clearing agency without action under proposed Rule 17Ab2-2 by
the Commission.\371\ Because the two dormant registered clearing
agencies would not meet the definition of a covered clearing agency, if
they elected to begin providing clearance and settlement services, they
could potentially be subject to a determination under Rule 17Ab2-
2.\372\ In addition, the Commission notes that it would consider, upon
receiving an application for registration as a clearing agency, either
making a determination regarding a registrant's status as a covered
clearing agency as part of the registration process, if the Commission
believes the clearing agency already meets the definition of a covered
clearing agency, or after registration, if the Commission determines
that the clearing agency does not meet the definition of a covered
clearing agency upon registration but does so at a later date, as
either market conditions or the characteristics of the clearing agency
itself change, pursuant to proposed Rule 17Ab2-2.\373\
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\371\ See supra notes 82-87 and accompanying text. As noted, the
CFTC has been designated the supervisory agency for two registered
clearing agencies, CME and ICE, which have been designated as
systemically important by the FSOC pursuant to the Clearing
Supervision Act, and accordingly they would not be covered clearing
agencies under proposed Rules 17Ad-22(e) and 17Ab2-2.
\372\ See supra note 88 and accompanying text.
\373\ See supra note 9 and accompanying text (discussing the
requirements for registration as a clearing agency pursuant to
Section 17A of the Exchange Act).
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1. Determination That a Registered Clearing Agency Is a Covered
Clearing Agency
Under proposed Rule 17Ab2-2(a), the Commission may, if it deems
appropriate, upon application by any registered clearing agency or
member thereof, or on its own initiative, determine whether a
registered clearing agency should be considered a covered clearing
agency.\374\ In determining whether a registered clearing agency should
be considered a covered clearing agency, the Commission may consider
characteristics such as the clearing of financial instruments that are
characterized by discrete jump-to-default price changes or that are
highly correlated with potential participant defaults or other such
factors as it deems appropriate in the circumstances. The Commission
preliminarily believes it should reserve the right to make a
determination on its own initiative in the event that it independently
determines that a registered clearing agency meets the definition of a
covered clearing agency, as either market conditions or the
characteristics of the clearing agency itself change. The Commission
preliminarily believes that the clearing of financial instruments that
are characterized by discrete jump-to-default price changes or that are
highly correlated with potential participant defaults are two factors
that indicate a registered clearing agency may raise systemic risk
concerns supporting application of the requirements under proposed Rule
17Ad-22(e).\375\
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\374\ See proposed Rule 17Ab2-2(a), infra Part VII.
\375\ See Clearing Agency Standards Release, supra note 5, at
66234 n.162 (describing the risks that arise from financial
instruments that are characterized by discrete jump-to-default price
changes or that are highly correlated with potential participant
defaults).
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The Commission preliminarily believes that proposed Rule 17Ab2-2(a)
would provide the Commission with the flexibility necessary to achieve
the goals of Section 17A of the Exchange Act,\376\ Title VII of the
Dodd-Frank Act,\377\ and the Clearing Supervision Act,\378\ given the
ever-changing nature of the U.S. securities markets, including the
nature and character of participants in the market and the products
required to be cleared and settled in practice. The Commission
preliminarily believes that Rule 17Ab2-2(a) is necessary to ensure that
a registered clearing agency not otherwise meeting the definition of
either a designated clearing agency or a complex risk profile clearing
agency can nonetheless be subject to the requirements for covered
clearing agencies in proposed Rule 17Ad-22(e) upon a determination made
by the Commission. The Commission preliminarily believes this is
necessary to ensure that the Commission is appropriately able to
respond to registered clearing agencies that raise systemic risk
concerns supporting application of the requirements under proposed Rule
17Ad-22(e).
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\376\ See supra Part I.A.
\377\ See supra Part I.B.1.
\378\ See supra Part I.B.2.
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2. Determination That a Covered Clearing Agency Is Systemically
Important in Multiple Jurisdictions
Under proposed Rule 17Ab2-2(b), the Commission may, if it deems
appropriate, upon application by any clearing agency or member thereof,
or on its own initiative, determine whether a covered clearing agency
meets the definition of ``systemically important in multiple
jurisdictions.'' \379\ In determining whether a covered clearing agency
is systemically important in multiple jurisdictions, the Commission may
consider (i) whether the covered clearing agency is a designated
clearing agency; (ii) whether the clearing agency has been determined
to be systemically important by one or more jurisdictions other than
the United States through a process that includes consideration of
whether the foreseeable effects of a failure or disruption of the
designated clearing agency could threaten the stability of each
relevant jurisdiction's financial system; \380\ or (iii) such other
factors as the Commission may deem appropriate in the circumstances.
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\379\ See proposed Rule 17Ab2-2(b), infra Part VII.
\380\ The Commission notes that this provision of proposed Rule
17Ab2-2(b) parallels the definition of systemic importance in
Section 803(9) of the Clearing Supervision Act, which states that
systemic importance means a situation where the failure of or a
disruption to the functioning of an FMU could create, or increase,
the risk of significant liquidity or credit problems spreading among
financial institutions or markets and thereby threaten the stability
of the financial system of the United States. See 12 U.S.C. 5462(9).
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The Commission preliminarily believes that it should propose the
procedures set forth in Rule 17Ab2-2(b) for designating a covered
clearing agency as systemically important in multiple jurisdictions.
Accordingly, the Commission is proposing Rule 17Ab2-2(b) to provide
procedures for determining when a clearing agency has become
systemically important in multiple jurisdictions. In this regard, the
Commission preliminarily believes that proposed Rule 17Ab2-2(b)(ii) is
consistent with Section 804(a)(2)(D) of the Clearing Supervision
Act.\381\ The Commission is also proposing that it may consider
additional factors in determining whether a covered clearing agency is
systemically important in multiple jurisdictions, in addition to
whether the foreseeable effects of a failure or disruption of the
designated clearing agency could threaten the stability of multiple
jurisdictions' financial systems. Such analysis could include whether
foreign regulatory authorities have designated the covered clearing
agency as systemically important and whether any findings were made in
anticipation of that designation.
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\381\ See 12 U.S.C. 5463(a)(2)(D) (listing, as one of the
systemic importance criteria for the FSOC to consider, the effect
that the failure of or a disruption to the FMU or PCS activity would
have on critical markets, financial institutions, or the broader
financial system).
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[[Page 29559]]
3. Determination That a Clearing Agency Has a More Complex Risk Profile
Under proposed Rule 17Ab2-2(c), the Commission may, if it deems
appropriate, determine whether any of the activities of a clearing
agency providing central counterparty services, in addition to clearing
agencies registered with the Commission for the purpose of clearing
security-based swaps, have a more complex risk profile.\382\ In
determining whether a clearing agency's activity has a more complex
risk profile, the Commission may consider (i) characteristics such as
the clearing of financial instruments that are characterized by
discrete jump-to-default price changes or that are highly correlated
with potential participant defaults; and (ii) such other
characteristics as it deems appropriate in the circumstances. The
Commission preliminarily believes that the clearing of financial
instruments that are characterized by discrete jump-to-default price
changes or that are highly correlated with potential participant
defaults are two factors that indicate a registered clearing agency
raises systemic risk concerns supporting application of the
requirements under proposed Rule 17Ad-22(e).\383\
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\382\ See proposed Rule 17Ab2-2(c), infra Part VII.
\383\ See supra note 375 and accompanying text.
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The Commission preliminarily believes that proposed Rule 17Ab2-2(c)
would provide the Commission with the flexibility necessary to achieve
the goals of Section 17A of the Exchange Act,\384\ Title VII of the
Dodd-Frank Act,\385\ and the Clearing Supervision Act,\386\ given the
dynamic nature of the U.S. securities markets, including the nature and
character of participants in the market and the products required to be
cleared and settled in practice, by permitting the Commission to
determine that certain registered clearing agencies are complex risk
profile clearing agencies. The Commission also preliminarily believes
that activities involving a more complex risk profile, because they may
involve the clearing of financial instruments that are characterized by
discrete jump-to-default price changes or that are highly correlated
with potential participant defaults, implicate systemic risk concerns
supporting application of the requirements under proposed Rule 17Ad-
22(e).\387\
---------------------------------------------------------------------------
\384\ See supra Part I.A.
\385\ See supra Part I.B.1.
\386\ See supra Part I.B.2.
\387\ See supra note 375 and accompanying text.
---------------------------------------------------------------------------
4. Request for Comments
The Commission generally requests comments on all aspects of
proposed Rule 17Ab2-2. In addition, the Commission requests comments on
the following specific issues:
Should the Commission establish procedures for making
determinations affecting covered clearing agencies? Why or why not?
In determining whether a clearing agency should be
considered a covered clearing agency, should the Commission consider
characteristics such as the clearing of financial instruments that are
characterized by discrete jump-to-default price changes or that are
highly correlated with potential participant defaults, as proposed? Why
or why not? Are there particular other characteristics that the
Commission should consider? If so, please explain the relevance of
those characteristics in detail.
Does the proposed rule sufficiently describe the types of
factors that would be considered when the Commission considers a
determination that a registered clearing agency is a covered clearing
agency? What factors should be considered?
Should the Commission, if it deems appropriate, determine
whether a covered clearing agency is systemically important in multiple
jurisdictions? Why or why not? If not, what alternative approach should
the Commission use to assess whether a covered clearing agency is
systemically important in multiple jurisdictions? For instance, what
weight should the Commission give to determinations by other
jurisdictions or regulators regarding the systemic importance in
multiple jurisdictions of a covered clearing agency? Is it appropriate
for the Commission to assess whether such determination was made
through a process that includes consideration of whether the
foreseeable effects of a failure or disruption of the designated
clearing agency could threaten the stability of each relevant
jurisdiction's financial system, as proposed? Please explain. Are there
particular other factors that the Commission should consider? If so,
please explain the relevance of those characteristics in detail.
Does the proposed rule sufficiently describe the types of
factors that would be considered when the Commission considers a
determination that a covered clearing agency is systemically important
in multiple jurisdictions? What factors should be considered?
In determining whether any of the activities of a clearing
agency providing CCP services have a more complex risk profile, should
the Commission consider characteristics such as the clearing of
financial instruments that are characterized by discrete jump-to-
default price changes or that are highly correlated with potential
participant defaults, as proposed? Why or why not? Are there particular
other characteristics that the Commission should consider? If so,
please explain the relevance of those characteristics in detail.
Does the proposed rule sufficiently describe the types of
factors that would be considered when the Commission considers a
determination that a clearing agency is a complex risk profile clearing
agency? What factors should be considered?
Does the proposed process for determinations under Rule
17Ab2-2 conflict with the PFMI Report's use of ``systemic importance in
multiple jurisdictions'' and ``more complex risk profile'' activities?
If so, please explain.
D. Proposed Rule 17Ad-22(f)
The Commission is proposing Rule 17Ad-22(f) to codify its special
enforcement authority over designated clearing agencies for which the
Commission acts as the supervisory agency, pursuant to the Clearing
Supervision Act. Under Section 807(c) of the Clearing Supervision Act,
for purposes of enforcing the provisions of the Clearing Supervision
Act, a designated clearing agency is subject to, and the Commission has
authority under, the provisions of subsections (b) through (n) of
Section 8 of the Federal Deposit Insurance Act in the same manner and
to the same extent as if a designated clearing agency were an insured
depository institution and the Commission were the appropriate Federal
banking agency for such insured depository institution.\388\
---------------------------------------------------------------------------
\388\ See 12 U.S.C. 5466(c); see also 12 U.S.C. 1818 (relevant
provisions under the Federal Deposit Insurance Act).
---------------------------------------------------------------------------
Request for Comments. The Commission requests comment on proposed
Rule 17Ad-22(f), including whether the proposed rule is clear and
consistent with the requirements of the Exchange Act and the Clearing
Supervision Act.
E. Proposed Amendment to Rule 17Ad-22(d)
To facilitate consistency with proposed Rule 17Ad-22(e), the
Commission is proposing to amend Rule 17Ad-22(d). Rule 17Ad-22(d) sets
forth certain minimum requirements for the operation and governance of
registered
[[Page 29560]]
clearing agencies.\389\ The first paragraph of Rule 17Ad-22(d)
currently provides that a registered clearing agency shall establish,
implement, maintain and enforce written policies and procedures
reasonably designed to fulfill the requirements of Rule 17Ad-22(d), as
applicable. The Commission is proposing to amend this first paragraph
of Rule 17Ad-22(d) to state that Rule 17Ad-22(d) applies to registered
clearing agencies other than covered clearing agencies.\390\ As a
result, the proposed amendment would limit the applicability of Rule
17Ad-22(d) to CME and ICE, as systemically important FMUs for which the
CFTC is the supervisory agency under the Clearing Supervision Act,\391\
the two registered but dormant clearing agencies,\392\ and any clearing
agency registered with the Commission in the future that is not one of
the following: A designated clearing agency, a complex risk profile
clearing agency, or a clearing agency that the Commission has otherwise
determined to be a covered clearing agency pursuant to proposed Rule
17Ab2-2.\393\
---------------------------------------------------------------------------
\389\ See 17 CFR 240.17Ad-22(d); see also Clearing Agency
Standards Release, supra note 5, at 66244-58.
\390\ See proposed amendment to Rule 17Ad-22(d), infra Part VII.
\391\ See supra notes 84-87 and accompanying text.
\392\ See supra note 88 and accompanying text (discussing SCCP
and BSECC).
\393\ See supra Part II.A.1 (further discussing the scope of the
proposed rules).
---------------------------------------------------------------------------
Request for Comments. The Commission requests comment on the
proposed amendment to Rule 17Ad-22(d), including whether the proposed
amendment is clear and consistent with the requirements of the Exchange
Act, the Clearing Supervision Act, and proposed Rule 17Ad-22(e)
thereunder.
III. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \394\ imposes certain
requirements on federal agencies in connection with the conducting or
sponsoring of any ``collection of information.'' \395\ More
specifically, an agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. Additionally, 44 U.S.C. 3507(a)(1)(D)
provides that before adopting (or revising) a collection of information
requirement, an agency must, among other things, publish a notice in
the Federal Register stating that the agency has submitted the proposed
collection of information to the Office of Management and Budget
(``OMB'') and setting forth certain required information, including (1)
a title for the collection of information; (2) a summary of the
collection information; (3) a brief description of the need for the
information and the proposed use of the information; (4) a description
of the likely respondents and proposed frequency of response to the
collection of information; (5) an estimate of the paperwork burden that
shall result from the collection of information; and (6) notice that
comments may be submitted to the agency and director of OMB.\396\
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\394\ 44 U.S.C. 3501 et seq.
\395\ See 44 U.S.C. 3502(3).
\396\ See 44 U.S.C. 3507(a)(1)(D); see also 5 CFR
1320.5(a)(1)(iv).
---------------------------------------------------------------------------
Certain provisions of the proposed rules would impose new
``collection of information'' requirements within the meaning of the
PRA. Accordingly, the Commission has submitted the information to the
OMB for review in accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. A
title and control number already exists for Rule 17Ad-22 adopted in
October 2012 (OMB Control No. 3235-0695 for ``Clearing Agency Standards
for Operation and Governance''). Because the Commission is proposing to
revise the collection of information under this proposed rulemaking for
amendments to Rule 17Ad-22, the Commission will use OMB Control No.
3235-0695 for the collections of information for proposed Rule 17Ad-
22(e).
Additionally, proposed Rule 17Ab2-2 would contain a new collection
of information requirement for PRA purposes. The title of the new
collection of information under this proposed rulemaking is
Determinations Affecting Covered Clearing Agencies (a proposed new
collection of information).
A. Overview and Organization
The Commission preliminarily believes information that would be
required to be collected by virtue of written policies and procedure
requirements contained in this proposed rulemaking reflects to a degree
existing practices at covered clearing agencies.\397\ In certain
instances, however, the proposed requirements would require covered
clearing agencies to establish, implement, maintain and enforce written
policies and procedures reasonably designed to comply with this
proposed rulemaking.
---------------------------------------------------------------------------
\397\ See infra Part IV.B.3 (describing current practices at
registered clearing agencies).
---------------------------------------------------------------------------
With regard to proposed Rule 17Ad-22(e), given that several
provisions of the proposed rule are intended to be consistent with Rule
17Ad-22, the Commission preliminarily believes that covered clearing
agencies currently in compliance with the requirements of existing Rule
17Ad-22 may already have some written rules and procedures similar to
those in proposed Rule 17Ad-22(e). Accordingly, when covered clearing
agencies review and update their policies and procedures in order to
come into compliance with proposed Rule 17Ad-22(e), the Commission
preliminarily believes that the PRA burden would vary across the
requirements of proposed Rule 17Ad-22(e), based on the complexities of
the requirements under each paragraph of the proposed rule and the
extent to which covered clearing agencies currently comply with the
proposed requirements under their existing policies and
procedures.\398\
---------------------------------------------------------------------------
\398\ For a discussion of the differences between Rule 17Ad-
22(d) and proposed Rule 17Ad-22(e), see Parts II.B.1-20.
---------------------------------------------------------------------------
The portions of proposed Rule 17Ad-22(e) for which the PRA burden
is preliminarily expected to be higher are the provisions contemplating
requirements not addressed in Rule 17Ad-22, as discussed in Part
II.A.4. Because these proposed requirements may not reflect established
practices of covered clearing agencies or reflect the normal course of
their activities, the PRA burden for these proposed rules may entail
both initial one-time burdens to create new written policies and
procedures and ongoing burdens. The expected PRA burden for the
proposed rules is discussed in detail below.\399\
---------------------------------------------------------------------------
\399\ See infra Parts III.D.6 (estimated burdens under proposed
Rule 17Ad-22(e)(15)) and 7 (estimated burdens under proposed Rule
17Ad-22(e)(19)).
---------------------------------------------------------------------------
In addition to the collection of information requirements imposed
under proposed Rule 17Ad-22(e), proposed Rule 17Ab2-2 also would
contain collection of information requirements for PRA purposes.
Proposed Rule 17Ab2-2 establishes a process for making determinations
regarding whether or not a clearing agency would be a covered clearing
agency and whether a covered clearing agency is either involved in
activities with a more complex risk profile or systemically important
in multiple jurisdictions.\400\ The expected PRA burden for proposed
Rule 17Ab2-2 is discussed below.
---------------------------------------------------------------------------
\400\ See infra Part II.C (further discussing the purpose,
scope, and application of proposed Rule 17Ab2-2) and Part VII
(proposed text of Rule 17Ab2-2).
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[[Page 29561]]
B. Summary of Collection of Information and Proposed Use of Information
for Proposed Rule 17Ad-22(e) \401\ and Proposed Rule 17Ab2-2
---------------------------------------------------------------------------
\401\ Proposed Rule 17Ad-22(e) would require covered clearing
agencies to establish, implement, maintain and enforce certain
written policies and procedures that would be used, among other
things, in connection with staff examinations.
---------------------------------------------------------------------------
1. Proposed Rules 17Ad-22(e)(1) Through (3): General Organization
a. Proposed Rule 17Ad-22(e)(1)
Proposed Rule 17Ad-22(e)(1) would require a covered clearing agency
to establish, implement, maintain and enforce written 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.\402\ The purpose of this
collection of information is to reduce the legal risks involved in the
clearance and settlement process and to ensure that a covered clearing
agency's policies and procedures do not cause legal uncertainty among
participants due to a lack of clarity, completeness, or conflicts with
applicable laws and judicial precedent.
---------------------------------------------------------------------------
\402\ See supra Part II.B.1 (discussing proposed Rule 17Ad-
22(e)(1)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(2)
Proposed Rule 17Ad-22(e)(2) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for governance arrangements
that are clear and transparent, clearly prioritize the safety and
efficiency of the covered clearing agency, and support the public
interest requirements of Section 17A of the Exchange Act, and the
objectives of owners and participants. Proposed Rule 17Ad-22(e)(2)
would also require a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to provide for governance arrangements reasonably designed to
establish that the covered clearing agency's board of directors and
senior management have appropriate experience and skills to discharge
their duties and responsibilities.\403\
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\403\ See supra Part II.B.2 (discussing proposed Rule 17Ad-
22(e)(2)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
The purpose of this collection of information is to promote boards
of directors that are composed of qualified members and that exercise
oversight of the covered clearing agency's management, while also
prioritizing the safety and efficiency of the covered clearing agency
and supporting the public interest.
c. Proposed Rule 17Ad-22(e)(3)
Proposed Rule 17Ad-22(e)(3) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain a sound risk management
framework for comprehensively managing legal, credit, liquidity,
operational, general business, investment, custody, and other risks
that arise in or are borne by the covered clearing agency. Under the
proposed rule, risk management policies, procedures, and systems must
provide for the identifying, measuring, monitoring, and managing of
risks that arise in or are borne by the covered clearing agency. Such
policies and procedures must be subject to review on a specified
periodic basis and be approved by the board of directors annually. The
proposed rule would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide for plans for the recovery and orderly
wind-down of the covered clearing agency in the event of credit losses,
liquidity shortfalls, losses from general business risk, or any other
losses. The proposed rule would also require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to establish that risk management and
internal audit personnel have sufficient resources, authority, and
independence from management. The proposed rule would further require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to establish that
risk management and internal audit personnel have a direct reporting
line to, and are overseen by, a risk management committee and an audit
committee of the board of directors, respectively. The proposed rule
would also require policies and procedures providing for an independent
audit committee.\404\
---------------------------------------------------------------------------
\404\ See supra Part II.B.3 (discussing proposed Rule 17Ad-
22(e)(3)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
The purpose of this collection of information is to enhance a
covered clearing agency's ability to identify, monitor, and manage the
risks clearing agencies face, including by subjecting the relevant
policies and procedures to regular review, and to facilitate an orderly
recovery and wind-down process in the event that a covered clearing
agency is unable to continue operating as a going concern.
2. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management
a. Proposed Rule 17Ad-22(e)(4)
Proposed Rule 17Ad-22(e)(4) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to each participant and those
exposures arising from payment, clearing, and settlement processes.
Proposed Rule 17Ad-22(e)(4)(i) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain sufficient financial
resources to cover its credit exposure to each member fully with a high
degree of confidence. To the extent not already maintained pursuant to
proposed Rule 17Ad-22(e)(4)(i), a covered clearing agency that provides
CCP services would also have to establish, implement, maintain, and
enforce written policies and procedures to meet either the ``cover
one'' requirement under proposed Rule 17Ad-22(e)(4)(iii) or, if it is a
complex risk profile clearing agency or systemically important in
multiple jurisdictions, the ``cover two'' requirement under proposed
Rule 17Ad-22(e)(4)(ii).
Proposed Rule 17Ad-22(e)(4)(iv) would require covered clearing
agencies to establish, implement, maintain and enforce written policies
and procedures reasonably designed to cover its credit exposures by
including prefunded financial resources and excluding assessments for
additional guaranty fund contributions or other resources that are not
prefunded, when calculating financial resources available to meet the
requirements under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable.\405\
---------------------------------------------------------------------------
\405\ See supra Part II.B.4.c (discussing proposed Rule 17Ad-
22(e)(4)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(4)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain the financial resources
required under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable, in combined or separately maintained clearing or guaranty
funds, and to test the sufficiency of its total financial resources by
conducting a stress test of total financial resources once each day
[[Page 29562]]
using standard predetermined parameters and assumptions.
Proposed Rule 17Ad-22(e)(4)(vi) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to test the sufficiency of its total
financial resources available to meet the minimum financial resource
requirements under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable, by conducting stress tests and other comprehensive
analyses. Specifically, those would include conducting a stress test of
its total financial resources once each day using standard
predetermined parameters and assumptions. It would also include
conducting a comprehensive analysis on at least a monthly basis of the
existing stress testing scenarios, models, and underlying parameters
and assumptions, and considering modifications to ensure that they are
appropriate for determining the covered clearing agency's required
level of default protection in light of current market conditions. It
would also include conducting a comprehensive analysis of stress
testing scenarios, models, and underlying parameters and assumptions
more frequently than monthly when the products cleared or markets
served display high volatility, become less liquid, or when the size or
concentration of positions held by its participants increases
significantly. It would also include reporting the results of this
analysis to appropriate decision makers, including its risk management
committee or board of directors, and to use these results to evaluate
the adequacy of and adjust its margin methodology, model parameters,
models used to generate clearing or guaranty fund requirements, and any
other relevant aspects of its credit risk management policies and
procedures, in supporting compliance with the minimum financial
resources requirements discussed above.
Finally, proposed Rule 17Ad-22(e)(4)(vii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to require the covered
clearing agency to perform a conforming model validation for its credit
risk models at least annually, or more frequently if dictated by the
covered clearing agency's risk management policies and procedures
established under proposed Rule 17Ad-22(e)(3).\406\
---------------------------------------------------------------------------
\406\ See id.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(5)
Rule 17Ad-22(e)(5) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to limit the assets it accepts as
collateral to those with low credit, liquidity, and market risks. It
also would require policies that set and enforce appropriately
conservative haircuts and concentration limits if the covered clearing
agency requires collateral to manage its or its participants' credit
exposure and would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to require a not-less-than-annual review of the
sufficiency of its collateral haircut and concentration limits.\407\
---------------------------------------------------------------------------
\407\ See supra Part II.B.4.d (discussing proposed Rule 17Ad-
22(e)(5)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(6)
Proposed Rule 17Ad-22(e)(6) would require a covered clearing agency
that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to cover
its credit exposures to its participants by establishing a risk-based
margin system. The proposed rule would require such margin system to
consider, and produce margin levels commensurate with, the risks and
particular attributes of each relevant product, portfolio, and market.
Furthermore, under the proposed rule the margin system would mark
participant positions to market and collect margin, including variation
margin or equivalent charges if relevant, at least daily, and include
the authority and operational capacity to make intraday margin calls in
defined circumstances. The proposed rule also requires policies and
procedures with respect to the following: The calculation of margin
sufficient to cover a covered clearing agency's potential future
exposure to participants in the interval between the last margin
collection and close out of positions following a participant default;
the use of reliable sources of timely price data and procedures and
sound valuation models for addressing circumstances in which pricing
data are not readily available or reliable; and the use of an
appropriate method for measuring credit exposure that accounts for
relevant product risk factors and portfolio effects across
products.\408\
---------------------------------------------------------------------------
\408\ See supra Part II.B.4.e (discussing proposed Rule 17Ad-
22(e)(6)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
In addition to requiring policies and procedures with respect to a
risk-based margin system, proposed Rule 17Ad-22(e)(6) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to regularly
review, test, and verify risk-based margin systems by conducting
backtests at least once each day and, at least monthly, a conforming
sensitivity analysis of its margin resources and its parameters and
assumptions for backtesting, and consider modifications to ensure the
backtesting practices are appropriate for determining the adequacy of
its margin resources. Such review, testing, and verification would
include conducting a conforming sensitivity analysis more frequently
than monthly when the products cleared or markets served display high
volatility, become less liquid, or when the size or concentration of
positions held by participants increase or decrease significantly. The
proposed rule would also require a covered clearing agency providing
CCP services to establish, implement, maintain and enforce written
policies and procedures reasonably designed to report the results of
such conforming sensitivity analysis to appropriate decision makers,
including its risk management committee or board of directors, and use
these results to evaluate the adequacy of and adjust its margin
methodology, model parameters, and any other relevant aspects of its
credit risk management policies and procedures. Finally, under such
policies and procedures, a not less than annual conforming model
validation would be required for the covered clearing agency's margin
system and related models.\409\
---------------------------------------------------------------------------
\409\ See id.
---------------------------------------------------------------------------
d. Proposed Rule 17Ad-22(e)(7)
Proposed Rule 17Ad-22(e)(7) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively measure, monitor, and
manage the liquidity risk that arises in or is borne by the covered
clearing agency, including measuring, monitoring, and managing its
settlement and funding flows on an ongoing and timely basis and its use
of intraday liquidity. Under the proposed rule, a covered clearing
agency would be required to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
sufficient liquid resources in all relevant currencies to effect same-
day and,
[[Page 29563]]
where appropriate, intraday and multiday settlement of payment
obligations with a high degree of confidence under a wide range of
potential stress scenarios that includes the default of the participant
family that would generate the largest aggregate payment obligation for
it in extreme but plausible market conditions. Under such policies and
procedures, use of access to accounts and services at a Federal Reserve
Bank, pursuant to Section 806 of the Clearing Supervision Act,\410\ or
other relevant central bank, when available and where determined to be
practical by the board of directors of the covered clearing agency,
would be required.\411\
---------------------------------------------------------------------------
\410\ 12 U.S.C. 5465(a).
\411\ See supra Part II.B.4.f (discussing proposed Rule 17Ad-
22(e)(7)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
For the purposes of meeting such liquid resource requirements, a
covered clearing agency would be required to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to require the holding of qualifying liquid resources in each
relevant currency for which clearing activities are performed, limited
to (i) cash at the central bank of issue or at creditworthy commercial
banks; (ii) assets that are readily available and convertible into cash
through prearranged funding arrangements without material adverse
change provisions, such as committed lines of credit, committed foreign
exchange swaps, committed repurchase agreements, and other prearranged
funding arrangements determined to be highly reliable even in extreme
but plausible market conditions by the board of directors, following an
annual review conducted for this purpose; and (iii) other assets that
are readily available and eligible for pledging to (or conducting other
appropriate forms of transactions with) a relevant central bank,
provided that the covered clearing agency had access to routine credit
at the central bank.
With respect to a covered clearing agency's sources of liquidity,
the proposed rule would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to undertake due diligence to confirm that it has a
reasonable basis to believe each of its liquidity providers, whether or
not such liquidity provider is a clearing member, has sufficient
information to understand and manage the liquidity provider's liquidity
risks, and the capacity to perform as required under its commitments to
provide liquidity. Furthermore, under such policies and procedures, on
at least an annual basis, a covered clearing agency would be required
to maintain and test with each liquidity provider to the extent
practicable the covered clearing agency's procedures and operational
capacity for accessing each type of liquidity resource by conducting
stress testing of its liquidity resources using standard and
predetermined parameters and assumptions at least once each day.
Additionally, a covered clearing agency would be required to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to determine the amount and regularly test the
sufficiency of the liquid resources held for purposes of meeting the
minimum liquid resource requirement by (i) conducting a stress test of
its liquidity resources using standard and predetermined parameters and
assumptions at least once each day; and (ii) conducting a comprehensive
analysis of the existing stress testing scenarios, models, and
underlying parameters and assumptions used in evaluating liquidity
needs and resources, and considering modifications to ensure they are
appropriate in light of current and evolving market conditions at least
once a month and more frequently when products cleared or markets
served display high volatility, become less liquid, or when the size or
concentration of positions held by participants increase
significantly.\412\
---------------------------------------------------------------------------
\412\ See id.
---------------------------------------------------------------------------
Under such policies and procedures required by the proposed rule,
stress test results must be reported to appropriate decision makers,
including the risk management committee or board of directors, at the
covered clearing agency for use in evaluating the adequacy of and
adjusting its liquidity risk management policies and procedures. A
covered clearing agency would also be required to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to perform an annual conforming model validation of its
liquidity risk models and would be required to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to address foreseeable liquidity shortfalls that would not be
covered by its liquid resources and to seek to avoid unwinding,
revoking, or delaying the same-day settlement of payment obligations.
Additionally, a covered clearing agency would be required to establish,
implement, maintain and enforce written policies and procedures that
describe the covered clearing agency's process to replenish any liquid
resources that may be employed during a stress event.\413\
---------------------------------------------------------------------------
\413\ See id.
---------------------------------------------------------------------------
Finally, a covered clearing agency would be required to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to require the covered clearing agency to undertake
an analysis at least once a year that evaluates the feasibility of
maintaining sufficient liquid resources at a minimum in all relevant
currencies to effect same-day and, where appropriate, intraday and
multiday settlement of payment obligations with a high degree of
confidence under a wide range of foreseeable stress scenarios that
includes, but is not limited to, the default of the two participant
families that would potentially cause the largest aggregate credit
exposure for the covered clearing agency in extreme but plausible
market conditions if the covered clearing agency provides central
counterparty services and is either systemically important in multiple
jurisdictions or a clearing agency involved in activities with a more
complex risk profile.
The purpose of this information collection is to enable a covered
clearing agency to be able to effectively identify and limit exposures
to participants, to maintain sufficient collateral or margin, and to
satisfy all of its settlement obligations in the event of a participant
default.
3. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement
a. Proposed Rule 17Ad-22(e)(8)
Proposed Rule 17Ad-22(e)(8) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to define the point at which settlement
is final no later than the end of the day on which the payment or
obligation is due and, where necessary or appropriate, either intraday
or in real time.\414\
---------------------------------------------------------------------------
\414\ See supra Part II.B.5 (discussing proposed Rule 17Ad-
22(e)(8)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(9)
Proposed Rule 17Ad-22(e)(9) would require covered clearing agencies
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to have the covered clearing agency
conduct its money settlements in central bank money, where available
and determined to be
[[Page 29564]]
practical by the board of directors of the covered clearing agency, and
minimize and manage credit and liquidity risk arising from the clearing
agency's money settlements in commercial bank money where central bank
money is not used.\415\
---------------------------------------------------------------------------
\415\ See supra Part II.B.6 (discussing proposed Rule 17Ad-
22(e)(9)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(10)
Proposed Rule 17Ad-22(e)(10) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
reasonably designed to set forth transparent written standards
regarding a clearing agency's obligations with respect to the delivery
of physical instruments, as well as operational practices that
identify, monitor, and manage the risk associated with such physical
deliveries.\416\
---------------------------------------------------------------------------
\416\ See supra Part II.B.7 (discussing proposed Rule 17Ad-
22(e)(10)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
The purpose of this information collection is to promote consistent
standards of timing and reliability in the settlement process, promote
reliability in a covered clearing agency's settlement operations, and
to provide a covered clearing agency's participants with information
necessary to evaluate the risks and costs associated with participation
in the covered clearing agency.
4. Proposed Rules 17Ad-22(e)(11) Through (12): CSDs and Exchange-of-
Value Settlement Systems
The purpose of this collection of information is to reduce
securities transfer processing costs and risks associated with
securities settlement and custody, increase the speed and efficiency of
the settlement process, and eliminate risk in transactions with linked
obligations.
a. Proposed Rule 17Ad-22(e)(11)
Proposed Rule 17Ad-22(e)(11) would require a covered CSD to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to implement internal auditing and other
controls to safeguard the rights of securities issuers and holders and
prevent the unauthorized creation or deletion of securities. A covered
CSD would also be required to establish, implement, maintain and
enforce written policies and procedures reasonably designed to conduct
periodic and at least daily reconciliation of securities issues that
the CSD maintains. Additionally, the proposed rule would require a
covered CSD to establish, implement, maintain and enforce written
policies and procedures reasonably designed to maintain securities in
an immobilized or dematerialized form, ensure the integrity of
securities issues, and minimize and manage the risks associated with
the safekeeping and transfer of securities, as well as protect assets
against custody risk.\417\
---------------------------------------------------------------------------
\417\ See supra Part II.B.8 (discussing proposed Rule 17Ad-
22(e)(11)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(12)
Proposed Rule 17Ad-22(e)(12) would require a covered clearing
agency that settles transactions involving the settlement of two linked
obligations to establish, implement, maintain and enforce written
policies and procedures reasonably designed to eliminate principal risk
by conditioning the final settlement of one obligation upon the final
settlement of the other, irrespective of whether the covered clearing
agency settles on a gross or net basis and when finality occurs.\418\
---------------------------------------------------------------------------
\418\ See supra Part II.B.9 (discussing proposed Rule 17Ad-
22(e)(12)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
5. Proposed Rules 17Ad-22(e)(13) Through (14): Default Management
The purpose of this collection of information is to facilitate the
functioning of a covered clearing agency in the event that a
participant fails to meet its obligations, as well as limit the extent
to which a participant's failure can spread to other participants or
the covered clearing agency itself, and to ensure the safe and
effective holding and transfer of customers' positions and collateral
in the event of a participant's default or insolvency.
a. Proposed Rule 17Ad-22(e)(13)
Proposed Rule 17Ad-22(e)(13) would require covered clearing
agencies providing CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to ensure
that a covered clearing agency subject to this rule has sufficient
authority and operational capability to contain losses and liquidity
demands in a timely fashion and continue to meet its own obligations.
The proposed rule would also require that a covered clearing agency
subject to the rule establish, implement, maintain and enforce written
policies and procedures reasonably designed to address the allocation
of credit losses it may face if its collateral or other resources are
insufficient to fully cover its credit exposures, describe the process
whereby the clearing agency would replenish any financial resources it
may use following a default or other event in which the use of such
resources is contemplated, and require participants and other
stakeholders, to the extent applicable, to participate in the testing
and review of its default procedures, including any close out
procedures. Under such policies and procedures, the testing and review
must occur at least annually and following any material changes
thereto.\419\
---------------------------------------------------------------------------
\419\ See supra Part II.B.10 (discussing proposed Rule 17Ad-
22(e)(13)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(14)
Proposed Rule 17Ad-22(e)(14) would require a covered clearing
agency that provides CCP services for security-based swaps or engages
in activities that the Commission has determined to have a more complex
risk profile to establish, implement, maintain and enforce written
policies and procedures reasonably designed to enable the segregation
and portability of positions of a participant's customers and
collateral and effectively protect such positions and collateral from
the default or insolvency of that participant.\420\
---------------------------------------------------------------------------
\420\ See supra Part II.B.11 (discussing proposed Rule 17Ad-
22(e)(14)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
6. Proposed Rules 17Ad-22(e)(15) Through (17): General Business and
Operational Risk Management
The purpose of this collection of information is to mitigate the
potential impairment of a covered clearing agency as a result of a
decline in revenues or increase in expenses, to limit disruptions that
may impede the proper functioning of a covered clearing agency, and to
improve the ability of a covered clearing agency to meet its settlement
obligations.
a. Proposed Rule 17Ad-22(e)(15)
Proposed Rule 17Ad-22(e)(15) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage
general business risk and hold sufficient liquid net assets funded by
equity to cover potential general business losses so that the covered
clearing agency can continue operations and services as a going concern
if losses materialize. Covered clearing agencies would also be required
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to determine the amount of liquid net
assets funded by equity based upon the general risk profile of that
clearing agency and the
[[Page 29565]]
length of time necessary to achieve recovery or orderly wind-down. The
proposed rule would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to hold liquid net assets funded by
equity in an amount equal to the greater of either six months of
current operating expenses or the amount determined by the agency's
board of directors to be sufficient to ensure a recovery or orderly
wind-down of critical operations and services. Under such policies and
procedures, these resources are to be held in addition to resources
held to cover participant default or other risks and must be of high
quality and sufficiently liquid. Furthermore, under such policies and
procedures, a covered clearing agency would be required to maintain a
viable plan for raising additional equity in the event that its equity
falls close to, or below, the required amount, and the plan would be
required to be approved by the board of directors and updated at least
annually.\421\
---------------------------------------------------------------------------
\421\ See supra Part II.B.12 (discussing proposed Rule 17Ad-
22(e)(15)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(16)
Proposed Rule 17Ad-22(e)(16) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to safeguard its own assets, as well
as the assets of its participants, and to minimize the risk of loss and
delay in access to such assets. A covered clearing agency would be
required to establish, implement, maintain and enforce written policies
and procedures reasonably designed to invest such assets in instruments
with minimal credit, market and liquidity risks.\422\
---------------------------------------------------------------------------
\422\ See supra Part II.B.13 (discussing proposed Rule 17Ad-
22(e)(16)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(17)
Proposed Rule 17Ad-22(e)(17) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to manage operational risk. A
covered clearing agency would be required to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to identify the plausible sources of operational risk, both
internal and external, and mitigate their impact through the use of
appropriate systems, policies, procedures, and controls. A covered
clearing agency would also be required to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to ensure that systems have a high degree of security,
resiliency, operational reliability, and adequate, scalable capacity.
The proposed rule would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to establish and maintain a business
continuity plan that addresses events posing a significant risk of
disrupting operations.\423\
---------------------------------------------------------------------------
\423\ See supra Part II.B.14 (discussing proposed Rule 17Ad-
22(e)(17)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
7. Proposed Rules 17Ad-22(e)(18) Through (20): Access
The purpose of the collection of information is to enable a covered
clearing agency to ensure that only entities with sufficient financial
and operational capacity are direct participants in the covered
clearing agency while ensuring that all qualified persons can access a
covered clearing agency's services; to enable a covered clearing agency
to monitor that participation requirements are met on an ongoing basis
and to identify a participant experiencing financial difficulties
before the participant fails to meet its settlement obligations; and to
enable a covered clearing agency to identify and manage risks posed by
non-member entities.
a. Proposed Rule 17Ad-22(e)(18)
Proposed Rule 17Ad-22(e)(18) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish objective, risk-based,
and publicly disclosed criteria for participation, which permit fair
and open access by direct and, where relevant, indirect participants
and other FMUs, and require participants to have sufficient financial
resources and robust operational capacity to meet obligations arising
from participation in the clearing agency. A covered clearing agency
would also be required to establish, implement, maintain and enforce
written policies and procedures reasonably designed to monitor
compliance with such participation requirements on an ongoing
basis.\424\
---------------------------------------------------------------------------
\424\ See supra Part II.B.15 (discussing proposed Rule 17Ad-
22(e)(18)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(19)
Proposed Rule 17Ad-22(e)(19) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage the
material risks to the covered clearing agency arising from arrangements
in which firms that are indirect participants rely on services provided
by direct participants to access the covered clearing agency's payment,
clearing, or settlement facilities.\425\
---------------------------------------------------------------------------
\425\ See supra Part II.B.16 (discussing proposed Rule 17Ad-
22(e)(19)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(20)
Proposed Rule 17Ad-22(e)(20) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage
risks related to any link with one or more other clearing agencies,
FMUs, or trading markets.\426\
---------------------------------------------------------------------------
\426\ See supra Part II.B.17 (discussing proposed Rule 17Ad-
22(e)(20)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
8. Proposed Rules 17Ad-22(e)(21) Through (22): Efficiency
The purpose of this collection of information is to ensure that the
services provided by a covered clearing agency do not become
inefficient and to promote the sound operation of a covered clearing
agency. The collection of information is also intended to ensure the
prompt and accurate clearance and settlement of securities transactions
by enabling participants to communicate with a clearing agency in a
timely, reliable, and accurate manner.
a. Proposed Rule 17Ad-22(e)(21)
Proposed Rule 17Ad-22(e)(21) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to require the covered clearing
agency to be efficient and effective in meeting the requirements of its
participants and the markets it serves. Additionally, the rule would
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to have the
management of a covered clearing agency regularly review the efficiency
and effectiveness of the covered clearing agency's (i) clearing and
settlement arrangement; (ii) operating structure, including risk
management policies, procedures, and systems; (iii) scope of products
cleared, settled, or recorded; and (iv) use of technology and
communications procedures.\427\
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\427\ See supra Part II.B.18 (discussing proposed Rule 17Ad-
22(e)(21)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
[[Page 29566]]
b. Proposed Rule 17Ad-22(e)(22)
Proposed Rule 17Ad-22(e)(22) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to use, or at a minimum,
accommodate, relevant internationally accepted communication procedures
and standards in order to facilitate efficient payment, clearing, and
settlement.\428\
---------------------------------------------------------------------------
\428\ See supra Part II.B.19 (discussing proposed Rule 17Ad-
22(e)(22)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
9. Proposed Rule 17Ad-22(e)(23): Disclosure
Proposed Rule 17Ad-22(e)(23) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for (i) publicly disclosing all
relevant rules and material procedures, including key aspects of
default rules and procedures; (ii) providing sufficient information to
enable participants to identify and evaluate the risks, fees, and other
material costs incurred by participating in a covered clearing agency;
and (iii) publicly disclosing relevant basic data on transaction volume
and values. The proposed rule would also require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for a comprehensive public disclosure
of its material rules, policies, and procedures regarding governance
arrangements and legal, financial, and operational risk management that
is accurate in all material respects at the time of publication and to
update this public disclosure every two years, or more frequently
following changes to the clearing agency's system or the environment in
which it operates to the extent necessary to ensure that previous
statements remain accurate in all material respects.\429\ The purpose
of the collection of information is to ensure that participants, as
well as prospective participants, are provided with a complete picture
of the covered clearing agency's operations and risk mitigation
procedures in order to be able to fully and clearly understand the
risks and responsibilities of participation in a clearing agency.
---------------------------------------------------------------------------
\429\ See supra Part II.B.20 (discussing proposed Rule 17Ad-
22(e)(23)) and infra Part VII (providing the proposed rule text).
---------------------------------------------------------------------------
10. Proposed Rule 17Ab2-2
Proposed Rule 17Ab2-2 establishes a process for making
determinations regarding whether a clearing agency is a covered
clearing agency and whether a covered clearing agency is either
involved in activities with a more complex risk profile or systemically
important in multiple jurisdictions.\430\ Each of these determinations
may be initiated by a registered clearing agency, a member of the
clearing agency, or upon the Commission's own initiative.\431\ In each
case, under proposed Rule 17Ab2-2(d), the Commission would publish
notice of its intention to consider such determinations, together with
a brief statement of the grounds under consideration, and provide at
least a 30-day public comment period prior to any determination. Under
proposed Rule 17Ab2-2(e), notice of determinations in each case would
be given prompt publication by the Commission, together with a
statement of written reasons supporting the determination.
---------------------------------------------------------------------------
\430\ See infra Part II.C (further discussing the purpose,
scope, and application of proposed Rule 17Ab2-2) and Part VII
(proposed text of Rule 17Ab2-2).
\431\ See proposed Rule 17Ab2-2(a), infra Part VII.
---------------------------------------------------------------------------
C. Respondents
The Commission estimates that the majority of the proposed
requirements under proposed Rule 17Ad-22(e) would apply to five
registered clearing agencies. The proposed requirements in proposed
Rules 17Ad-22(e)(1) through (23) would impose a PRA burden on covered
clearing agencies. A covered clearing agency is defined under proposed
Rule 17Ad-22(a)(7) as any designated clearing agency, clearing agency
involved in activities with a more complex risk profile for which the
CFTC is not the supervisory agency as defined in Section 803(8) of the
Clearing Supervision Act, or a clearing agency determined by the
Commission to be a covered clearing agency pursuant to proposed Rule
17Ab2-2.\432\ A designated clearing agency is defined under proposed
Rule 17Ad-22(a)(8) as a registered clearing agency that has been
designated systemically important by the FSOC.\433\ The FSOC has
designated six registered clearing agencies as systemically
important.\434\ The Commission is the supervisory agency with respect
to four of these designated clearing agencies, and the CFTC is the
supervisory agency for the remaining two.\435\ Accordingly, proposed
Rule 17Ad-22(e) would apply to the four designated clearing agencies
for which the Commission is the supervisory agency.\436\
---------------------------------------------------------------------------
\432\ See proposed Rule 17Ad-22(a)(7), infra Part VII; see also
supra Part II.A.1 (describing the scope of proposed Rule 17Ad-22(e)
and defining ``covered clearing agency'').
\433\ See proposed Rule 17Ad-22(a)(8), infra Part VII; see also
supra Part II.A.1 (describing the scope of proposed Rule 17Ad-22(e)
and defining ``designated clearing agency''); supra Part I.B.2
(describing designation as systemically important by the FSOC under
the Clearing Supervision Act).
\434\ See supra note 38 and accompanying text.
\435\ See supra note 41 and accompanying text.
\436\ See supra notes 82, 84-87, and accompanying text.
---------------------------------------------------------------------------
In addition to the four designated clearing agencies for which the
Commission is the supervisory agency, a fifth clearing agency would
also be subject to the proposed rules as a complex risk profile
clearing agency that provides CCP services for security-based swaps for
which the CFTC is not the supervisory agency under the Clearing
Supervision Act.\437\
---------------------------------------------------------------------------
\437\ See supra note 83 and accompanying text.
---------------------------------------------------------------------------
While the proposed rules would be applicable to the five registered
clearing agencies currently captured by the definition of covered
clearing agency, the Commission estimates that two additional entities
may seek to register with the Commission and that one of these entities
may seek to register in order to provide CCP services for security-
based swaps. Upon registration, these two entities may be deemed
covered clearing agencies and would be subject to proposed Rule 17Ad-
22(e).
The number of covered clearing agencies subject to proposed Rule
17Ad-22(e) could increase if the FSOC designates additional clearing
agencies as systemically important.\438\ Additionally, the Commission
could determine additional clearing agencies to be covered clearing
agencies under proposed Rule 17Ab2-2,\439\ subjecting them to the
provisions of proposed Rule 17Ad-22(e). While the number of clearing
agencies subject to proposed Rule 17Ad-22(e) could increase, the
Commission is not able to predict whether the FSOC will exercise its
authority in the future to designate additional clearing entities as
systemically important FMUs or whether the Commission will determine
additional clearing agencies to be covered clearing agencies. As a
result, for the purposes of the PRA analysis, the Commission is
preliminarily estimating that there would be seven respondents for a
majority of the proposed requirements under proposed Rule
[[Page 29567]]
17Ad-22(e). With regard to proposed Rule 17Ad-22(e)(6), the number of
respondents would be six because the proposed rule would apply to
covered clearing agencies that provide CCP services. With regard to
proposed Rule 17Ad-22(e)(11), the number of respondents would be one
because the proposed rule would apply to covered clearing agencies that
provide CSD services. With regard to proposed Rule 17Ad-22(e)(14), the
number of respondents would be two because the proposed rule would
apply to covered clearing agencies that provide CCP services for
security-based swaps.
---------------------------------------------------------------------------
\438\ See supra Part I.B.2, in particular notes 27-28, 38-41,
and accompanying text.
\439\ See supra Part II.C (discussing the purpose, scope, and
application of proposed Rule 17Ab2-2) and Part VII (proposed text of
Rule 17Ab2-2).
---------------------------------------------------------------------------
With regard to proposed Rule 17Ab2-2, the Commission preliminarily
estimates for purposes of the PRA analysis that two registered clearing
agencies or their members on their behalf will apply for a Commission
determination, or may be subject to a Commission-initiated
determination, regarding whether the registered clearing agency is a
covered clearing agency, whether a registered clearing agency is
involved in activities with a more complex risk profile, or whether a
covered clearing agency is systemically important in multiple
jurisdictions.
D. Total Annual Reporting and Recordkeeping Burden for Proposed Rule
17Ad-22(e)
The Commission preliminarily believes that the potential PRA burden
imposed by the requirements under proposed Rule 17Ad-22(e) will vary
depending on the requirement in question because registered clearing
agencies are subject to existing requirements under Rule 17Ad-22 that,
in some cases, are similar to those in proposed Rule 17Ad-22(e), as
discussed in Part II.
First, because proposed Rules 17Ad-22(e)(1), (8) through (10),
(12), (14),\440\ (16), and (22) \441\ contain requirements that are
either substantially similar to those under existing Rule 17Ad-22 or
have current practices that the Commission understands largely conform
with the proposed rules, the Commission preliminarily believes that
covered clearing agencies may need to make only limited changes to
update their policies and procedures to satisfy these proposed
requirements. In these cases, as an example, a covered clearing agency
may need to conduct a review of the proposed rule against its existing
policies and procedures to confirm that it satisfies the proposed
requirements.\442\
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\440\ In the case of proposed Rule 17Ad-22(e)(14), the
Commission preliminarily believes that the current practices of
covered clearing agencies already largely conform to the proposed
requirement, and accordingly believes that covered clearing agencies
may need to make only limited changes to update their policies and
procedures pursuant to the proposed rule. See infra note 508 and
accompanying text; see also infra Parts IV.B.3.e.ii and IV.C.3.a.ix
(discussing the current practices at registered clearing agencies
regarding segregation and portability and the anticipated economic
effect of the proposed rule, respectively).
\441\ In the case of proposed Rule 17Ad-22(e)(22), the
Commission preliminarily believes that the current practices of
covered clearing agencies already largely conform to the proposed
requirement, and accordingly believes that covered clearing agencies
may need to make only limited changes to update their policies and
procedures pursuant to the proposed rule. See supra Part II.B.19
(discussing the requirements under the proposed rule) and infra
Parts IV.B.3.h.ii and IV.C.3.a.xv (discussing the current practices
at registered clearing agencies regarding communication procedures
and standards and the anticipated economic effect of the proposed
rule, respectively).
\442\ In this regard, the Commission notes that its estimates
for the initial one-time and ongoing burdens for proposed Rules
17Ad-22(e)(8) through (10) and (12) are the same across each of the
proposed rules because the Commission preliminarily believes that
the burdens associated with each would primarily constitute a review
of the covered clearing agency's policies and procedures to confirm
that those policies and procedures satisfy the proposed requirement.
---------------------------------------------------------------------------
Second, because proposed Rules 17Ad-22(e)(2), (3), (5), (11), (13),
(17), (18), (20), and (21) contain provisions that are similar to those
under existing Rule 17Ad-22 but would impose additional requirements
that do not appear in existing Rule 17Ad-22, the Commission
preliminarily believes that covered clearing agencies may need to make
changes to update their policies and procedures to satisfy the proposed
requirements. In these cases, as an example, a covered clearing agency
may need to review and amend its existing rule book, policies, and
procedures but may not need to develop, design, or implement new
operations and practices to satisfy the proposed requirements.
Third, for proposed Rules 17Ad-22(e)(4), (6), (7), (15), (19), and
(23), for which no similar existing requirements under Rule 17Ad-22
have been identified,\443\ the Commission preliminarily believes that
covered clearing agencies may need to make more extensive changes to
their policies and procedures (or implement new policies and
procedures), and may need to take other steps to satisfy the proposed
requirements. In these cases, the PRA burden would be greater since a
covered clearing agency may need to, as an example, develop, design,
and implement new operations and practices. With respect to these
provisions, the PRA burden may be greater since these proposed
requirements may not reflect established practices of covered clearing
agencies or reflect the normal course of their activities, and the PRA
burden for these proposed rules may therefore entail initial one-time
burdens to create new written policies and procedures and ongoing
burdens, including burdens associated with disclosure requirements.
---------------------------------------------------------------------------
\443\ In the case of Rule 17Ad-22(e)(23), registered clearing
agencies are subject to existing requirements for disclosure under
existing Rule 17Ad-22, but new requirements under the proposed rule
would impose greater burdens relative to other proposed rules that
have similar requirements to those under existing Rule 17Ad-22. See
supra Part II.B.20 (discussing the requirements under proposed Rule
17Ad-22(e)(23) and their relationship to requirements under existing
Rule 17Ad-22(d)(9)).
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The Commission requests comment regarding the accuracy of the
estimates discussed below.
1. Proposed Rules 17Ad-22(e)(1) Through (3): General Organization
a. Proposed Rule 17Ad-22(e)(1)
Proposed Rule 17Ad-22(e)(1) contains substantially the same
requirements as Rule 17Ad-22(d)(1).\444\ As a result, a respondent
clearing agency would already have written rules, policies, and
procedures substantially similar to the requirements that would be
imposed under the proposed rule. The PRA burden imposed by the proposed
rules would therefore be minimal and would likely be limited to the
review of current policies and procedures and updating existing
policies and procedures where appropriate in order to ensure compliance
with the proposed rule. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(1),\445\ the
Commission preliminarily believes that respondent clearing agencies
would incur an aggregate one-time burden of approximately 56 hours to
review and update existing policies and procedures.\446\
---------------------------------------------------------------------------
\444\ See 17 CFR 240.17Ad-22(d)(1); proposed Rule 17Ad-22(e)(1),
infra Part VII; see also supra Part II.B.1 (discussing the
requirements under the proposed rule).
\445\ See Clearing Agency Standards Release, supra note 5, at
66260.
\446\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours)) = 8 hours
x 7 respondent clearing agencies = 56 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(1) would also impose ongoing burdens on a
respondent clearing agency. The proposed rule would require ongoing
monitoring and compliance activities with respect to the written
policies and procedures created in response to the
[[Page 29568]]
proposed rule.\447\ Based on the Commission's previous estimates for
ongoing monitoring and compliance burdens with respect to existing Rule
17Ad-22,\448\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rule 17Ad-22(e)(1) would impose an
aggregate annual burden on respondent clearing agencies of 21
hours.\449\
---------------------------------------------------------------------------
\447\ Where the Commission refers to anticipated burdens related
to ``enforcement activities,'' the Commission notes that such
policies and procedures contemplate enforcement by the respondent
clearing agency itself. See Clearing Agency Standards Release, supra
note 5, at 66246 (stating that ``the clearing agency must be able to
enforce its policies and procedures that contemplate enforcement by
the clearing agency'').
\448\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\449\ This figure was calculated as follows: (Compliance
Attorney for 3 hours) x 7 respondent clearing agencies = 21 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(2)
Proposed Rule 17Ad-22(e)(2) contains some provisions that are
similar to Rule 17Ad-22(d)(8), but also adds additional requirements
that do not appear in existing Rule 17Ad-22.\450\ As a result, a
respondent clearing agency is required to have some written rules,
policies, and procedures substantially similar to the requirements that
would be imposed under proposed Rule 17Ad-22(e)(2) and would need to
establish and implement a limited number of new policies and
procedures. The PRA burden imposed by the proposed rule would therefore
be associated with reviewing current policies and procedures and
updating those policies and procedures or establishing new policies and
procedures, where appropriate, in order to ensure compliance with the
proposed rule. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(8),\451\ the
Commission preliminarily believes that respondent clearing agencies
would incur an aggregate one-time burden of approximately 154 hours to
review and update existing policies and procedures and to create new
policies and procedures, as necessary.\452\
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\450\ See 17 CFR 240.17Ad-22(d)(8); proposed Rule 17Ad-22(e)(2),
infra Part VII; see also supra Part II.B.2 (discussing the
requirements under the proposed rule).
\451\ See Clearing Agency Standards Release, supra note 5, at
66260.
\452\ This figure was calculated as follows: ((Assistant General
Counsel for 24 hours) + (Compliance Attorney for 10 hours)) = 22
hours x 7 respondent clearing agencies = 154 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(2) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to existing Rule 17Ad-
22,\453\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rule 17Ad-22(e)(2) would impose an
aggregate annual burden on respondent clearing agencies of 28
hours.\454\
---------------------------------------------------------------------------
\453\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\454\ This figure was calculated as follows: (Compliance
Attorney for 4 hours) x 7 respondent clearing agencies = 28 hours.
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(3)
Proposed Rule 17Ad-22(e)(3) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for a sound risk management
framework.\455\ Under Rule 17Ad-22(d), registered clearing agencies are
required to have policies and procedures to manage certain risks faced
by these entities,\456\ but the proposed rule would require a
comprehensive framework for risk management that would require risk
management policies and procedures be designed holistically, be
consistent with each other, and work effectively together. Accordingly,
the proposed rule may impose a PRA burden that would require respondent
clearing agencies to update current policies and procedures in order to
develop a more comprehensive framework that would include a periodic
review thereof and a plan for orderly recovery and wind-down of the
covered clearing agency. As a result, the Commission preliminarily
estimates that respondent clearing agencies would incur an aggregate
one-time burden of 399 hours to review and update existing policies and
procedures and to create new policies and procedures, as
necessary.\457\
---------------------------------------------------------------------------
\455\ See proposed Rule 17Ad-22(e)(3), infra Part VII.
\456\ See 17 CFR 240.17Ad-22(d); see also Part II.B.3
(discussing the requirements under the proposed rule and their
relationship to existing requirements under Rule 17Ad-22).
\457\ This figure was calculated as follows: ((Assistant General
Counsel for 25 hours) + (Compliance Attorney for 18 hours) + (Senior
Risk Management Specialist for 7 hours) + (Computer Operations
Manager for 7 hours)) = 57 hours x 7 respondent clearing agencies =
399 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(3) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule and activities related to preparing documents facilitating a
periodic review of the risk management framework. Based on the
Commission's previous estimates for ongoing monitoring and compliance
burdens with respect to existing Rule 17Ad-22,\458\ the Commission
preliminarily estimates that the ongoing activities required by
proposed Rule 17Ad-22(e)(3) would impose an aggregate annual burden on
respondent clearing agencies of 343 hours.\459\ The Commission notes
that the estimated ongoing burden for Proposed Rule 17Ad-22(e)(3) is
similar to the initial one-time burden because the proposed rule
includes a specific requirement that policies and procedures for
comprehensive risk management include review on a specified periodic
basis and approval by the board of directors annually.
---------------------------------------------------------------------------
\458\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\459\ This figure was calculated as follows: ((Compliance
Attorney for 8 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 5 hours) + (Risk Management Specialist
for 33 hours)) = 49 hours x 7 respondent clearing agencies = 343
hours.
---------------------------------------------------------------------------
2. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management
a. Proposed Rule 17Ad-22(e)(4)
The Commission preliminarily believes that the estimated PRA
burdens for proposed Rule 17Ad-22(e)(4) would be more significant, as
changes to existing policies and procedures would involve more than
adjustments and may require a respondent clearing agency to make
substantial changes to its policies and procedures.\460\ In addition,
proposed Rule 17Ad-22(e)(4) would require one-time systems adjustments
related to the capability to test the sufficiency of financial
resources and to perform an annual conforming model validation. As a
result, the Commission preliminarily estimates that respondent clearing
agencies would incur an aggregate one-time burden of 1,400 hours.\461\
---------------------------------------------------------------------------
\460\ See proposed Rule 17Ad-22(e)(4), infra Part VII; see also
supra Part II.B.4.c (discussing the requirements under the proposed
rule).
\461\ This figure was calculated as follows: ((Assistant General
Counsel for 60 hours) + (Compliance Attorney for 40 hours) + (Senior
Risk Management Specialist for 30 hours) + (Computer Operations
Manager for 45 hours) + (Chief Compliance Officer for 15 hours) +
(Senior Programmer for 10 hours)) = 200 hours x 7 respondent
clearing agencies = 1,400 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(4) would also impose ongoing burdens on a
respondent clearing agency. The proposed rule would require ongoing
monitoring and compliance activities
[[Page 29569]]
with respect to the written policies and procedures created in response
to the proposed rule and ongoing activities with respect to testing the
sufficiency of financial resources and model validation. Based on the
Commission's previous estimates for ongoing monitoring and compliance
burdens with respect to existing Rule 17Ad-22,\462\ the Commission
preliminarily estimates that the ongoing activities required by
proposed Rule 17Ad-22(e)(4) would impose an aggregate annual burden on
respondent clearing agencies of 420 hours.\463\
---------------------------------------------------------------------------
\462\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\463\ This figure was calculated as follows: ((Compliance
Attorney for 24 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours) + (Risk Management Specialist
for 30 hours)) = 60 hours x 7 respondent clearing agencies = 420
hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(5)
Respondent clearing agencies that would be subject to proposed Rule
17Ad-22(e)(5) may already have some written policies and procedures
designed to address the collateral risks borne by these entities.\464\
As a result, the Commission preliminarily believes that a respondent
clearing agency may need to review and update existing policies and
procedures as necessary and may need to adopt new policies and
procedures with respect to an annual review of the sufficiency of
collateral haircuts and concentration limits. Accordingly, based on the
similar policies and procedures requirements in and the Commission's
previous corresponding burden estimates for existing Rule 17Ad-
22(d)(3),\465\ the Commission preliminarily believes that respondent
clearing agencies would incur an aggregate one-time burden of
approximately 294 hours to review and update existing policies and
procedures and to create new policies and procedures, as
necessary.\466\
---------------------------------------------------------------------------
\464\ See 17 CFR 240.17Ad-22(d)(3); proposed Rule 17Ad-22(e)(5),
infra Part VII; see also supra Part II.B.4.d (discussing the
requirements under the proposed rule).
\465\ See Clearing Agency Standards Release, supra note 5, at
66260.
\466\ This figure was calculated as follows: ((Assistant General
Counsel for 16 hours) + (Compliance Attorney for 12 hours) + (Senior
Risk Management Specialist for 7 hours) + (Computer Operations
Manager for 7 hours)) = 42 hours x 7 respondent clearing agencies =
294 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(5) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule and would also result in an annual review of collateral haircuts
and concentration limits. Based on the Commission's previous estimates
for ongoing monitoring and compliance burdens with respect to existing
Rule 17Ad-22,\467\ the Commission preliminarily estimates that the
ongoing activities required by proposed Rule 17Ad-22(e)(5) would impose
an aggregate annual burden on respondent clearing agencies of 252
hours.\468\ The Commission notes that the estimated ongoing burden for
Proposed Rule 17Ad-22(e)(5) is similar to the initial one-time burden
because the proposed rule includes a specific requirement that policies
and procedures for collateral include a not-less-than-annual review of
the sufficiency of a covered clearing agency's collateral haircuts and
concentration limits.
---------------------------------------------------------------------------
\467\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\468\ This figure was calculated as follows: ((Compliance
Attorney for 6 hours) + (Risk Management Specialist for 30 hours)) =
36 hours x 7 respondent clearing agencies = 252 hours.
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(6)
The Commission preliminarily believes that the estimated PRA
burdens for proposed Rule 17Ad-22(e)(6) would be more significant and
may require a respondent clearing agency to make substantial changes to
its policies and procedures.\469\ In addition, proposed Rule 17Ad-
22(e)(6) would require one-time systems adjustments related to the
capability to perform daily backtesting and monthly (or more frequent
than monthly) conforming sensitivity analyses. As a result, the
Commission preliminarily estimates that respondent clearing agencies
would incur an aggregate one-time burden of 1,080 hours to review and
update existing policies and procedures.\470\
---------------------------------------------------------------------------
\469\ See proposed Rule 17Ad-22(e)(6), infra Part VII; see also
supra Part II.B.4.e (discussing the requirements under the proposed
rule, including those that do not appear in existing Rule 17Ad-22).
\470\ This figure was calculated as follows: ((Assistant General
Counsel for 50 hours) + (Compliance Attorney for 40 hours) + (Senior
Risk Management Specialist for 25 hours) + (Computer Operations
Manager for 40 hours) + (Chief Compliance Officer for 15 hours) +
(Senior Programmer for 10 hours)) = 180 hours x 6 respondent
clearing agencies = 1,080 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(6) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule and activities associated with the daily backtesting and monthly
(or more frequent) sensitivity analysis requirements and annual model
validation. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to existing Rule 17Ad-
22,\471\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rule 17Ad-22(e)(6) would impose an
aggregate annual burden on respondent clearing agencies of 360
hours.\472\
---------------------------------------------------------------------------
\471\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\472\ This figure was calculated as follows: ((Compliance
Attorney for 24 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours) + (Risk Management Specialist
for 30 hours)) = 60 hours x 6 respondent clearing agencies = 360
hours.
---------------------------------------------------------------------------
d. Proposed Rule 17Ad-22(e)(7)
The Commission preliminarily believes that the estimated PRA
burdens for proposed Rule 17Ad-22(e)(7) would be more significant and
may require a respondent clearing agency to make substantial changes to
its policies and procedures.\473\ In addition, proposed Rule 17Ad-
22(e)(7) would require one-time systems adjustments related to the
capability to perform an annual conforming model validation, the
testing of sufficiency of liquid resources and the testing of access to
liquidity providers. As a result, the Commission preliminarily
estimates that respondent clearing agencies would incur an aggregate
one-time burden of 2,310 hours to review and update existing policies
and procedures.\474\
---------------------------------------------------------------------------
\473\ See proposed Rule 17Ad-22(e)(7), infra Part VII; see also
supra Part II.B.4.f (discussing the requirements under the proposed
rule).
\474\ This figure was calculated as follows: ((Assistant General
Counsel for 95 hours) + (Compliance Attorney for 85 hours) + (Senior
Risk Management Specialist for 45 hours) + (Computer Operations
Manager for 60 hours) + (Chief Compliance Officer for 30 hours) +
(Senior Programmer for 15 hours)) = 330 hours x 7 respondent
clearing agencies = 2,310 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule as well as activities related to the testing of sufficiency of
liquidity resources and the testing of access to liquidity providers.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\475\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-
[[Page 29570]]
22(e)(7) would impose an aggregate annual burden on respondent clearing
agencies of 896 hours.\476\
---------------------------------------------------------------------------
\475\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\476\ This figure was calculated as follows: ((Compliance
Attorney for 48 hours) + (Administrative Assistant for 5 hours) +
(Senior Business Analyst for 5 hours) + (Risk Management Specialist
for 60 hours) + (Senior Risk Management Specialist for 10 hours)) =
128 hours x 7 respondent clearing agencies = 896 hours.
---------------------------------------------------------------------------
3. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement
a. Proposed Rule 17Ad-22(e)(8)
Proposed Rule 17Ad-22(e)(8) contains substantially similar
provisions to Rule 17Ad-22(d)(12).\477\ As a result, a respondent
clearing agency would already have written rules, policies, and
procedures substantially similar to the requirements that would be
imposed under the proposed rule. In this regard, the Commission
preliminarily believes that respondent clearing agencies would incur
the incremental burdens of reviewing and updating existing policies and
procedures as necessary. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(12),\478\ the
Commission preliminarily believes that respondent clearing agencies
would incur an aggregate one-time burden of approximately 84 hours to
review and update existing policies and procedures.\479\
---------------------------------------------------------------------------
\477\ See 17 CFR 240.17Ad-22(d)(12); proposed Rule 17Ad-
22(e)(8), infra Part VII; see also supra Part II.B.5 (discussing the
requirements under the proposed rule).
\478\ See Clearing Agency Standards Release, supra note 5, at
66260.
\479\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(8) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirements would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rules. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to existing Rule 17Ad-
22,\480\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rule 17Ad-22(e)(8) would impose an
aggregate annual burden on respondent clearing agencies of
approximately 35 hours.\481\
---------------------------------------------------------------------------
\480\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\481\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(9)
Proposed Rule 17Ad-22(e)(9) contains substantially similar
provisions to Rule 17Ad-22(d)(5).\482\ As a result, a respondent
clearing agency would already have written rules, policies, and
procedures substantially similar to the requirements that would be
imposed under the proposed rule. In this regard, the Commission
preliminarily believes that respondent clearing agencies would incur
the incremental burdens of reviewing and updating existing policies and
procedures as necessary. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(5),\483\ the
Commission preliminarily believes that respondent clearing agencies
would incur an aggregate one-time burden of approximately 84 hours to
review and update existing policies and procedures.\484\
---------------------------------------------------------------------------
\482\ See 17 CFR 240.17Ad-22(d)(5); proposed Rule 17Ad-22(e)(9),
infra Part VII; see also supra Part II.B.6 (discussing the
requirements under the proposed rule).
\483\ See Clearing Agency Standards Release, supra note 5, at
66260.
\484\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(9) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to existing Rule 17Ad-
22,\485\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rule 17Ad-22(e)(9) would impose an
aggregate annual burden on respondent clearing agencies of
approximately 35 hours.\486\
---------------------------------------------------------------------------
\485\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\486\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(10)
Proposed Rule 17Ad-22(e)(10) contains substantially similar
provisions to Rule 17Ad-22(d)(15).\487\ As a result, a respondent
clearing agency would already have written rules, policies, and
procedures substantially similar to the requirements that would be
imposed under the proposed rule. In this regard, the Commission
preliminarily believes that a respondent clearing agency would incur
the incremental burdens of reviewing and updating existing policies and
procedures as necessary. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(15),\488\ the
Commission preliminarily believes that respondent clearing agencies
would incur an aggregate one-time burden of approximately 84 hours to
review and update existing policies and procedures.\489\
---------------------------------------------------------------------------
\487\ See 17 CFR 240.17Ad-22(d)(15); proposed Rule 17Ad-
22(e)(10), infra Part VII; see also supra Part II.B.7 (discussing
the requirements under the proposed rule).
\488\ See Clearing Agency Standards Release, supra note 5, at
66260.
\489\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(10) would also impose ongoing burdens on a
respondent clearing agency. The proposed requirement would require
ongoing monitoring and compliance activities with respect to the
written policies and procedures created in response to the proposed
rule. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to existing Rule 17Ad-
22,\490\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rule 17Ad-22(e)(10) would impose an
aggregate annual burden on respondent clearing agencies of
approximately 35 hours.\491\
---------------------------------------------------------------------------
\490\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\491\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
4. Proposed Rules 17Ad-22(e)(11) Through (12): CSDs and Exchange-of-
Value Settlement Systems
a. Proposed Rule 17Ad-22(e)(11)
Proposed Rule 17Ad-22(e)(11) contains similar provisions to Rule
17Ad-22(d)(10).\492\ As a result, a respondent clearing agency
providing CSD services would already have written rules, policies, and
procedures similar to the requirements that would
[[Page 29571]]
be imposed under the proposed rule but also imposes additional
requirements that do not appear in existing Rule 17Ad-22,\493\ and
accordingly a covered clearing agency providing CSD services may need
to update or amend existing policies and procedures, as necessary, to
satisfy the proposed requirements and may need to create new policies
and procedures. Based on the similar policies and procedures
requirements and the corresponding burden estimates previously made by
the Commission for Rule 17Ad-22(d)(10),\494\ the Commission
preliminarily believes that the respondent clearing agency would incur
a one-time burden of approximately 55 hours to review and update
existing policies and procedures and to create new policies and
procedures, as necessary.\495\
---------------------------------------------------------------------------
\492\ See 17 CFR 240.17Ad-22(d)(10); proposed Rule 17Ad-
22(e)(11), infra Part VII.
\493\ See supra Part II.B.8 (discussing the requirements under
the proposed rule and their relationship to existing requirements
under Rule 17Ad-22(d)(10)).
\494\ See Clearing Agency Standards Release, supra note 5, at
66260.
\495\ This figure was calculated as follows: ((Assistant General
Counsel for 20 hours) + (Compliance Attorney for 10 hours) +
(Intermediate Accountant for 15 hours) + (Senior Business Analyst
for 5 hours) + (Computer Operations Manager for 5 hours)) = 55 hours
x 1 respondent clearing agency = 55 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(11) would also impose ongoing burdens on
the respondent clearing agency providing CSD services. The proposed
requirement would require ongoing monitoring and compliance activities
with respect to the written policies and procedures created in response
to the proposed rule. Based on the Commission's previous estimates for
ongoing monitoring and compliance burdens with respect to existing Rule
17Ad-22,\496\ the Commission preliminarily estimates that the ongoing
activities required by proposed Rules 17Ad-22(e)(11) would impose a
total annual burden on the respondent clearing agency of approximately
8 hours.\497\
---------------------------------------------------------------------------
\496\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\497\ This figure was calculated as follows: (Compliance
Attorney for 8 hours) x 1 respondent clearing agency = 8 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(12)
Proposed Rule 17Ad-22(e)(12) contains substantially similar
provisions to Rule 17Ad-22(d)(13).\498\ As a result, a respondent
clearing agency would already have written rules, policies, and
procedures substantially similar to the requirements that would be
imposed under the proposed rule. In this regard, the Commission
preliminarily believes that a respondent clearing agency would incur
the incremental burdens of reviewing and updating existing policies and
procedures as necessary. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(13),\499\ the
Commission preliminarily believes that respondent clearing agencies
would incur an aggregate one-time burden of approximately 84 hours to
review and update existing policies and procedures.\500\
---------------------------------------------------------------------------
\498\ See 17 CFR 240.17Ad-22(d)(13); proposed Rule 17Ad-
22(e)(12), infra Part VII; see also supra Part II.B.9 (discussing
the requirements under the proposed rule).
\499\ See Clearing Agency Standards Release, supra note 5, at
66260.
\500\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(12) would also impose ongoing burdens on a
covered clearing agency. The proposed requirement would require ongoing
monitoring and compliance activities with respect to the written
policies and procedures created in response to the proposed rule. Based
on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\501\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-22(e)(12) would impose an aggregate annual burden
on respondent clearing agencies of approximately 35 hours.\502\
---------------------------------------------------------------------------
\501\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\502\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
5. Proposed Rules 17Ad-22(e)(13) Through (14): Default Management
a. Proposed Rule 17Ad-22(e)(13)
Proposed Rule 17Ad-22(e)(13) would require a respondent clearing
agency to have written policies and procedures reasonably designed to
address participant default and ensure that the clearing agency can
contain losses and liquidity demands and continue to meet its
obligations. Proposed Rule 17Ad-22(e)(13) contains similar provisions
to Rule 17Ad-22(d)(11) but would also impose additional requirements
that do not appear in existing Rule 17Ad-22.\503\ As a result, the
Commission preliminarily believes that a respondent clearing agency
would incur burdens of reviewing and updating existing policies and
procedures in order to comply with the provisions of proposed Rule
17Ad-22(e)(13) and, in some cases, may need to create new policies and
procedures. Accordingly, based on the similar policies and procedures
requirements and the corresponding burden estimates previously made by
the Commission for Rule 17Ad-22(d)(11),\504\ the Commission
preliminarily believes that respondent clearing agencies would incur an
aggregate one-time burden of approximately 420 hours to review and
update existing policies and procedures and to create new policies and
procedures, as necessary.\505\
---------------------------------------------------------------------------
\503\ See 17 CFR 240.17Ad-22(d)(11); proposed Rule 17Ad-
22(e)(13), infra Part VII; see also supra Part II.B.10 (discussing
the requirements under the proposed rule and their relationship to
existing Rule 17Ad-22(d)(11).
\504\ See Clearing Agency Standards Release, supra note 5, at
66260.
\505\ This figure was calculated as follows: ((Assistant General
Counsel for 20 hours) + (Compliance Attorney for 16 hours) + (Senior
Business Analyst for 12 hours) + (Computer Operations Manager for 12
hours)) = 60 hours x 7 respondent clearing agencies = 420 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(13) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require annual review and testing of a clearing agency's default
policies and procedures. Based on the Commission's previous estimates
for ongoing monitoring and compliance burdens with respect to existing
Rule 17Ad-22,\506\ the Commission preliminarily believes that the
ongoing activities required by proposed Rule 17Ad-22(e)(13) would
impose an aggregate annual burden on respondent clearing agencies of
approximately 63 hours.\507\
---------------------------------------------------------------------------
\506\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\507\ This figure was calculated as follows: (Compliance
Attorney for 9 hours) x 7 respondent clearing agencies = 63 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(14)
Registered clearing agencies that provide CCP services for
security-based swaps generally have written policies and procedures
regarding the segregation and portability of customer positions and
collateral as a result of applicable regulations but not existing Rule
17Ad-22.\508\ As a result, respondent clearing agencies providing CCP
services for security-based swaps would incur burdens of reviewing and
updating existing policies and
[[Page 29572]]
procedures as necessary in order to comply with the proposed rule. The
Commission preliminarily estimates that Rule 17Ad-22(e)(14) would
impose on respondent clearing agencies an aggregate one-time burden of
72 hours to review and update existing policies and procedures.\509\
---------------------------------------------------------------------------
\508\ See, e.g., 77 FR 6336 (Feb. 7, 2012) (CFTC adopting rules
imposing LSOC on DCOs for cleared swaps); see also supra Part
II.B.11, in particular note 297 and accompanying text. Because the
affected clearing agencies are subject to the CFTC's segregation and
portability requirements with respect to cleared swaps under LSOC,
the Commission preliminarily believes the burden imposed by proposed
Rule 17Ad-22(e)(14) would be limited.
\509\ This figure was calculated as follows: ((Assistant General
Counsel for 12 hours) + (Compliance Attorney for 10 hours) +
(Computer Operations Manager for 7 hours) + (Senior Business Analyst
for 7 hours)) = 36 hours x 2 respondent clearing agency that
provide, or would potentially provide, CCP services with respect to
security-based swaps = 72 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(14) would also impose ongoing burdens on a
respondent clearing agency that provides CCP services for security-
based swaps. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to existing Rule 17Ad-
22,\510\ the Commission preliminarily believes that the ongoing
activities required by proposed Rule 17Ad-22(e)(14) would impose an
aggregate annual burden on respondent clearing agencies of
approximately 12 hours.\511\
---------------------------------------------------------------------------
\510\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\511\ This figure was calculated as follows: (Compliance
Attorney for 6 hours) x 2 respondent clearing agencies = 12 hours.
---------------------------------------------------------------------------
6. Proposed Rules 17Ad-22(e)(15) Through (17): General Business and
Operational Risk Management
a. Proposed Rule 17Ad-22(e)(15)
Respondent clearing agencies would be required to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify and manage general business risks borne
by the clearing agency. Policies and procedures governing the
identification and mitigation of general business risk are not
currently required under existing Rule 17Ad-22 and, as a result, the
Commission preliminarily believes that the estimated PRA burdens for
proposed Rule 17Ad-22(e)(15) would be more significant and may require
a respondent clearing agency to make substantial changes to its
policies and procedures.\512\ The Commission preliminarily estimates
that proposed Rule 17Ad-22(e)(15) would impose an aggregate one-time
burden on respondent covered clearing agencies of 1,470 hours to review
and update existing policies and procedures and to create new policies
and procedures, as necessary.\513\
---------------------------------------------------------------------------
\512\ See proposed Rule 17Ad-22(e)(15), infra Part VII; see also
supra Part II.B.12 (discussing the requirements under the proposed
rule).
\513\ This figure was calculated as follows: ((Assistant General
Counsel for 40 hours) + (Compliance Attorney for 30 hours) +
(Computer Operations Manager for 10 hours) + (Senior Business
Analyst for 10 hours) + (Financial Analyst for 70 hours) + (Chief
Financial Officer for 50 hours)) = 210 hours x 7 respondent clearing
agencies = 1,470 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(15) would also imposed ongoing burdens on
a respondent clearing agency. Proposed Rule 17Ad-22(e)(15) would
require a respondent clearing agency to establish, implement, maintain
and enforce written policies and procedures reasonably designed to
maintain a viable plan, approved by its board of directors and updated
at least annually, for raising additional equity in the event that the
covered clearing agency's liquid net assets fall below the level
required by the proposed rule. Based on the Commission's previous
estimates for ongoing monitoring and compliance burdens with respect to
existing Rule 17Ad-22,\514\ the Commission preliminarily estimates that
the ongoing activities required by proposed Rule 17Ad-22(e)(15) would
impose an aggregate annual burden on respondent clearing agencies of
336 hours.\515\
---------------------------------------------------------------------------
\514\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\515\ This figure was calculated as follows: ((Compliance
Attorney for 42 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours)) = 48 hours x 7 respondents
clearing agencies = 336 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(16)
A registered clearing agency is currently required to have written
policies and procedures reasonably designed to address, in large part,
the safeguarding of assets of its assets and those of its participants
under Rule 17Ad-22(d)(3).\516\ Proposed Rule 17Ad-22(e)(16) contains
substantially similar provisions. As a result, the Commission
preliminarily believes that a respondent clearing agency would be
required to conduct a review of current policies and procedures and
update these existing policies and procedures where appropriate in
order to ensure compliance with the proposed rule and that the PRA
burden imposed by the proposed rule would be limited. Accordingly,
based on the similar policies and procedures requirements and the
corresponding burden estimates previously made by the Commission for
Rule 17Ad-22(d)(3),\517\ the Commission preliminarily estimates that
all respondent clearing agencies would incur an aggregate one-time
burden of approximately 140 hours to review and update existing
policies and procedures.\518\
---------------------------------------------------------------------------
\516\ See 17 CFR 240.17Ad-22(d)(3); proposed Rule 17Ad-
22(e)(16), infra Part VII; see also supra Part II.B.13 (discussing
the requirements under the proposed rule).
\517\ See Clearing Agency Standards Release, supra note 5, at
66260.
\518\ This figure was calculated as follows: ((Assistant General
Counsel for 4 hours) + (Compliance Attorney for 8 hours) + (Senior
Business Analyst for 4 hours) + (Computer Operations Manager for 4
hours)) = 20 hours x 7 respondent clearing agencies = 140 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(16) would also impose ongoing burdens on a
respondent clearing agency. It would require ongoing monitoring and
compliance activities with respect to the policies and procedures
implemented in response to the requirements of the proposed rule. Based
on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\519\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-22(e)(16) would impose an aggregate annual burden
on respondent clearing agencies of 42 hours.\520\
---------------------------------------------------------------------------
\519\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\520\ This figure was calculated as follows: (Compliance
Attorney for 6 hours) x 7 respondent clearing agencies = 42 hours.
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(17)
Proposed Rule 17Ad-22(e)(17) contains similar requirements to those
under Rule 17Ad-22(d)(4) but would also impose additional requirements
that do not appear in existing Rule 17Ad-22.\521\ As a result, a
respondent clearing agency is currently required to have some written
rules, policies and procedures containing provisions similar to the
requirements that would be imposed under the proposed rule, but it
would also need to review and update existing policies and procedures,
where necessary, and may need to create policies and procedures to
address the additional requirements. Accordingly, based on the similar
policies and procedures requirements and the corresponding burden
estimates previously made by the Commission for Rule 17Ad-
22(d)(4),\522\ the Commission preliminarily estimates that respondent
clearing agencies would incur an aggregate one-time burden of 196 hours
to review and update existing policies and procedures and to create new
policies and procedures, as necessary.\523\
---------------------------------------------------------------------------
\521\ See 17 CFR 240.17Ad-22(d)(4); proposed Rule 17Ad-
22(e)(17), infra Part VII; see also supra Part II.B.14 (discussing
the requirements under the proposed rule).
\522\ See Clearing Agency Standards Release, supra note 5, at
66260.
\523\ This figure was calculated as follows: ((Assistant General
Counsel for 4 hours) + (Compliance Attorney for 8 hours) + (Computer
Operations Manager for 6 hours) + (Senior Business Analyst for 4
hours) + (Chief Compliance Officer for 4 hours) + (Senior Programmer
for 2 hours)) = 28 hours x 7 respondent clearing agency = 196 hours.
---------------------------------------------------------------------------
[[Page 29573]]
Proposed Rule 17Ad-22(e)(17) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\524\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-22(e)(17) would impose an aggregate annual burden
on respondent clearing agencies of 112 hours.\525\
---------------------------------------------------------------------------
\524\ See Clearing Agency Standards Release, supra note 5, at
66260-63.
\525\ This figure was calculated as follows: (Compliance
Attorney for 6 hours) x 7 respondent clearing agencies = 42 hours.
---------------------------------------------------------------------------
7. Proposed Rules 17Ad-22(e)(18) Through (20): Access
a. Proposed Rule 17Ad-22(e)(18)
Proposed Rule 17Ad-22(e)(18) contains similar requirements to those
in existing Rules 17Ad-22(b)(5) through (7) and (d)(2).\526\ As a
result, a respondent clearing agency is currently required to have
written rules, policies, and procedures containing provisions similar
to the requirements that would be imposed under the proposed rule.
Thus, for certain portions of proposed Rule 17Ad-22(e)(18), the
Commission preliminarily believes that a respondent clearing agency
would need to review and update existing policies and procedures where
necessary. Because proposed Rule 17Ad-22(e)(18) also imposes additional
requirements that do not appear in existing Rule 17Ad-22, however,\527\
a respondent clearing agency may be required to create policies and
procedures to address these additional requirements. Accordingly, based
on the similar policies and procedures requirements and the
corresponding burden estimates previously made by the Commission for
Rules 17Ad-22(b)(5) through (7) and (d)(2),\528\ the Commission
preliminarily estimates that respondent clearing agencies would incur
an aggregate one-time burden of 308 hours to review and update existing
policies and procedures and to create new policies and procedures, as
necessary.\529\
---------------------------------------------------------------------------
\526\ See 17 CFR 240.17Ad-22(b)(5) through (7) and (d)(2).
\527\ See proposed Rule 17Ad-22(e)(18), infra Part VII; see also
supra Part II.B.15 (discussing the requirements under the proposed
rule).
\528\ See Clearing Agency Standards Release, supra note 5, at
66260.
\529\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) + Computer
Operations Manager for 15 hours) + (Senior Business Analyst for 5
hours) + (Chief Compliance Officer for 5 hours) + (Senior Programmer
for 2 hours)) = 44 hours x 7 respondent clearing agencies = 308
hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(18) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\530\ the
Commission preliminarily estimates that the ongoing activities required
by the proposed rule would impose an aggregate annual burden on
respondent clearing agencies of 49 hours.\531\
---------------------------------------------------------------------------
\530\ See Clearing Agency Standards Release, supra note 5, at
66260.
\531\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(19)
Respondent clearing agencies would be required to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to address material risks associated from tiered
participation arrangements as required by proposed Rule 17Ad-22(e)(19).
Tiered participation arrangements are not addressed in existing Rule
17Ad-22. To the extent that a respondent clearing agency has not
addressed tiered participation arrangements in its policies and
procedures, the Commission preliminarily believes that the respondent
clearing agency would need to create policies and procedures to address
these proposed requirements. In this regard, the PRA burden for
proposed Rule 17Ad-22(e)(19) would impose one-time initial burdens to
create policies and procedures. The Commission preliminarily estimates
that proposed Rule 17Ad-22(e)(19) would impose an aggregate one-time
burden on respondent clearing agencies of 308 hours to create said
policies and procedures.\532\
---------------------------------------------------------------------------
\532\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) +
(Computer Operations Manager for 15 hours) + (Senior Business
Analyst for 5 hours) + (Chief Compliance Officer for 5 hours) +
(Senior Programmer for 2 hours)) = 44 hours x 7 respondent clearing
agencies = 308 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(19) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\533\ the
Commission preliminarily estimates that the ongoing activities required
by the proposed rule would impose an annual aggregate burden on
respondent clearing agencies of 49 hours.\534\
---------------------------------------------------------------------------
\533\ See Clearing Agency Standards Release, supra note 5, at
66260.
\534\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(e)(20)
Registered clearing agencies are currently required to have written
policies and procedures reasonably designed to manage risks related to
links between the clearing agency and others under Rule 17Ad-22(d)(7).
Proposed Rule 17Ad-22(e)(20) contains similar requirements, but also
imposes additional requirements.\535\ As a result, a respondent
clearing agency may need to review and update existing policies and
procedures or establish new policies and procedures, as necessary, to
satisfy the proposed requirement. Accordingly, based on the similar
policies and procedures requirements and the corresponding burden
estimates previously made by the Commission for Rule 17Ad-
22(d)(7),\536\ the Commission preliminarily believes that respondent
clearing agencies would incur an aggregate one-time burden of
approximately 308 hours to review and update existing policies and
procedures.\537\
---------------------------------------------------------------------------
\535\ See 17 CFR 240.17Ad-22(d)(7); proposed Rule 17Ad-
22(e)(20), infra Part VII; see also supra Part II.B.17 (discussing
the requirements under the proposed rule).
\536\ See Clearing Agency Standards Release, supra note 5, at
66260.
\537\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) + (Senior
Business Analyst for 5 hours) + (Computer Operations Manager for 15
hours) + (Chief Compliance Officer for 5 hours) + (Senior Programmer
for 2 hours) = 44 hours x 7 respondent clearing agencies = 308
hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(20) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance
[[Page 29574]]
burdens with respect to existing Rule 17Ad-22,\538\ the Commission
preliminarily estimates that the ongoing activities required by the
proposed rule would impose an aggregate annual burden on respondent
clearing agencies of 49 hours.\539\
---------------------------------------------------------------------------
\538\ See Clearing Agency Standards Release, supra note 5, at
66260.
\539\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
8. Proposed Rules 17Ad-22(e)(21) Through (22): Efficiency
a. Proposed Rule 17Ad-22(e)(21)
Registered clearing agencies are currently required to have written
policies and procedures requiring the clearing agency to be cost
effective with respect to meeting the requirements of its participants
and the markets it serves under Rule 17Ad-22(d)(6), and proposed Rule
17Ad-22(e)(21) contains similar requirements but also imposes new
requirements.\540\ As a result, a respondent clearing agency would
likely incur the burdens of reviewing and updating existing policies
and procedures and may need to create new policies and procedures to
satisfy the proposed rule, as necessary. Accordingly, based on the
similar policies and procedures requirements and the corresponding
burden estimates previously made by the Commission for Rule 17Ad-
22(d)(6),\541\ the Commission preliminarily estimates that that
respondent clearing agencies would incur an aggregate one-time burden
of approximately 224 hours to review and update existing policies and
procedures.\542\
---------------------------------------------------------------------------
\540\ See 17 CFR 240.17Ad-22(d)(6).
\541\ See Clearing Agency Standards Release, supra note 5, at
66260.
\542\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) + (Senior
Business Analyst for 5 hours) + (Computer Operations Manager for 10
hours)) = 32 hours x 7 respondent clearing agencies = 224 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(21) would also impose ongoing burdens on a
respondent clearing agency. The proposed rule would require ongoing
monitoring and compliance activities with respect to the written
policies and procedures required under the proposed rule. Based on the
Commission's previous estimates for ongoing monitoring and compliance
burdens with respect to existing Rule 17Ad-22,\543\ the Commission
preliminarily estimates that the ongoing activities required by
proposed Rule 17Ad-22(e)(21) would impose an aggregate annual burden on
respondent clearing agencies of 77 hours.\544\
---------------------------------------------------------------------------
\543\ See Clearing Agency Standards Release, supra note 5, at
66260.
\544\ This figure was calculated as follows: ((Compliance
Attorney for 5 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours) = 11 hours x 7 respondent
clearing agencies = 77 hours.
---------------------------------------------------------------------------
b. Proposed Rule 17Ad-22(e)(22)
Respondent clearing agencies would be required to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to implement the requirements of proposed Rule
17Ad-22(e)(22) with respect to the use of relevant internationally
accepted communication procedures and standards. Although registered
clearing agencies are not subject to an existing similar requirement
under Rule 17Ad-22, the Commission understands that covered clearing
agencies currently use the relevant internationally accepted
communication procedures and standards and expects a covered clearing
agency would need to make only limited changes to satisfy the
requirements under the proposed rule.\545\ Accordingly, the Commission
preliminarily estimates that proposed Rule 17Ad-22(e)(22) would impose
an aggregate one-time burden on respondent clearing agencies of 168
hours to review and update existing policies and procedures.\546\
---------------------------------------------------------------------------
\545\ See supra note 441.
\546\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Computer
Operations Manager for 7 hours) + (Senior Business Analyst for 2
hours) + (Chief Compliance Officer for 5 hours) + (Senior Programmer
for 2 hours)) = 24 hours x 7 respondent clearing agencies = 168
hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(22) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\547\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-22(e)(22) would impose an aggregate annual burden
on respondent clearing agencies of 35 hours.\548\
---------------------------------------------------------------------------
\547\ See Clearing Agency Standards Release, supra note 5, at
66260.
\548\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
9. Proposed Rule 17Ad-22(e)(23): Disclosure
Proposed Rule 17Ad-22(e)(23) contains similar requirements to Rule
17Ad-22(d)(9) but also imposes substantial new requirements.\549\ As a
result, although a respondent clearing agency is already required to
have written rules, policies and procedures containing provisions
similar to some of the requirements in the proposed rule, for some
provisions of proposed Rule 17Ad-22(e)(23), a respondent clearing
agency would be required to establish policies and procedures to
address the additional requirements. Accordingly, based on the similar
policies and procedures requirements and the corresponding burden
estimates previously made by the Commission for Rule 17Ad-
22(d)(9),\550\ the Commission preliminarily estimates that respondent
clearing agencies would incur an aggregate one-time burden of 966 hours
to review and update existing policies and procedures and to create
policies and procedures, as necessary.\551\
---------------------------------------------------------------------------
\549\ See 17 CFR 240.17Ad-22(d)(9); proposed Rule 17Ad-
22(e)(23), infra Part VII; see also supra Part II.B.20 (discussing
the requirements under the proposed rule).
\550\ See Clearing Agency Standards Release, supra note 5, at
66260.
\551\ This figure was calculated as follows: ((Assistant General
Counsel for 38 hours) + (Compliance Attorney for 24 hours) +
(Computer Operations Manager for 32 hours) + (Senior Business
Analyst for 18 hours) + (Chief Compliance Officer for 18 hours) +
(Senior Programmer for 8 hours)) = 138 hours x 7 respondent clearing
agencies = 966 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(23) would also impose ongoing burdens on a
respondent clearing agency. Specifically, the proposed rule would
require ongoing monitoring and compliance activities with respect to
the written policies and procedures created in response to the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\552\ the
Commission preliminarily estimates that the ongoing activities required
by proposed Rule 17Ad-22(e)(23) would impose an aggregate annual burden
on respondent clearing agencies of 238 hours.\553\
---------------------------------------------------------------------------
\552\ See Clearing Agency Standards Release, supra note 5, at
66260.
\553\ This figure was calculated as follows: (Compliance
Attorney for 34 hours) x 7 respondent clearing agencies = 238 hours.
---------------------------------------------------------------------------
10. Total Burden for Proposed Rule 17Ad-22(e)
The aggregate initial burden for respondent clearing agencies under
proposed Rule 17Ad-22(e) would be 10,664 hours. The aggregate ongoing
burden for respondent clearing agencies under proposed Rule 17Ad-22(e)
would be 3,460 hours.
[[Page 29575]]
E. Total Annual Reporting and Recordkeeping Burden for Proposed Rule
17Ab2-2
Proposed Rule 17Ab2-2 would govern Commission determinations as to
whether a registered clearing agency is a covered clearing agency and
whether a covered clearing agency is either involved in activities with
a more complex risk profile or systemically important in multiple
jurisdictions.\554\ Because such determinations may be made upon
request of a clearing agency or its members, the respondents would have
the burdens of preparing such requests for submission to the
Commission. The Commission preliminarily notes that, to the extent such
determinations are carried out by the Commission on its own initiative
pursuant to proposed Rule 17Ab2-2, the PRA burdens on the respondents
would be limited. Accordingly, based on the Commission's previous
estimates for ongoing monitoring and compliance burdens with respect to
existing Rule 17Ad-22,\555\ the Commission preliminarily believes that
respondent clearing agencies would incur an aggregate one-time burden
of approximately 24 hours to draft and review a determination request
to the Commission.\556\
---------------------------------------------------------------------------
\554\ See infra Part II.C (further discussing the purpose,
scope, and application of proposed Rule 17Ab2-2) and Part VII
(proposed text of Rule 17Ab2-2).
\555\ See Clearing Agency Standards Release, supra note 5, at
66260.
\556\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Staff Attorney for 4 hours) + (Outside
Counsel for 6 hours)) = 12 hours x 2 respondent clearing agencies =
24 hours.
---------------------------------------------------------------------------
F. Collection of Information Is Mandatory
The collection of information relating to proposed Rules 17Ad-
22(e)(1) through (3), 17Ad-22(e)(4)(ii) through (v), 17Ad-22(e)(7)(i)
through (ix), and 17Ad-22(e)(8) through (23) would be mandatory for all
respondent clearing agencies. The collection of information requirement
relating to proposed Rule 17Ad-22(e)(4)(i) and 17Ad-22(e)(7)(x) would
be mandatory for a respondent clearing agency that provides CCP
services and that is designated by the Commission either as
systemically important in multiple jurisdictions or as a complex risk
profile clearing agency. The collection of information requirement
relating to proposed Rule 17Ad-22(e)(6) would be mandatory for a
respondent clearing agency that provides CCP services.
The collection of information requirement relating to proposed Rule
17Ab2-2 is voluntary.
G. Confidentiality
The Commission preliminarily expects that the written policies and
procedures generated pursuant to proposed Rule 17Ad-22(e) would be
communicated to the members, subscribers, and employees (as applicable)
of all entities covered by the proposed rule and the public (as
applicable). To the extent that this information is made available to
the Commission, it would not be kept confidential. Such policies and
procedures would be required to be preserved in accordance with, and
for periods specified in, Exchange Act Rules 17a-1 \557\ and 17a-
4(e)(7).\558\ To the extent that the Commission receives confidential
information pursuant to this collection of information, such
information would be kept confidential subject to the provisions of
applicable law.\559\
---------------------------------------------------------------------------
\557\ 17 CFR 240.17a-1.
\558\ 17 CFR 240.17a-4(e)(7).
\559\ See, e.g., 5 U.S.C. 552. Exemption 4 of the Freedom of
Information Act provides an exemption for trade secrets and
commercial or financial information obtained from a person and
privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of
the Freedom of Information Act provides an exemption for matters
that are contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions. See 5 U.S.C. 552(b)(8).
---------------------------------------------------------------------------
To the extent that the Commission receives confidential information
pursuant to the collection of information under proposed Rule 17Ab2-2,
the Commission preliminarily expects such information would be kept
confidential subject to the provisions of applicable law.\560\
---------------------------------------------------------------------------
\560\ See id.
---------------------------------------------------------------------------
H. Request for Comments
The Commission invites comments on all of the above estimates.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission requests comment in
order to (a) evaluate whether the collection of information is
necessary for the proper performance of our functions, including
whether the information will have practical utility; (b) evaluate the
accuracy of our estimates of the burden of the collection of
information; (c) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; (d)
evaluate whether there are ways to minimize the burden of the
collection of information on those who respond, including through the
use of automated collection techniques or other forms of information
technology; and (e) determine whether there are cost savings associated
with the collection of information that have not been identified in
this proposal.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Kevin M. O'Neill, Deputy
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090, with reference to File No. S7-03-14.
Requests for materials submitted to OMB by the Commission with regard
to this collection of information should be in writing, with reference
to File No. S7-03-14, and be submitted to the Securities and Exchange
Commission, Office of Investor Education and Advocacy, 100 F Street
NE., Washington, DC 20549-0213. As OMB is required to make a decision
concerning the collections of information between 30 and 60 days after
publication, a comment to OMB is best assured of having its full effect
if OMB receives it by April 25, 2014.
IV. Economic Analysis
A. Introduction
The purpose of the proposed amendments to Rule 17Ad-22 and of
proposed Rule 17Ab2-2 is to establish requirements for the operation
and governance of registered clearing agencies that meet the definition
of a ``covered clearing agency.'' Registered clearing agencies have
become an essential part of the infrastructure of the U.S. securities
markets. Many securities transactions are centrally cleared and
settled, and central clearing and settlement is becoming more prevalent
in the security-based swap markets. For example, DTCC reported
processing $1.6 quadrillion in transactions in 2012.\561\ For the same
period, Intercontinental Exchange, Inc. reported $10.2 trillion in
gross notional CDS cleared and settled.\562\ While clearing
[[Page 29576]]
agencies generally benefit the markets they serve, such entities can
pose substantial risk to the financial system as a whole, due in part
to the fact that clearing agencies concentrate risk. Disruption to a
clearing agency's operations, or failure on the part of a clearing
agency to meet its obligations, could serve as a potential source of
contagion, resulting in significant costs not only to the clearing
agency and its members but also the broader economy and market
participants.\563\ As a result, proper management of the risks
associated with central clearing and settlement is necessary to ensure
the stability of U.S. securities markets.
---------------------------------------------------------------------------
\561\ See DTCC, 2012 Annual Report, available at http://www.dtcc.com/about/annual-report.aspx.
\562\ See Intercontinental Exchange, Inc., 2012 Annual Report,
at 66, available at https://materials.proxyvote.com/Approved/45865V/20130319/AR_159922/. Intercontinental Exchange, Inc. is the parent
company of ICE and ICEEU.
ICE began clearing corporate single-name CDS in December 2009,
and as of February 1, 2013, had cleared $1.9 trillion gross notional
of single-name CDS on 153 North American corporate reference
entities. See Exchange Act Release No. 34-61662 (Mar. 5, 2010), 75
FR 11589, 11591 (Mar. 11, 2010) (discussing ICE's credit default
swap clearing activities as of March 2010); ICE, Volume of ICE CDS
Clearing, available at https://www.theice.com/clear_credit.jhtml.
ICEEU began clearing CDS on single-name corporate reference
entities in December 2009, and, as of February 1, 2013, had cleared
[euro]1.6 trillion in gross notional of single-name CDS on 121
European corporate reference entities. See Exchange Act Release No.
61973 (Apr. 23, 2010), 75 FR 22656, 22657 (Apr. 29, 2010)
(discussing ICEEU's credit default swap clearing activity as of
April 2010); ICEEU, Volume of ICE CDS Clearing, available at https://www.theice.com/clear_credit.jhtml.
\563\ See generally Darrell Duffie, Ada Li & Theo Lubke, Policy
Perspectives on OTC Derivatives Market Infrastructure, at 9 (Fed.
Reserve Bank N.Y. Staff Reps., Mar. 2010), available at http://www.newyorkfed.org/research/staff_reports/sr424.pdf (``If a CCP is
successful in clearing a large quantity of derivatives trades, the
CCP is itself a systemically important financial institution. The
failure of a CCP could suddenly expose many major market
participants to losses. Any such failure, moreover, is likely to
have been triggered by the failure of one or more large clearing
members, and therefore to occur during a period of extreme market
fragility.''); Pirrong, The Inefficiency of Clearing Mandates,
Policy Analysis, No. 655, at 11-14, 16-17, 24-26 (2010), available
at http://www.cato.org/pubs/pas/PA665.pdf, at 11-14, 16-17, 24-26
(stating, among other things, that ``CCPs are concentrated points of
potential failure that can create their own systemic risks,'' that
``[a]t most, creation of CCPs changes the topology of the network of
connections among firms, but it does not eliminate these
connections,'' that clearing may lead speculators and hedgers to
take larger positions, that a CCP's failure to effectively price
counterparty risks may lead to moral hazard and adverse selection
problems, that the main effect of clearing would be to
``redistribute losses consequent to a bankruptcy or run,'' and that
clearinghouses have failed or come close to failing in the past,
including in connection with the 1987 market break); Manmohan Singh,
Making OTC Derivatives Safe--A Fresh Look, at 5-11 (IMF Working
Paper, Mar. 2011), available at http://www.imf.org/external/pubs/ft/wp/2011/wp1166.pdf (addressing factors that could lead central
counterparties to be ``risk nodes'' that may threaten systemic
disruption).
---------------------------------------------------------------------------
The mandated central clearing and settlement of security-based
swaps wherever possible and appropriate, a core component of Title VII,
reinforces this need.\564\ Where a clearing agency provides CCP
services, clearing and settlement of security-based swap contracts
replaces bilateral counterparty exposures with exposures against the
clearing agency providing CCP services. Consequently, a move from
voluntary central clearing and settlement of security-based swap
contracts to mandatory clearing of security-based swap contracts,
holding the volume of security-based swap transactions constant, will
increase economic exposures against CCPs that clear security-based
swaps. Increased exposures in turn raise the possibility that these
CCPs may serve as a transmission mechanism for systemic events.
---------------------------------------------------------------------------
\564\ See supra Part I.B.1.
---------------------------------------------------------------------------
Clearing agencies have several incentives to implement
comprehensive risk management programs. First, the ongoing viability of
a clearing agency depends on its reputation and the confidence that
market participants have in its services. Clearing agencies therefore
have an incentive to minimize the likelihood that a member default or
operational outage would disrupt settlement. Second, some clearing
agencies, including those that mutualize default risks, contribute a
portion of their own capital as part of their contingent resources.
Clearing agencies with such capital contributions to their contingent
resources thus have an economic interest in sound risk management.
Registered clearing agencies are SROs that enforce applicable rules and
requirements under Commission oversight and are also in certain
instances subject to CFTC oversight.\565\ Registered clearing agencies
consequently also face a legal requirement that their rules be designed
to protect the public interest in the process of clearing securities or
derivatives.\566\
---------------------------------------------------------------------------
\565\ See supra Part I.A and note 96 (describing the
Commission's framework for regulation of SROs and the SRO rule
filing process); see also supra note 53 (describing regulations
adopted by the CFTC for DCOs).
\566\ See 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
Nevertheless, clearing agencies' incentives for sound risk
management may be tempered by pressures to reduce costs and maximize
profits that are distinct from the public interest goals set forth in
governing statutes, such as financial stability, and may result in
clearing agencies choosing tradeoffs between the costs and benefits of
risk management that are not socially efficient. Because the current
market for clearing services is characterized by high barriers to entry
and limited competition, \567\ the market power exercised by clearing
agencies in the markets they serve may blunt incentives to invest in
risk management systems.\568\ Further, even if clearing agencies do
internalize costs that they impose on their clearing members, they may
fail to internalize the consequences of their risk management decisions
on other financial entities that are connected to them through
relationships with clearing members.\569\ Such a failure represents a
financial network externality imposed by clearing agencies on the
broader financial markets and suggests that financial stability, as a
public good, may be under-produced in equilibrium.
---------------------------------------------------------------------------
\567\ See Clearing Agency Standards Release, supra note 5, at
66263.
\568\ See infra Part IV.C.2.a.
\569\ See Daron Acemoglu, Asuman Ozdaglar & Alireza Tahbaz-
Salehi, Systemic Risk and Stability in Financial Networks (NBER
Working Paper No. 18727, Jan. 2013), available at http://www.nber.org/papers/w18727.
---------------------------------------------------------------------------
As discussed in more detail below, the proposed amendments to Rule
17Ad-22 represent a strengthening of the Commission's regulation of
registered clearing agencies. The Commission preliminarily believes
that the more specific requirements imposed by the proposed amendments
will further mitigate potential moral hazard associated with risk
management at covered clearing agencies. For instance, in the absence
of policies and procedures that require periodic stress-testing and
validation of credit and liquidity risk models, clearing agencies could
potentially choose to recalibrate models in periods of low volatility
and avoid recalibration in periods of high volatility, causing them to
underestimate the risks they face.
The Commission also preliminarily believes that the additional
specificity of proposed Rule 17Ad-22(e), along with proposed testing
requirements, would be more effective at mitigating these particular
manifestations of incentive misalignments than existing Rule 17Ad-22.
The Commission preliminarily believes, as a result, that a general
benefit of the proposed amendments would be reductions in the
likelihood of CCP failure that result from improved safeguards. This
general benefit would be realized to the extent that clearing agencies
do not already conform to new requirements under the proposed
amendments. Despite the potential incentive problems noted above and
perhaps in anticipation of regulatory efforts, some registered clearing
agencies have taken steps to update their policies and procedures in
accordance with the standards contained in the proposed rules. The
Commission notes that in some instances the proposed rules establish as
a minimum regulatory requirement
[[Page 29577]]
certain current practices at some registered clearing agencies. In
these cases, the Commission preliminarily believes that imposing the
proposed requirements on covered clearing agencies will have the effect
of imposing consistent, higher minimum risk management standards across
covered clearing agencies.
In analyzing the economic consequences and effects of the rules
proposed in this release, the Commission has been guided by the
objectives of Section 17A of the Exchange Act to have due regard for
the public interest, the protection of investors, the safeguarding of
securities and funds, the maintenance of fair competition, and to
otherwise further the purposes of the Exchange Act through the
registration and regulation of clearing agencies.\570\ It has also been
guided by the objectives of the Dodd-Frank Act to mitigate risks to the
U.S. financial system, promote counterparty protection, increase market
transparency for OTC derivatives, and facilitate financial
stability.\571\ The Commission has also taken into account the
importance of maintaining a well-functioning security-based swap market
and the objectives of the Clearing Supervision Act to establish an
enhanced supervisory and risk control system for systemically important
clearing agencies and other FMUs.\572\ In addition, as directed by the
Clearing Supervision Act, the Commission makes this proposal after
giving careful consideration to the standards set forth in the PFMI
Report as the relevant international standard. Proposing rules that
maintain consistency with the standards set forth in the PFMI Report
may reduce the likelihood that market participants, including members
of covered clearing agencies, would restructure in an effort to operate
in less-regulated markets.
---------------------------------------------------------------------------
\570\ See supra note 2 and accompanying text (noting the
requirements of Section 17A of the Exchange Act).
\571\ See supra note 13 and accompanying text (noting the
purpose of the Dodd-Frank Act to, among other things, promote
financial stability); supra note 14 and accompanying text (noting
the purpose of the Dodd-Frank Act to, among other things, create a
regulatory framework for the OTC derivatives markets).
\572\ See supra Part I.B.2 (describing the regulatory framework
for FMUs set forth in the Clearing Supervision Act).
---------------------------------------------------------------------------
The Commission preliminarily believes that the proposed amendments
to Rule 17Ad-22 and proposed Rule 17Ab2-2 are consistent with the goals
of Section 17A of the Exchange Act, to promote the prompt and accurate
clearing and settlement of transactions in securities, of the Clearing
Supervision Act, to enhance the supervision and oversight of clearing
entities, and of Title VII, to create a robust regulatory structure for
security-based swaps. In proposing these rules, the Commission is also
mindful of the benefits that would accrue through maintaining
consistency with regulations adopted by the Board and the CFTC.
The Commission is sensitive to the economic consequences and
effects of the proposed rules, including their benefits and costs. In
proposing these rules, the Commission has been mindful of the economic
consequences of the decisions it makes regarding the scope of applying
the proposed rules to covered clearing agencies. Moreover, the
Commission acknowledges that, since many of the proposed rules require
a covered clearing agency to adopt new policies and procedures, the
economic effects and consequences of the proposed rules include those
flowing from the substantive results of those new policies and
procedures. Under Section 3(f) of the Exchange Act, whenever the
Commission engages in rulemaking under the Exchange Act and is required
to consider or determine whether an action is necessary or appropriate
in the public interest, it must consider, in addition to the protection
of investors, whether the action will promote efficiency, competition,
and capital formation.\573\ Further, as noted above, Section 17A of the
Exchange Act directs the Commission to have due regard for the public
interest, the protection of investors, the safeguarding of securities
and funds, and maintenance of fair competition among brokers and
dealers, clearing agencies, and transfer agents when using its
authority to facilitate the establishment of a national system for
clearance and settlement transactions in securities.\574\ In addition,
Section 23(a)(2) of the Exchange Act requires the Commission, when
making rules under the Exchange Act, to consider the impact such rules
would have on competition.\575\ Section 23(a)(2) also prohibits the
Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.\576\
---------------------------------------------------------------------------
\573\ See 15 U.S.C. 78c(f).
\574\ See supra note 2 and accompanying text (noting the
requirements of Section 17A).
\575\ See 15 U.S.C. 78w(a)(2).
\576\ See id.
---------------------------------------------------------------------------
The Commission has attempted, where possible, to quantify the
benefits and costs anticipated to flow from the proposed rules. In some
cases, as indicated below, data to quantify the benefits and costs
associated with the proposed rules are unavailable. For example,
implementing policies and procedures that require stress testing of
financial resources available to a covered clearing agency at least
once each day may require additional investment in infrastructure, but
the particular infrastructure requirements will depend on existing
systems and a covered clearing agency's choice of modeling techniques.
In other cases, quantification depends heavily on factors outside the
control of the Commission, particularly with regard to the number of
potential new entrants affected by the proposed rules that in the
future may be designated systemically important by the FSOC.
Overall, the Commission preliminarily believes that the proposed
rules represent improvements in risk management, be it systemic, legal,
credit, liquidity, general business, custody, investment, or
operational risk, in keeping with the requirements of Section 17A of
the Exchange Act and the Dodd-Frank Act. The Commission preliminarily
believes that the proposed rules will result in an increase in
financial stability insofar as they result in minimum standards at
covered clearing agencies that are higher than those standards implied
by current practices at covered clearing agencies. In particular cases,
such as new requirements related to management of liquidity risk and
general business risk, stability may arise as a result of higher risk
management standards at covered clearing agencies that effectively
lower the probability that either covered clearing agencies or their
members default. As explained in Part IV.C.2, reduced default
probabilities for covered clearing agencies may, in turn, improve
efficiency and capital formation.
Request for Comments. The Commission requests comment on all
aspects of the economic analysis of the proposed rules, including their
benefits and costs, as well as any effect these proposed rules may have
on competition, efficiency, and capital formation. Acknowledging the
data limitations noted above, the Commission encourages commenters to
provide data and analysis to help further quantify or estimate the
potential benefits and costs of the proposed rules.
B. Economic Baseline
1. Overview
To assess the economic effects of the proposed rules, including
possible
[[Page 29578]]
effects on efficiency, competition, and capital formation, the
Commission is using a baseline composed of (1) the current regulatory
framework under which registered clearing agencies operate,\577\ and
(2) the current practices of registered clearing agencies as they
relate to the rules being proposed today.
---------------------------------------------------------------------------
\577\ A brief summary of the regulatory framework appears in
Part IV.B.2. For a more detailed summary of the current regulatory
framework, see Part I.
---------------------------------------------------------------------------
More specifically, the baseline includes existing legal
requirements applicable to registered clearing agencies providing CCP
or CSD services as they exist at the time of this proposal, including
applicable rules adopted by the Commission. Rule 17Ad-22 established a
regulatory framework for registered clearing agencies, including
security-based swap clearing agencies deemed registered pursuant to the
Dodd-Frank Act.\578\ Section 17A of the Exchange Act generally
regulates the national system for clearance and settlement, while
Section 19 of the Exchange Act describes the registration,
responsibilities, and oversight of SROs. Further, clearing agencies are
subject to new requirements related to security-based swaps under the
Dodd-Frank Act.
---------------------------------------------------------------------------
\578\ See Clearing Agency Standards Release, supra note 5; see
also supra note 25 and accompanying text (discussing the deemed
registered provision).
---------------------------------------------------------------------------
In terms of current practice, registered clearing agencies are
required to operate in compliance with the requirements set forth in
Rule 17Ad-22, though they may vary in the particular ways they meet
these requirements. Some variation in practices across clearing
agencies derives from the products they clear and the markets they
serve. Additionally, the Commission understands that certain registered
clearing agencies have already adopted practices consistent with
several of the standards set forth in the PFMI Report. Accordingly,
because proposed Rule 17Ad-22(e) and proposed Rule 17Ab2-2 result in
general consistency with the standards set forth in the PFMI Report,
the Commission preliminarily believes the resulting benefits and costs
to covered clearing agencies would, in some cases, be incremental
because of the relationship between existing requirements applicable to
registered clearing agencies,\579\ the anticipation of new requirements
consistent with the standards set forth in the PFMI Report,\580\ and
the CPSS-IOSCO Recommendations that preceded the PFMI Report.\581\ In
certain other cases, such as management of liquidity risk and general
business risk, registered clearing agencies that are covered clearing
agencies would be required to make changes to current policies and
procedures, so the resulting costs, benefits and economic effects may
be significant.
---------------------------------------------------------------------------
\579\ See supra Part I.C (discussing existing requirements under
Rule 17Ad-22).
\580\ See supra note 49.
\581\ See supra note 50 and accompanying text.
---------------------------------------------------------------------------
In order to consider the broader implications of these proposed
rules on market activity, including possible effects on efficiency,
competition, and capital formation, the baseline also considers the
current state of clearing and settlement services, including the number
of registered clearing agencies, the distribution of members across
these clearing agencies, and the volume of transactions these clearing
agencies process. There are currently six registered clearing agencies
that provide CCP services and one registered clearing agency that
provides CSD services. As shown in Table 1, membership rates vary
across these clearing agencies. Together, registered clearing agencies
processed over $2 quadrillion in financial market transactions in
2012.\582\
---------------------------------------------------------------------------
\582\ See, e.g., CME Group, 2012 Annual Report, at 2, available
at http://www.cmegroup.com/investor-relations/annual-review/2012/downloads/cme-group-2012-annual-report.pdf (indicating $806 trillion
notional in trading volume); DTCC, 2012 Annual Report, available at
http://www.dtcc.com/about/annual-report.aspx (indicating $1.6
quadrillion in transactions cleared).
Table 1--Membership Statistics for Registered Clearing Agencies \583\
------------------------------------------------------------------------
Number
------------------------------------------------------------------------
CME Total Members............................................ 72
--Of which clear CDS....................................... 14
DTC Full Service Members..................................... 272
FICC GSD Members............................................. 107
MBSD Members............................................... 76
ICE Clear Credit Members..................................... 28
Clear Europe Members...................................... 79
--Clear Europe Members that clear CDS...................... 18
NSCC Full Service Members.................................... 175
OCC Total Members............................................ 117
------------------------------------------------------------------------
---------------------------------------------------------------------------
\583\ Membership statistics are taken from the Web sites of each
of the listed clearing agencies and are current, for CME and ICE, as
of October 2013; for FICC, including the Government Securities
Division (``GSD'') and the Mortgage-Backed Securities Division
(``MBSD''), as of September 2013; for OCC as of January 2014; and
for DTC and NSCC as of December 6, 2013.
---------------------------------------------------------------------------
Registered clearing agencies are currently characterized by
specialization and limited competition. Clearing and settlement
services exhibit high barriers to entry and economies of scale. These
features of the existing market, and the resulting concentration of
clearing and settlement within a handful of entities, informs our
examination of effects of the proposed amendments and rules on
competition, efficiency, and capital formation.\584\
---------------------------------------------------------------------------
\584\ See infra Part IV.C.2 (discussing the effect of the
proposed rules on competition, efficiency, and capital formation).
---------------------------------------------------------------------------
2. Current Regulatory Framework for Clearing Agencies
The proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2
fit within the Commission's broad approach to regulation of the
national system for clearance and settlement that comprises the
baseline for the Commission's economic analysis. Key elements of the
current regulatory framework for registered clearing agencies are
Section 17A of the Exchange Act,\585\ Titles VII and VIII of the Dodd-
Frank Act, and existing Rule 17Ad-22. Section 17A of the Exchange Act
directs the Commission to facilitate the establishment of a national
system for the prompt and accurate clearance and settlement of
securities transactions, having due regard for the public interest, the
protection of investors, the safeguarding of securities and funds, and
the maintenance of fair competition among brokers and dealers, clearing
agencies, and transfer agents.\586\
---------------------------------------------------------------------------
\585\ See 15 U.S.C. 78q-1. For a more detailed discussion of the
regulatory framework for registered clearing agencies under Section
17A of the Exchange Act, see Part I.A.
\586\ See supra note 2 and accompanying text (noting the
requirements of Section 17A of the Exchange Act).
---------------------------------------------------------------------------
Title VII, in response to the 2008 financial crisis, provides the
Commission and the CFTC with authority to regulate the mandatory
exchange trading and central clearing and settlement of swaps that
formerly may have been OTC derivatives.\587\ Title VII amended Section
17A of the Exchange Act by adding new paragraphs (g) through (j)
requiring the registration of clearing agencies serving the security-
based swap market, giving the Commission authority to adopt rules
governing security-based swap clearing agencies, and requiring
compliance by registered clearing agencies with said rules. New Section
17A(i) of the Exchange Act provides that the Commission may conform
standards for and oversight of clearing agencies to reflect evolving
international standards.
---------------------------------------------------------------------------
\587\ See Dodd-Frank Act, 124 Stat. at 1641-1802. For a more
detailed discussion of the regulatory framework for registered
clearing agencies under Title VII, see Part I.B.1.
---------------------------------------------------------------------------
The Clearing Supervision Act, adopted in Title VIII, provides for
enhanced regulation of FMUs, such as clearing agencies, and for
enhanced coordination between the Commission,
[[Page 29579]]
the CFTC, and the Board by facilitating examinations and information
sharing.\588\ It also requires the Commission and the CFTC to
coordinate with the Board to develop risk management supervision
programs for clearing agencies designated systemically important.
Section 805(a) of the Clearing Supervision Act further provides that
the Commission, considering relevant international standards and
existing prudential requirements, may prescribe regulations that
contain risk management standards for designated clearing agencies or
the conduct of designated activities by a financial institution.
---------------------------------------------------------------------------
\588\ See 12 U.S.C. 5461 et seq. For a more detailed discussion
of the regulatory framework for registered clearing agencies under
Title VIII, see Part I.B.2.
---------------------------------------------------------------------------
Rule 17Ad-22 under the Exchange Act, adopted in 2012, requires a
registered clearing agency to establish, implement, maintain and
enforce written policies and procedures that are reasonably designed to
meet certain minimum requirements for their operations and risk
management practices on an ongoing basis. These requirements are
designed to work in tandem with the SRO rule filing process and the
requirement in Section 17A that the Commission must make certain
determinations regarding a clearing agency's rules and operations for
purposes of initial and ongoing registration.\589\ In its economic
analysis of the rule, the Commission noted that the economic
characteristics of clearing agencies, including economies of scale,
barriers to entry, and the particulars of their legal mandates, may
limit competition and confer market power on such clearing agencies,
which may lead to lower levels of service, higher prices, or under-
investment in risk management systems.\590\ To address these potential
market failures, Rule 17Ad-22 was adopted to strengthen the substantive
regulation of clearing agencies, promote the safe and reliable
operation of clearing agencies, improve efficiency, transparency, and
access to clearing agencies, and promote consistency with international
standards.\591\ Part IV.B.3 discusses current practices at registered
clearing agencies related to the requirements under Rule 17Ad-22.
---------------------------------------------------------------------------
\589\ See Clearing Agency Standards Release, supra note 5. For a
more detailed discussion of the regulatory framework for registered
clearing agencies under Rule 17Ad-22, see Part I.C. For a comparison
of the requirements under proposed Rule 17Ad-22(e) and existing
requirements under Rule 17Ad-22, see Part II.A.4. For further
discussion of current industry practices subject to the requirements
in Rule 17Ad-22, see Part IV.B.3.
\590\ See id.
\591\ See Clearing Agency Standards Release, supra note 5, at
66225, 66263-64.
---------------------------------------------------------------------------
a. Basel III Capital Requirements
In addition to requirements under the Exchange Act, the Dodd-Frank
Act, and Rule 17Ad-22, other regulatory efforts are relevant to our
analysis of the economic effects of proposed Rule 17Ad-22(e). In July
2012, the BCBS published the Basel III capital requirements, which set
forth interim rules governing the capital charges arising from bank
exposures to CCPs related to OTC derivatives, exchange-traded
derivatives, and securities financing transactions.\592\ Once in
effect, the Basel III capital requirements will create incentives for
banks to clear derivatives and securities financing transactions with
CCPs licensed in a jurisdiction where the relevant regulator has
adopted rules or regulations consistent with the standards set forth in
the PFMI Report. Specifically, the Basel III capital requirements
introduce new capital charges based on counterparty risk for banks
conducting derivatives transactions or securities financing
transactions through a CCP.\593\
---------------------------------------------------------------------------
\592\ See supra note 48 (discussing the Basel III capital
requirements). For a more detailed discussion of the Basel III
framework, see Part IV.C.1.e.
\593\ Since the Basel III framework applies lower capital
requirements only to bank exposures related to OTC and exchange-
traded derivatives activity and securities financing transactions,
the Commission currently expects that, among all registered clearing
agencies, FICC, ICEEU, and OCC would be those affected by the Basel
III capital requirements. Each would meet the proposed definition of
``covered clearing agency.''
---------------------------------------------------------------------------
New capital charges under the Basel III framework relate to a
bank's trade exposure and default fund exposure to a CCP and are a
function of multiplying these exposures by a corresponding risk weight.
Historically, these exposures have carried a risk weight of zero. As
banking regulators adopt rules consistent with the Basel III capital
requirements, however, these weights will increase. The risk weight
assigned under the Basel III capital requirements varies depending on
whether the counterparty is a QCCP. For example, risk weights for trade
exposures to a CCP generally would vary between 20% and 100% depending
on the CCP's credit quality, while trade exposures to a QCCP would
carry only a 2% risk weight.\594\ In addition, bank exposures to CCP
default funds would carry a risk weight of 1250%. While bank exposures
to QCCP default funds will also carry a 1250% risk weight at low
levels, under the Basel III framework, default fund exposures'
contribution to a bank's risk weighed assets will be limited to at most
18% of the bank's trade exposures to a given QCCP.
---------------------------------------------------------------------------
\594\ The Basel III framework and rules adopted by the Board and
the Office of the Comptroller of the Currency consistent with that
framework apply lower risk weights of 2% or 4% to indirect exposures
of banks to QCCPs. See Basel III capital requirements, supra note
59, paras. 114-15; Regulatory Capital Rules, supra note 53, at
62103.
---------------------------------------------------------------------------
In some jurisdictions, banking regulators have already adopted
rules that implement many requirements under the Basel III framework.
For example, in its Capital Requirements Directive IV, which went into
effect on July 17, 2013, the E.U. incorporated into its own legal
framework the Basel III framework. Article 301 contains rules governing
bank exposures to CCPs that are consistent with the Basel III
framework. Similarly, the BCBS reports that the Basel III capital
requirements, with the exception of capital conservation buffers and
countercyclical buffers, are currently in force for Japanese
banks.\595\ Canada and Switzerland also have risk-based capital rules
in place.\596\
---------------------------------------------------------------------------
\595\ See BCBS, Progress Report on Implementation of the Basel
Regulatory Framework (Oct. 2013), available at http://www.bis.org/bcbs/implementation/bprl1.htm.
\596\ See id.
---------------------------------------------------------------------------
In the United States, on July 9, 2013, the Board and the Office of
the Comptroller of the Currency jointly issued regulatory capital rules
for U.S. banks consistent with the Basel III framework. Upon its
effective date of January 1, 2014, the Regulatory Capital Rules subject
bank exposures to CCPs and QCCPs to increased risk weights as specified
in the Basel III framework.\597\ In addition to specifying risk
weights, the rules define the term QCCP for banks supervised by the
Board and the Office of the Comptroller of the Currency.\598\ According
to these rules, QCCP status applies to any CCP that is a designated
FMU. Further, any CCP that (i) requires full collateralization of
contracts on a daily basis, and (ii), as demonstrated to the
satisfaction of its supervisory regulator, is in sound financial
condition, is subject to supervision by the Commission, and meets or
exceeds the risk management standards established by the Commission
under Titles VII and VIII of the Dodd-Frank Act, is a QCCP. Based on
this definition, for banks regulated by the Board and the Office of the
Comptroller of the Currency, all covered clearing agencies, with the
exception of ICEEU,\599\ will be considered QCCPs for
[[Page 29580]]
purposes of calculating risk weights for trade exposures and default
fund exposures.
---------------------------------------------------------------------------
\597\ See Regulatory Capital Rules, supra note 53.
\598\ See id.
\599\ Although ICEEU would not be subject to QCCP treatment as a
designated FMU, it would nonetheless be considered a QCCP because it
is subject to regulation by the Commission. See Regulatory Capital
Rules, supra note 53, at 62166 (defining ``Qualifying Central
Counterparty'' at 1.iii(B)(2)).
---------------------------------------------------------------------------
In Europe, under EMIR, legal persons incorporated under the law of
an E.U. member state will only be able to use non-E.U. CCPs if those
CCPs have been recognized under EMIR. Further, only non-E.U. CCPs
recognized under EMIR will meet the conditions necessary to be
considered a QCCP for E.U. purposes. Article 25 of EMIR outlines a
recognition procedure for non-E.U. CCPs and Article 89 provides a
timeline for recognition.\600\ FICC, NSCC, and OCC applied for
recognition under EMIR prior to a September 15, 2013 deadline.\601\ As
a result of applying for recognition, these covered clearing agencies
will be permitted to continue to offer clearing services to existing
E.U. clearing members until their applications are accepted or
rejected.
---------------------------------------------------------------------------
\600\ See Eur. Comm'n, Practical Implementation of the EMIR
Framework to Non-EU Central Counterparties (CCPs) (May 13, 2013),
available at http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/130513_equivalence-procedure_en.pdf.
\601\ These three clearing agencies agreed to have their names
publicly disclosed and do not necessarily represent the full set of
registered clearing agencies that applied for recognition under
EMIR. See ESMA, List of Central Counterparties (CCPs) Established in
Non-EEA Countries Which Have Applied for Recognition Under Article
25 of Regulation (EU) No 648/2012 of the European Parliament and of
the Council of 4 July 2012 on OTC Derivatives, CCPs and Trade
Repositories (TRs) (EMIR) (Dec. 16, 2013), available at http://www.esma.europa.eu/system/files/2013-1581_list_of_applicants_tc-ccps_version_16_december_2013.pdf.
---------------------------------------------------------------------------
Additionally, the Basel III capital requirements, as adopted by the
Board, the Office of the Comptroller of the Currency, and banking
regulators in other jurisdictions, impose new capital requirements
related to unconditionally cancellable commitments and other off-
balance sheet exposures. For example, the Board and the Office of the
Comptroller of the Currency will require banks to include 10% of the
notional amount of unconditionally cancellable commitments in their
calculation of total leverage exposure.\602\ The rules cap the ratio of
tier one capital to total leverage exposure at 3% for banks subject to
advanced approaches risk-based capital rules.\603\ To the extent that
clearing agencies rely on financial resources from banks as part of
their risk management activities, new constraints on off-balance sheet
exposures could raise the cost of these activities.
---------------------------------------------------------------------------
\602\ See Regulatory Capital Rules, supra note 53, at 62169.
\603\ See id. at 62284. The Regulatory Capital Rules require
compliance by banks no later than 2018.
---------------------------------------------------------------------------
b. Other Regulatory Efforts
Efforts by the Board and the CFTC to adopt rules that are
consistent with the standards set forth in the PFMI Report are also
relevant to the economic analysis of the proposed rules.\604\ In 2012,
the Board adopted Regulation HH setting forth risk management standards
for designated FMUs, and, on January 10, 2014, the Board proposed
amendments to Regulation HH and its PSR Policy based upon the standards
set forth in the PFMI Report.\605\ Similarly, the CFTC has published
final rules intended to be consistent with the standards set forth in
the PFMI Report.\606\
---------------------------------------------------------------------------
\604\ For a more detailed discussion of the regulatory efforts
undertaken by the Board and the CFTC, see note 53.
\605\ See id.
\606\ See id.
---------------------------------------------------------------------------
In proposing the amendments to Rule 17Ad-22 and new Rule 17Ab2-2,
the Commission is mindful of these regulations proposed by the Board
and adopted by the CFTC, which seek to establish standards for
designated FMUs and establish standards for certain DCOs,
respectively.\607\ Section 712(a)(2) of Title VII requires the
Commission, before commencing any rulemaking regarding, among other
things, security-based swap clearing agencies, to consult and
coordinate to the extent possible with the CFTC and prudential
regulators for the purposes of assuring regulatory consistency and
comparability where possible.\608\ In addition, as directed by the
Clearing Supervision Act, the Commission is proposing these amendments
to Rule 17Ad-22 and Rule 17Ab2-2 after giving careful consideration to
the PFMI Report as the relevant international standard.
---------------------------------------------------------------------------
\607\ See id. (discussing efforts by the Board and the CFTC to
adopt rules consistent with the standards set forth in the PFMI
Report).
\608\ See Dodd-Frank Act, Sec. 712(a)(2), Public Law 111-203,
124 Stat. 1376, 1641-42 (2010).
---------------------------------------------------------------------------
3. Current Practices
Current industry practices are a critical element of the economic
baseline for registered clearing agencies. Registered clearing agencies
are required to operate in compliance with existing Rule 17Ad-22 and,
the Commission understands, have begun implementing some of the
standards set forth in the PFMI Report. Because proposed Rule 17Ad-
22(e) is consistent with those standards and furthers the objectives of
Section 17A of the Exchange Act, the Clearing Supervision Act, and
Title VII of the Dodd-Frank Act, the Commission preliminarily believes
that the proposed rule represents, where it imposes higher minimum
standards on covered clearing agencies, an additional step towards
improved risk management.
An overview of current practices is set forth below and includes
discussion of covered clearing agency policies and procedures regarding
general organization and risk management, including the management of
legal, credit, liquidity, business, custody, investment, and
operational risk. This discussion is based on the Commission's general
understanding of current practices as of the date of this proposal,
reflects the Commission's experience supervising registered clearing
agencies, and is intended solely for the purpose of analyzing the
economic effects of the Commission's proposal. The Commission notes
that in each case, as SROs, registered clearing agencies are required
to submit any proposed rule or any proposed change in, addition to, or
deletion from the rules of the clearing agency to the Commission for
review.\609\ The Exchange Act also requires a registered clearing
agency to enforce its rules, subject to Commission oversight, and
empowers the Commission to enforce the rules of a registered clearing
agency.\610\
---------------------------------------------------------------------------
\609\ See supra Part I.A and note 95 (describing the
Commission's framework for regulation of SROs and the SRO rule
filing process).
\610\ See supra Part I.A, in particular notes 8-10 (describing
the requirements applicable to registered clearing agencies under
the Exchange Act and the supervisory and enforcement tools available
to the Commission to facilitate compliance with those requirements
under the Exchange Act).
---------------------------------------------------------------------------
a. General Organization
i. Legal Risk
Legal risk is the risk that a registered clearing agency's rules,
policies, or procedures may not be enforceable and concerns, among
other things, its contracts, the rights of members, netting
arrangements, discharge of obligations, and settlement finality. Cross-
border activities of a registered clearing agency may also present
elements of legal risk.
Rule 17Ad-22(d)(1) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for a well-founded,
transparent, and enforceable legal framework for each aspect of its
activities in all relevant jurisdictions.\611\ Each registered clearing
agency makes a large portion of these
[[Page 29581]]
policies and procedures available to members and participants. In
addition, each also publishes their rule books and other key procedures
publicly in order to promote the transparency of their legal
framework.\612\
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\611\ See 17 CFR 240.17Ad-22(d)(1); Clearing Agency Standards
Release, supra note 5, at 66245-46.
\612\ The rule book of each registered clearing agency, as well
as select policies and procedures, are publically available on each
registered clearing agency's Web site.
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ii. Governance
Rule 17Ad-22(d)(8) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to have governance arrangements that are
clear and transparent to fulfill the public interest requirements in
Section 17A of the Exchange Act applicable to clearing agencies, to
support the objectives of owners and participants, and to promote the
effectiveness of the clearing agency's risk management procedures.\613\
Important elements of a registered clearing agency's governance
arrangements include its ownership structure; its charter, bylaws, and
charters for committees of its board and management committees; its
rules, policies, and procedures; the composition and role of its board,
including the structure and role of board committees; reporting lines
between management and the board; and the processes that provide for
management accountability with respect to the registered clearing
agency's performance.
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\613\ See 17 CFR 240.17Ad-22(d)(8); see also Clearing Agency
Standards Release, supra note 5, at 66251-52.
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Each registered clearing agency has a board that governs its
operations and supervises senior management. Each registered clearing
agency also has an independent audit committee of the board and has
established a board committee or committee of members tasked with
overseeing the clearing agency's risk management functions. The boards
of registered clearing agencies that would be subject to proposed Rule
17Ad-22(e) as covered clearing agencies currently include non-
management members.
iii. Framework for the Comprehensive Management of Risks
Rules 17Ad-22(b) and (d) require registered clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to measure and mitigate credit
exposures, identify operational risks, evaluate risks arising in
connection with cross-border and domestic links for the purpose of
clearing or settling trades, achieve DVP settlement, and implement risk
controls to cover the clearing agency's credit exposures to
participants.\614\ Rule 17Ad-22(d)(4) requires a registered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish business continuity
plans setting forth procedures for the recovery of operations in the
event of a disruption.\615\ Rule 17Ad-22(d)(11) further requires a
registered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to make key
aspects of the clearing agency's default procedures publicly available
and establish default procedures that ensure that the clearing agency
can take timely action to contain losses and liquidity pressures and to
continue meeting its obligations in the event of a participant
default.\616\
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\614\ See 17 CFR 240.17Ad-22(b) and (d); see also Clearing
Agency Standards Release, supra note 5.
\615\ See 17 CFR 240.17Ad-22(d)(4); see also Clearing Agency
Standards Release, supra note 5, at 66248-49.
\616\ See 17 CFR 240.17Ad-22(d)(11).
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In addition to meeting these requirements, the Commission
understands that registered clearing agencies also specify actions to
be taken when their resources are insufficient to cover losses faced by
the registered clearing agency.\617\ These actions may include
assessment rights on clearing members, forced allocation, and contract
termination.
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\617\ See David Elliot, Central Counterparty Loss-Allocation
Rules, at tbl. 1A (Bank of England Financial Stability Paper No. 20,
Apr. 2013), available at http://www.bankofengland.co.uk/research/Documents/fspapers/fs_paper20.pdf (noting the loss-allocation rules
applied at the end of a clearing agency waterfall).
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b. Financial Risk Management
Registered clearing agencies that provide CCP services have a
variety of options available to mitigate the financial risks to which
they are exposed. While the manner in which a CCP chooses to mitigate
these financial risks depends on the precise nature of the CCP's
obligations, a common set of procedures have been implemented by many
CCPs to manage credit and liquidity risks. Broadly, these procedures
enable CCPs to manage their risks by reducing the likelihood of member
defaults, limiting potential losses and liquidity pressure in the event
of a member default, implementing mechanisms that allocate losses
across members, and providing adequate resources to cover losses and
meet payment obligations as required.
Registered clearing agencies that provide CCP services must be able
to effectively measure their credit exposures in order to properly
manage those exposures. A CCP faces the risk that its exposure to a
member can change as a result of a change in prices, positions, or
both. CCPs can ascertain current credit exposures to each member by, in
some cases, marking each member's outstanding contracts to current
market prices and, to the extent permitted by their rules and supported
by law, by netting any gains against any losses. Rule 17Ad-22 includes
certain requirements related to financial risk management by CCPs,
including requirements to measure credit exposures to members and to
use margin requirements to limit these exposures. These requirements
are general in nature and provide registered clearing agencies
flexibility to measure credit risk and set margin. Within the bounds of
Rule 17Ad-22, CCPs may employ models and choose parameters that they
conclude are appropriate to the markets they serve.
The current practices of registered clearing agencies that provide
CCP services generally include the following procedures: (1) Measuring
credit exposures at least once a day; (2) setting margin coverage at a
99% confidence level over some set period; (3) using risk-based models;
(4) establishing a fund that mutualizes losses of defaults by one or
more participants that exceed margin coverage; (5) maintaining
sufficient financial resources to withstand the default of at least the
largest participant family,\618\ and (6), in
[[Page 29582]]
the case of security-based swap transactions, maintaining enough
financial resources to be able to withstand the default of their two
largest participant families.\619\
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\618\ See, e.g., IMF, Publication of Financial Sector Assessment
Program Documentation--Detailed Assessment of Observance of the
National Securities Clearing Corporation's Observance of the CPSS-
IOSCO Recommendations for Central Counterparties, at 10 (May 2010),
available at http://www.imf.org/external/pubs/ft/scr/2010/cr10129.pdf (assessing NSCC's observance of Recommendation 5 from
the RCCP that a CCP should maintain sufficient financial resources
to withstand, at a minimum, the default of a participant to which it
has the largest exposure in extreme but plausible market conditions;
also noting that NSCC began evaluating itself against this standard
in 2009 and has backtesting results to support that it maintained
sufficient liquidity to cover the failure of the largest affiliated
family 99.98% of the time during the period from January through
April 2009); IMF, Publication of Financial Sector Assessment Program
Documentation--Detailed Assessment of Observance of the Fixed Income
Clearing Corporation--Government Securities Division's Observance of
the CPSS-IOSCO Recommendations for Central Counterparties, at 9-10
(2010), available at http://www.imf.org/external/pubs/ft/scr/2010/cr10130.pdf (finding that FICC's Government Securities Division
observed the requirement to maintain enough financial resources to
meet the default of its largest participant in extreme but plausible
market conditions).
\619\ See, e.g., CFTC-SEC Staff Roundtable on Clearing of Credit
Default Swaps, at 123 (Oct. 2010), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission7_102210-transcrip.pdf (Stan Ivanov of ICE stating, ``[A]t ICE we look
at two simultaneous defaults of the two biggest losers upon extreme
conditions. . . .''); see also ICE, CDS Client Clearing Overview, at
8 (Aug. 2013), available at https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Client_Clearing_Overview.pdf
(noting that the guaranty fund covers the simultaneous default of
the two largest clearing members); CME Rulebook, Ch. 8H, Rule 8H07,
available at http://www.cmegroup.com/rulebook/CME/I/8H/8H.pdf.
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i. Credit Risk
Rule 17Ad-22(b)(1) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to measure their
credit exposures at least once per day.\620\ Several CCPs have policies
and procedures designed to require measuring credit exposures multiple
times per day.
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\620\ See 17 CFR 240.17Ad-22(b)(1).
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Rule 17Ad-22(b)(3) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
sufficient financial resources to withstand, at a minimum, a default by
the participant family to which it has the largest exposure in extreme
but plausible market conditions.\621\ It further requires CCPs for
security-based swaps to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
additional financial resources sufficient to withstand, at a minimum, a
default by the two participant families to which it has the largest
exposures in extreme but plausible market conditions, in its capacity
as a CCP for security-based swaps.\622\ Accordingly, the Commission
notes that Rule 17Ad-22(b)(3) imposes a ``cover two'' requirement on
CCPs for security-based swaps in order to protect such CCPs from the
extreme jump-to-default risk and nonlinear payoffs associated with the
nature of the financial products they clear and the participants in the
markets they serve. Meanwhile, CCPs that clear products other than
security-based swaps are subject to a ``cover one'' requirement.\623\
Rule 17Ad-22(b)(3) also states that such policies and procedures may
provide that additional financial resources be maintained by the CCP in
combined or separately maintained funds.\624\
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\621\ See 17 CFR 240.17Ad-22(b)(2).
\622\ See id.
\623\ See supra Part II.B.4.c and infra Part IV.C.3.a.iv(1)
(discussing the related ``cover one'' and ``cover two'' requirements
in proposed Rule 17Ad-22(e)(4)).
\624\ See id.
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Under existing rules, CCPs collect contributions from their members
for the purpose of establishing guaranty or clearing funds to mutualize
losses under extreme but plausible market conditions. Currently, the
guaranty funds or clearing funds consist of liquid assets and their
sizes vary depending on a number of factors, including the products the
CCP clears and the characteristics of CCP members. In particular, the
guaranty funds for CCPs that clear security-based swaps are relatively
larger, as measured by the size of the fund as a percentage of the
total and largest exposures, than the guaranty or clearing funds
maintained by CCPs for other financial instruments. CCPs generally take
the liquidity of collateral into account when determining member
obligations. Applying haircuts to assets posted as margin, among other
things, mitigates the liquidity risk associated with selling margin
assets in the event of a participant default.
ii. Collateral and Margin
Rule 17Ad-22(b)(2) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to use margin
requirements to limit their exposures to participants.\625\ This margin
can also be used to reduce a CCP's losses in the event of a participant
default.
---------------------------------------------------------------------------
\625\ See 17 CFR 240.17Ad-22(b)(2).
---------------------------------------------------------------------------
Registered clearing agencies that provide CCP services take
positions as substituted counterparties once their trade guarantee goes
into effect. Therefore, if a counterparty whose obligations the
registered clearing agency has guaranteed defaults, the covered
clearing agency may face market risk, which can take one of two forms.
First, a covered clearing agency is subject to the risk of movement in
the market prices of the defaulting member's open positions. Where a
seller defaults and fails to deliver a security, the covered clearing
agency may need to step into the market to buy the security in order to
complete settlement and deliver the security to the buyer. Similarly,
where a buyer defaults, the covered clearing agency may need to meet
payment obligations to the seller. Thus, in the interval between when a
member defaults and when the covered clearing agency must meet its
obligations as a substituted counterparty in order to complete
settlement, market price movements expose the covered clearing agency
to market risk. Second, the covered clearing agency may need to
liquidate non-cash margin collateral posted by the defaulting member.
The covered clearing agency is therefore exposed to the risk that
erosion in market prices of the collateral posted by the defaulting
member could result in the covered clearing agency having insufficient
financial resources to cover the losses in the defaulting member's open
positions.
To manage their exposure to market risk resulting from fulfilling a
defaulting member's obligations, registered clearing agencies compute
margin requirements using inputs such as portfolio size, volatility,
and sensitivity to various risk factors that are likely to influence
security prices. Moreover, since the size of price movements is, in
part, a function of time, registered clearing agencies may limit their
exposure to market risk by marking participant positions to market
daily and, in some cases, more frequently. CCPs also use similar
factors to determine haircuts applied to assets posted by members in
satisfaction of margin requirements. To manage market risk associated
with collateral liquidation, CCPs consider the current prices of assets
posted as collateral and price volatility, asset liquidity, and the
correlation of collateral assets and a member's portfolio of open
positions. Further, because CCPs need to value their margin assets in
times of financial stress, their rulebooks may include features such as
market-maker domination charges that increase clearing fund obligations
regarding open positions of members in securities in which the member
serves as a dominant market maker. The reasoning behind this charge is
that, should a member default, liquidity in products in which the
member makes markets may fall, leaving these positions more difficult
to liquidate for non-defaulting participants.
Rule 17Ab-22(b)(2) also requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for
risk-based models and parameters to set margin requirements.\626\ The
generally recognized standard for such models and parameters is, under
normal market conditions, price movements that
[[Page 29583]]
produce changes in exposures that are expected to breach margin
requirements or other risk controls only 1% of the time (i.e., at a 99%
confidence interval) over a designated time horizon.\627\ Currently,
CCPs use margin models to ensure coverage at a single-tailed 99%
confidence interval. Losses beyond this level are typically covered by
the CCP's guaranty fund. This standard comports with existing
international standards for bank capital requirements, which require
banks to measure market risks at a 99% confidence interval when
determining regulatory capital requirements.\628\
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\626\ See id.
\627\ See 17 CFR 240.17Ad-22(a)(4). The Commission notes that
because it is proposing to add new definitions to Rule 17Ad-22(a),
``normal market conditions'' would appear in Rule 17Ad-22(a)(12) in
the event the proposed rules are adopted. The Commission is not
proposing to alter the definition of ``normal market conditions.''
\628\ See BCBS, International Convergence of Capital Measurement
and Capital Standards: A Revised Framework (June 2004), available at
http://www.bis.org/publ/bcbs107.pdf; see also Darryll Hendricks &
Beverly Hirtle, New Capital Rule Signals Supervisory Shift
(Secondary Mortgage Mkts, Sept. 1998), available at http://www.freddiemac.com/finance/smm/july98/pdfs/hen_hirt.pdf.
Prior to this standard, banks measured value-at-risk using a
range of confidence intervals from 90-99%. See BCBS, An Internal
Model-Based Approach to Market Risk Capital Requirements, at 12
(Apr. 1995), available at http://www.bis.org/publ/bcbs17.pdf. When
determining the minimum quantitative standards for calculating risk
measurements, the BCBS noted then the importance of specifying ``a
common and relatively conservative confidence level,'' choosing the
99% confidence interval over other less conservative measures. See
id.
Since its adoption in 1998, the standard has become a generally
recognized practice of banks to quantify credit risk as the worst
expected loss that a portfolio might incur over an appropriate time
horizon at a 99% confidence interval. See Kenji Nishiguchi, Hiroshi
Kawai & Takanori Sazaki, Capital Allocation and Bank Management
Based on the Quantification of Credit Risk, at 83 (FRBNY Econ.
Policy Rev., Oct. 1998), available at http://www.newyorkfed.org/research/epr/98v04n3/9810nish.pdf; Jeff Aziz & Narat Charupat,
Calculating Credit Exposure and Credit Loss: A Case Study, at 34
(Sept. 1998), available at http://www.bis.org/bcbs/ca/alrequse98.pdf.
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Rule 17Ad-22(b)(2) also requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to review such
margin requirements and the related risk-based models and parameters at
least monthly.\629\ CCPs are accordingly required to establish a model
validation process that evaluates the adequacy of margin models,
parameters, and assumptions. Additionally, CCPs are required to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for an annual model
validation consisting of evaluating the performance of the CCPs' margin
models and the related parameters and assumptions associated with such
models by a qualified person who is free from influence from the
persons responsible for the development or operation of the models
being validated.\630\
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\629\ See 17 CFR 240.17Ad-22(b)(2).
\630\ See 17 CFR 240.17Ad-22(b)(4).
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iii. Liquidity Risk
In addition to credit risk and the aforementioned market risk,
registered clearing agencies also face liquidity or funding risk.
Currently, to complete the settlement process, registered clearing
agencies that employ netting rely on incoming payments from
participants in net debit positions in order to make payments to
participants in net credit positions. If a participant does not have
sufficient funds or securities in the form required to fulfill a
payment obligation immediately when due (even though it may be able to
pay at some future time), or if a settlement bank is unable to make an
incoming payment on behalf of a participant, a registered clearing
agency may face a funding shortfall. Such funding shortfalls may occur
due to a lack of financial resources necessary to meet delivery or
payment obligations, however even registered clearing agencies that do
hold sufficient financial resources to meet their obligations may not
carry those in the form required for delivery or payments to
participants.
A registered clearing agency that provides CCP services may hold
additional financial resources to cover potential funding shortfalls in
the form of collateral. As noted above, CCPs may take the liquidity of
collateral into account when determining member obligations. Applying
haircuts to illiquid assets posted as margin mitigates the liquidity
risk associated with selling margin assets in the event of participant
default. Some registered CCPs also arrange for liquidity provision from
other financial institutions using lines of credit. Additionally, some
registered clearing agencies enter into prearranged funding agreements
with their members pursuant to their rules. For example, members of one
registered clearing agency are obligated to enter into repurchase
agreements against securities that would have been delivered to a
defaulting member.
No rule under the Exchange Act currently requires a registered
clearing agency through its written policies and procedures to address
liquidity risk.
c. Settlement
Rule 17Ad-22(d)(5) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to employ money settlement arrangements
that eliminate or strictly limit the clearing agency's settlement bank
risks and require funds transfers to the clearing agency to be final
when effected.\631\ Rule 17Ad-22(d)(12) further requires a registered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure that final
settlement occurs no later than the end of the settlement day.\632\
Accordingly, for example, certain registered clearing agencies provide
for final settlement of securities transfers no later than the end of
the day of the transaction. Rule 17Ad-22(d)(15) also requires a
registered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to state to
its participants the clearing agency's obligations with respect to
physical deliveries and identify and manage the risks from these
obligations.\633\
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\631\ See 17 CFR 240.17Ad-22(d)(5).
\632\ See 17 CFR 240.17Ad-22(d)(12).
\633\ See 17 CFR 240.17Ad-22(d)(15).
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d. CSDs and Exchange-of-Value Settlement Systems
i. CSDs
Rule 17Ad-22(d)(10) requires a registered clearing agency that
provides CSD services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
securities in an immobilized or dematerialized form for transfer by
book entry to the greatest extent possible. Currently, some securities,
such as mutual fund securities and government securities, are issued
primarily or solely on a dematerialized basis. Dematerialized shares do
not exist as physical certificates but are held in book entry form in
the name of the owner (which, where the master security holder file is
not maintained on paper due to the use of technology, is also referred
to as electronic custody). Other types of securities may be issued in
the form of one or more physical security certificates, which could be
held by the CSD to facilitate immobilization. Alternatively, securities
may be held by the beneficial owner in record name, in the form of
book-entry positions, where the issuer offers the ability for a
security holder to hold through the direct registration system.
[[Page 29584]]
Whether immobilization occurs at the CSD or through direct registration
depends on what is provided for by the issuer.
When a trade occurs, the depository's accounting system credits one
participant account and debits another participant account.
Transactions between counterparties in dematerialized shares are
recorded by the registrar responsible for maintaining the paper or
electronic register of security holders, such as by a transfer agent,
and reflected in customer accounts.
Registered CSDs currently reconcile ownership positions in
securities against CSD ownership positions on the security holders list
daily, mitigating the risk of unauthorized creation or deletion of
shares.
ii. Exchange-of-Value Settlement Systems
Rule 17Ad-22(d)(13) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to eliminate principal risk by linking
securities transfers to funds transfers in a way that achieves delivery
versus payment,\634\ which serves to link obligations by conditioning
the final settlement of one upon the final settlement of the other. One
registered clearing agency, for example, operates a Model 2 DVP system
that provides for gross securities transfers during the day followed by
an end-of-day net funds settlement. Under the rules governing the
clearing agency's system, the delivering party in a DVP transaction is
assured that it will be paid for the securities once they are credited
to the receiving party's securities account. DVP eliminates the risk
that a buyer would lose the purchase price of a security purchased from
a defaulting seller or that a seller would lose the sold security
without receiving payment for a security acquired by a defaulting
buyer.
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\634\ See 17 CFR 240.17Ad-22(d)(13); see also Clearing Agency
Standards Release, supra note 5, at 66256.
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For example, one registered clearing agency has rules governing its
continuous net settlement (``CNS'') system, under which it becomes the
counterparty for settlement purposes at the point its trade guarantee
attaches, thereby assuming the obligation of its members that are
receiving securities to receive and pay for those securities, and the
obligation of members that are delivering securities to make the
delivery. Unless the clearing agency has invoked its default rules, it
is not obligated to make those deliveries until it receives from
members with delivery obligations deliveries of such securities;
rather, deliveries that come into CNS ordinarily are promptly
redelivered to parties that are entitled to receive them through an
allocation algorithm. Members are obligated to take and pay for
securities allocated to them in the CNS process. These rules also
provide mechanisms to allow receiving members a right to receive high
priority in the allocation of deliveries, and also permit a member to
buy-in long positions that have not been delivered to it by the close
of business on the scheduled settlement date.
e. Default Management
i. Participant-Default Rules and Procedures
Rule 17Ad-22(d)(11) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to make key aspects of its default
procedures publicly available and establish default procedures that
ensure it can take timely action to contain losses and liquidity
pressures and to continue meeting its obligations in the event of a
participant default. The rules of registered clearing agencies
typically state what constitutes a default, identify whether the board
or a committee of the board may make that determination, and describe
what steps the clearing agency may take to protect itself and its
members. In this regard, registered clearing agencies typically
attempt, among other things, to hedge and liquidate a defaulting
member's positions. Rules of registered clearing agencies also include
information about the allocation of losses across available financial
resources.
ii. Segregation and Portability
No rule under the Exchange Act currently requires a registered
clearing agency through its written policies and procedures to enable
the portability of positions of a member's customers and the collateral
provided in connection therewith. Additionally, no rule under the
Exchange Act currently requires a registered clearing agency through
its written policies and procedures to protect the positions of a
member's customers from the default or insolvency of the member.\635\
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\635\ See supra note 293 (discussing existing rules applicable
to registered broker-dealers that address customer security
positions and funds in cash securities and listed option markets,
thereby promoting segregation and portability at the broker-dealer
level).
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f. General Business and Operational Risk Management
i. General Business Risk
Business risk refers to the risks and potential losses arising from
a registered clearing agency's administration and operation as a
business enterprise that are neither related to member default nor
separately covered by financial resources designated to mitigate credit
or liquidity risk. While Rule 17Ad-22 sets forth requirements for
registered clearing agencies to identify, monitor, and mitigate or
eliminate a broad array of risks through written policies and
procedures, no rule under the Exchange Act expressly requires a
registered clearing agency through its written policies and procedures
to identify, monitor, and manage general business risk or to meet a
capital requirement. Nonetheless, registered clearing agencies
currently have certain internal controls in place to mitigate business
risk. Some clearing agencies, for instance, have policies and
procedures that identify an auditor who is responsible for examining
accounts, records, and transactions, as well as other duties prescribed
in the audit program. Other registered clearing agencies allow members
to collectively audit the books of the clearing agency on an annual
basis, at their own expense.
ii. Custody and Investment Risks
Registered clearing agencies face default risk from commercial
banks that they use to effect money transfers among participants, to
hold overnight deposits, and to safeguard collateral. Rule 17Ad-
22(d)(3) requires a registered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to (i) hold assets in a manner that minimizes risk of loss or
delay in its access to them; and (ii) invest assets in instruments with
minimal credit, market, and liquidity risks.\636\ Registered clearing
agencies currently seek to minimize the risk of loss or delay in access
by holding assets that are highly liquid (e.g., cash, U.S. Treasury
securities, or securities issued by a U.S. government agency) and by
engaging banks to custody the assets and facilitate settlement.
Typically, registered clearing agencies take steps to ensure that
assets held in custody are protected from claims from the custodian's
creditors using trust accounts or equivalent arrangements.
Additionally, designated clearing agencies may gain access to account
[[Page 29585]]
services at a Federal Reserve Bank, to the extent such services are not
already available as the result of other laws and regulations.\637\
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\636\ See 17 CFR 240.17Ad-22(d)(3).
\637\ See supra Part II.B.4.f.iii (discussing the requirement
under proposed Rule 17Ad-22(e)(7)(iii) for a covered clearing agency
to have policies and procedures reasonably designed to ensure it has
access to account services at a Federal Reserve Bank or other
relevant central bank).
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iii. Operational Risk
Operational risk refers to a broad category of potential losses
arising from deficiencies in internal processes, personnel, and
information technology. Registered clearing agencies face operational
risk from both internal and external sources, including human error,
system failures, security breaches, and natural or man-made disasters.
Rule 17Ad-22(d)(4) requires a registered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify sources of operational risk and to
minimize those risks through the development of appropriate systems,
controls and procedures.\638\ It also requires a registered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to (i) implement systems that are
reliable and secure, and have adequate, scalable capacity; and (ii)
have business continuity plans that allow for timely recovery of
operations and fulfillment of a clearing agency's obligations.\639\
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\638\ See 17 CFR 240.17Ad-22(d)(4).
\639\ See id.
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As a result, registered clearing agencies have developed and
currently maintain plans to assure the safeguarding of securities and
funds, the integrity of automated data processing systems, and the
recovery of securities, funds, or data under a variety of loss or
destruction scenarios.\640\ These plans may include turning operations
over to a secondary site that is located a sufficient distance from the
primary location to ensure a distinct geographic risk profile. In
addition, registered clearing agencies generally maintain an internal
audit department to review the adequacy of their internal controls,
procedures, and records with respect to operational risks. Some
registered clearing agencies also engage independent accountants to
perform an annual study and evaluation of the internal controls
relating to their operations.\641\
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\640\ Many of these practices had been previously developed
pursuant to prior Commission guidelines. See ARP I and II, supra
note 324; see also supra note 326 (discussing related requirements
under proposed Regulation SCI).
\641\ See, e.g., NSCC, Assessment of Compliance with the CPSS/
IOSCO Recommendations for Central Counterparties (Nov. 2011),
available at http://www.dtcc.com/legal/policy-and-compliance.aspx.
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g. Access
i. Access and Participation Requirements
Rule 17Ad-22(b)(5) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide the
opportunity for a person that does not perform any dealer or security-
based swap dealer services to obtain membership on fair and reasonable
terms at the clearing agency to clear securities for itself or on
behalf of other persons.\642\ Rule 17Ad-22(b)(6) requires a registered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to have membership standards that do not require participants
to maintain a portfolio of any minimum size or a minimum transaction
volume.\643\ Rule 17Ad-22(b)(7) requires a registered clearing agency
that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to provide
a person that maintains net capital equal or greater than $50 million
with the ability to obtain membership at the clearing agency, provided
such persons are able to comply with reasonable membership standards,
with higher net capital requirements permissible subject to Commission
approval.\644\
---------------------------------------------------------------------------
\642\ See 17 CFR 240.17Ad-22(b)(5).
\643\ See 17 CFR 240.17Ad-22(b)(6).
\644\ See 17 CFR 240.17Ad-22(b)(7).
---------------------------------------------------------------------------
In addition, Rule 17Ad-22(d)(2) requires a registered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to require participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the clearing agency, have
procedures in place to monitor that participation requirements are met
on an ongoing basis, and have participation requirements that are
objective and publicly disclosed, and permit fair and open access.\645\
Typically, a registered clearing agency's rulebook requires applicants
for membership to provide certain financial and operational information
prior to being admitted as a member and on an ongoing basis as a
condition of continuing membership. Registered clearing agencies review
this information to ensure that the applicant has the operational
capability to meet the other demands of interfacing with the clearing
agency. In particular, registered clearing agencies typically require
that an applicant demonstrate that it has adequate personnel capable of
handling transactions with the clearing agency and adequate physical
facilities, books and records, and procedures to fulfill its
anticipated commitments to, and to meet the operational requirements
of, the clearing agency and other members with necessary promptness and
accuracy. As a result, an applicant needs to demonstrate that it has
adequate personnel capable of handling transactions with the clearing
agency and adequate physical facilities, books and records, and
procedures to conform to conditions or requirements in these areas that
the clearing agency reasonably may deem necessary for its protection.
Registered clearing agencies have published these requirements on their
Web sites.
---------------------------------------------------------------------------
\645\ See 17 CFR 240.17Ad-22(d)(2).
---------------------------------------------------------------------------
Registered clearing agencies use an ongoing monitoring process to
help them understand relevant changes in the financial condition of
their members and to mitigate credit risk exposure of the clearing
agency to its members. The risk management staff analyzes financial
statements filed with regulators, as well as information obtained from
other SROs and gathered from various financial publications, so that
the clearing agency may evaluate, for instance, whether members
maintain sufficient financial resources and robust operational capacity
to meet their obligations as participants in the clearing agency
pursuant to existing Rule 17Ad-22(d)(2)(i).
Table 1 contains membership statistics for registered clearing
agencies.\646\ Current membership generally reflects features of
cleared markets. The decision to become a clearing member depends on
the products being cleared, the structure of these asset markets as
well as the current state of regulation for cleared markets. For
example, the structure of security-based swap markets and the payoffs
to security-based swap contracts differs markedly from that of equity
markets and common stock, which may explain some of the differences
between the concentrated membership of certain clearing agencies and
the relatively broader membership of others.
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\646\ See supra Part IV.B.1.
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[[Page 29586]]
ii. Tiered Participation Arrangements
Tiered participation arrangements occur when clearing members
(direct participants) provide access to clearing services to third
parties (indirect participants). No rule under the Exchange Act
currently requires a registered clearing agency through its written
policies and procedures to identify, monitor, and manage material risks
arising from tiered participation arrangements. The Commission
understands, however, that certain registered clearing agencies have
policies and procedures currently in place in order to identify,
monitor, or manage such arrangements. Specifically, such clearing
agencies rely on information gathered from, and distributed by, direct
participants in order to manage these tiered participation
arrangements. For example, under some covered clearing agencies' rules,
direct participants generally have the responsibility to indicate to
the clearing agency whether a transaction submitted for clearing
represents a proprietary or customer position. Such rules further
require direct participants to calculate, and notify the clearing
agency of the value of, each customer's collateral. Direct participants
also communicate with indirect participants regarding the clearing
agency's margin and other requirements.
iii. Links
Rule 17Ad-22(d)(7) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to evaluate the potential sources of
risks that can arise when the clearing agency establishes links either
cross-border or domestically to clear or settle trades, and ensure that
the risks are managed prudently on an ongoing basis.\647\
---------------------------------------------------------------------------
\647\ See 17 CFR 240.17Ad-22(d)(7).
---------------------------------------------------------------------------
Each registered clearing agency is linked to other clearing
organizations, trading platforms, and service providers. For instance,
a link between U.S. and Canadian clearing agencies allows U.S. members
to clear and settle valued securities transactions with participants of
a Canadian securities depository. The link is designed to facilitate
cross-border transactions by allowing members to use a single
depository interface for U.S. and Canadian dollar transactions and
eliminate the need for split inventories.\648\ Registered clearing
agencies that provide CCP services currently establish links to allow
members to realize collateral and other operational efficiencies.
---------------------------------------------------------------------------
\648\ See Exchange Act Release No. 52784 (Nov. 16, 2005), 71 FR
70902 (Nov. 23, 2005); Exchange Act Release No. 55239 (Feb. 5,
2007), 72 FR 6797 (Feb. 13, 2007).
---------------------------------------------------------------------------
h. Efficiency
i. Efficiency and Effectiveness
Rule 17Ad-22(d)(6) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require the clearing agency to be
cost-effective in meeting the requirements of participants while
maintaining safe and secure operations.\649\ Registered clearing
agencies have procedures to control costs and to regularly review
pricing levels against operating costs. These clearing agencies may use
a formal budgeting process to control expenditures, and may review
pricing levels against their costs of operation during the annual
budget process. Registered clearing agencies also analyze workflows in
order to make recommendations to improve their operating efficiency.
---------------------------------------------------------------------------
\649\ See 17 CFR 240.17Ad-22(d)(6).
---------------------------------------------------------------------------
ii. Communication Procedures and Standards
Although no rule under the Exchange Act expressly requires a
registered clearing agency through its written policies and procedures
to use or accommodate relevant internationally accepted communication
procedures and standards, the Commission believes that registered
clearing agencies already use these standards. Registered clearing
agencies typically rely on electronic communication with market
participants, including members. For example, some registered clearing
agencies have rules in place stating that clearing members must
retrieve instructions, notices, reports, data, and other items and
information from the clearing agency through electronic data retrieval
systems. Some registered clearing agencies have the ability to rely on
signatures transmitted, recorded, or stored through electronic,
optical, or similar means. Other clearing agencies have policies and
procedures that provide for certain emergency meetings using telephonic
or other electronic notice.
i. Transparency
Transparency requirements and disclosures by registered clearing
agencies serve to limit the size of potential information asymmetries
between registered clearing agencies, their members, and market
participants. Rule 17Ad-22(d)(9) requires a registered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide market participants with
sufficient information for them to identify and evaluate risks and
costs associated with using the clearing agency's services.\650\
Information regarding the operations and services of each registered
clearing agency can be viewed publicly either on the clearing agency's
Web site or a Web site maintained by an affiliate of the clearing
agency. Because registered clearing agencies are SROs,\651\ changes to
their rules are published by the Commission and are available for
public viewing on each clearing agency's Web site.\652\
---------------------------------------------------------------------------
\650\ See 17 CFR 240.17Ad-22(d)(9).
\651\ See supra Part I.A and note 95 (describing the
Commission's framework for regulation of SROs and the SRO rule
filing process).
\652\ See supra note 362 (discussing requirements under Rule
19b-4(i)).
---------------------------------------------------------------------------
Besides providing market participants with information on the risks
and costs associated with their services, registered clearing agencies
regularly provide information to their members to assist them in
managing their risk exposures and potential funding obligations. Some
of these disclosures may be common to all members--such as information
about the composition of clearing fund assets--while other disclosures
that concern particular positions or obligations may only be made to
individual members.
4. Determinations by the Commission
Currently, although Rule 17Ad-22(d) applies to registered clearing
agencies, no mechanism exists for the Commission to make determinations
with regard to covered clearing agencies of the type that would occur
under proposed Rule 17Ab2-2.\653\
---------------------------------------------------------------------------
\653\ See proposed Rule 17Ab2-2, infra Part VII.
---------------------------------------------------------------------------
C. Consideration of Benefits, Costs, and the Effect on Competition,
Efficiency, and Capital Formation
The discussion below sets forth the potential economic effects
stemming from the proposed rules. The section begins by framing more
general economic issues related to the proposed amendments to Rule
17Ad-22 and proposed Rule 17Ab2-2. The discussion that follows
considers the effects of the proposed rules on efficiency, competition,
and capital formation. The section ends with a discussion of the
benefits and costs flowing from specific provisions of the proposed
amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2.
[[Page 29587]]
1. General Economic Considerations
The proposed amendments to Rule 17Ad-22, taken as a whole, would
likely produce economic effects that are either conditioned on multiple
provisions of proposed Rule 17Ad-22(e) being implemented as a set or
are simply common to multiple provisions of the proposal. Since these
economic effects are attributable in some way to each of the individual
subsections of proposed Rule 17Ad-22(e), this section considers
potential impacts of the proposed amendments, as a whole, through their
effects on systemic risk, the discretion with which covered clearing
agencies operate, market integrity, concentration in the market for
clearing services and among clearing members, and QCCP status.
a. Systemic Risk
A large portion of financial activity in the United States
ultimately flows through one or more registered clearing agencies that
would become covered clearing agencies under the proposed rules. These
clearing agencies have direct links to members and indirect links to
the customers of members. They are also linked to each other through
common members, operational processes, and in some cases cross-
margining and cross-guaranty agreements. These linkages allow covered
clearing agencies to provide opportunities for risk-sharing but also
allow them to serve as potential conduits for risk transmission.
Covered clearing agencies play an important role in fostering the
proper functioning of financial markets. If they are not effectively
managed, however, they may transmit financial shocks, particularly on
days of market stress.
The centralization of clearance and settlement activities at
covered clearing agencies allows market participants to reduce costs,
increase operational efficiency, and manage risks more
effectively.\654\ While providing benefits to market participants, the
concentration of these activities at a covered clearing agency
implicitly exposes market participants to the risks faced by covered
clearing agencies themselves, making risk management at covered
clearing agencies a key element of systemic risk mitigation.
---------------------------------------------------------------------------
\654\ Cf. PFMI Report, supra note 1, at 9.
---------------------------------------------------------------------------
b. Discretion
The Commission recognizes that the degree of discretion permitted
by the proposed rules partially determines their economic effect. Even
where current practices at covered clearing agencies would not need to
change significantly to comply with the proposed rules, covered
clearing agencies could still potentially face costs associated with
the limitations on discretion that will result from the proposed rules,
including costs related to limiting a clearing agency's flexibility to
respond to changing economic environments. For example, to the extent
that covered clearing agencies currently in compliance with the
proposed rules value the ability to periodically allow net liquid
assets to drop below the minimum level specified by the proposed rules,
they may incur additional costs because under the proposed rules they
lose the option to do so.
Although there may be costs to limiting the degree of discretion
covered clearing agencies have over risk management policies and
procedures, the Commission preliminarily believes there are also
potential benefits. As discussed above, clearing agencies may not fully
internalize the social costs of poor internal controls and thus, given
additional discretion, may not craft appropriate risk management
policies and procedures. For example, even if existing regulation
provides clearing agencies with the incentives necessary to manage
risks appropriately in a static sense, they may not provide clearing
agencies with incentives to update their risk management programs in
response to dynamic market conditions. Additionally, efforts at cost
reduction or profit maximization could encourage clearing agencies to
reduce the quality of risk management by, for example, choosing to
update parameters and assumptions rapidly in periods of low volatility
while maintaining stale parameters and assumptions in periods of high
volatility. By reducing covered clearing agencies' discretion over
their policies and procedures, the proposed amendments to Rule 17Ad-22
may reduce the likelihood that risk management practices lag behind
changing market conditions by requiring periodic analysis of model
performance while paying particular attention to periods of high
volatility or low liquidity.
Subjecting covered clearing agencies to more specific requirements
may have other benefits for cleared markets as well. Recent academic
research has explored the ways in which regulation affects liquidity in
financial markets when participants are ``ambiguity averse,'' where
ambiguity is defined as uncertainty over the set of payoff
distributions for an asset.\655\ Such investors may heavily weigh
worst-case scenarios when they decide whether to hold the asset. The
Commission preliminarily believes that regulation aimed at enhancing
standards for covered clearing agencies while reducing their discretion
may reduce the ambiguity associated with holding cleared assets in the
presence of credit risk and settlement risk \656\ and thus may allow
investors to rule out worst-case states of the world. In this regard,
more specific rules may encourage participation in cleared markets by
investors that benefit from resulting risk-sharing opportunities.\657\
---------------------------------------------------------------------------
\655\ See e.g., Itzhak Gilboa & David Schmeidler, Maxmin
Expected Utility with Non-Unique Prior, 18 J. Mathematical Econ. 141
(1989) (proposing an axiomatic foundation of a decision rule based
on maximizing expected minimum payoff of a strategy).
\656\ Specifically, by performing key roles in the transaction
process, clearing agencies serve to maintain higher minimum payoffs
in poor states of the world, by, for example, immobilizing
securities or adopting DVP systems.
\657\ See e.g., David Easley & Maureen O'Hara, Microstructure
and Ambiguity, 65 J. Fin. 1817 (2010) (using a theoretical model of
trade on venues that differ in rules, the authors show how rules
that reduce market-related ambiguity may induce a participatory
equilibrium).
---------------------------------------------------------------------------
c. Market Integrity
The Commission preliminarily believes that the proposed amendments
to Rule 17Ad-22 could provide the benefit of reduced potential for
market fragmentation that may arise from different requirements across
regulatory regimes. These benefits would flow to markets that are also
supervised by the Board and the CFTC, and internationally, since
cleared markets are global in nature and linked to one another through
common participants.
Based on its consultation and coordination with other regulators,
the Commission preliminarily believes its proposal is consistent and
comparable, where possible and appropriate, with the rules and policy
statement proposed by the Board and the rules adopted by the CFTC. The
Board's proposed revisions to its PSR Policy incorporate only the
headline principles contained in the PFMI Report and are consistent
with the Commission's approach in proposed Rule 17Ad-22(e).\658\
---------------------------------------------------------------------------
\658\ The Commission preliminarily notes that the Commission's
proposal provides a greater level detail than the proposed PSR
Policy and is tailored to take into account considerations
particular to covered clearing agencies, consistent with the
Commission's role as the supervisory agency under the Clearing
Supervision Act. The Commission further notes that, in contrast to
the Board's PSR Policy, proposed Rule 17Ad-22(e) would constitute an
enforceable federal regulation if adopted. See proposed PSR Policy,
supra note 53, at 2841 (distinguishing the legal effect of proposed
Reg. HH from the proposed PSR Policy).
---------------------------------------------------------------------------
With respect to the rules proposed by the Board and adopted by the
CFTC, in
[[Page 29588]]
many instances the rules proposed by the Commission are consistent with
these regulatory provisions, as each of the three rule sets are
intended to be consistent with the headline principles contained in the
PFMI Report,\659\ but the Commission's proposals differ from those
requirements proposed by the Board and adopted by the CFTC in terms of
the specific portions of the key considerations and explanatory text
contained in the PFMI Report that are, or are not, referenced or
emphasized. In some cases, the Commission is proposing more specific
requirements than those proposed by the Board or adopted the CFTC, and,
in others, it is proposing rules with fewer additional specific
requirements.
---------------------------------------------------------------------------
\659\ For example, the Commission preliminarily believes that
proposed Rule 17Ad-22(e)(23), requiring disclosure of rules, key
procedures, and market data, contains the same substantive
requirements as rules proposed by the Board and adopted by the CFTC.
See proposed Reg. HH, supra note 53, at 3686-88, 3693 (the Board
proposing Sec. 234.3(a)(23)); DCO Int'l Standards Release, supra
note 53, at 72493-94, 72521 (CFTC adopting Sec. 39.37).
In this case, the Commission notes that regulators have taken
slightly different approaches to achieving disclosure of rules, key
procedures, and market data. The CFTC requires disclosure through
the CPSS-IOSCO Disclosure Framework. See DCO Int'l Standards
Release, supra note 53, at 72493-94, 72521 (CFTC adopting Sec.
39.37(a)); see also CPSS-IOSCO, Disclosure Framework for Financial
Market Infrastructures (Apr. 2012), available at http://www.bis.org/publ/cpss101c.pdf. The Commission and the Board have proposed to
require disclosure through a comprehensive public disclosure set
forth in their proposed rules. The Commission preliminarily
believes, however, that the three disclosure regimes impose the same
substantive requirements.
---------------------------------------------------------------------------
The following discussion provides examples of proposed rule
provisions that are representative of the differences between the
Commission's proposal and the Board's proposal and the CFTC's final
rules, where the Commission is proposing more detailed requirements
than those proposed by the Board or adopted by the CFTC:
In proposing Rule 17Ad-22(e)(4), the Commission would
explicitly permit a covered clearing agency's policies and procedures
to be reasonably designed to maintain financial resources either in
combined or separately maintained clearing or default funds. Rules
proposed by the Board and adopted by the CFTC do not include a
comparable provision. The Commission preliminarily believes this
requirement is appropriate because permitting a covered clearing agency
to maintain a separate default fund for purposes of complying with
proposed Rules 17Ad-22(e)(4)(ii) and (iii) increases the range of
options available to covered clearing agencies when complying with this
requirement and, when used appropriately, will allow a covered clearing
agency to distribute the costs and responsibilities of clearing
membership more equitably among clearing members.
In proposing Rule 17Ad-22(e)(7), the Commission would
permit a covered clearing agency's policies and procedures to include
as qualifying liquid resources (i) assets that are readily available
and convertible into cash through prearranged funding arrangements
determined to be highly reliable even in extreme but plausible market
conditions by the board of directors of the covered clearing agency,
following a review conducted for this purpose not less than annually,
and (ii) other assets that are readily available and eligible for
pledging to a relevant central bank, if the covered clearing agency has
access to routine credit at such central bank that permits said pledges
or other transactions by the covered clearing agency. Rules proposed by
the Board do not include a provision comparable to either of these two
proposed requirements, and rules adopted by the CFTC do not include a
provision including as qualifying liquid resources assets readily
available and eligible for pledging to a central bank.\660\
---------------------------------------------------------------------------
\660\ See proposed Reg. HH, supra note 53, at 3677-78, 3691 (the
Board proposing Sec. 234.3(a)(7)); DCO Int'l Standards Release,
supra note 53, at 72487-91, 72518 (CFTC adopting Sec. 39.33(c)).
---------------------------------------------------------------------------
The Commission preliminarily believes this requirement is
appropriate given the specific circumstances of the U.S. securities
markets. U.S. securities markets are among the largest and most liquid
in the world, and CCPs operating in the United States are also among
the largest in the world. The resulting peak liquidity demands of CCPs
are therefore proportionately large on both an individual and an
aggregate basis, and the ability of CCPs to satisfy a requirement
limiting qualifying liquid resources to committed facilities could be
constrained by the capacity of traditional liquidity sources in the
U.S. banking sector in certain circumstances. The Commission
preliminarily believes that limiting the funding arrangements that are
included within the definition of qualifying liquid resources to
committed funding arrangements is not appropriate in the case of the
U.S. securities markets and expanding the concept of qualifying liquid
resources to include other highly reliable funding arrangements is
necessary and appropriate to ensure the proper functioning of covered
clearing agencies under the Exchange Act. For similar reasons, the
Commission preliminarily believes it is appropriate to include in the
definition of qualifying liquid resources assets that a central bank
would permit a covered clearing agency to use as collateral, to the
extent such covered clearing agency has access to routine credit at
such central bank.
In proposing Rule 17Ad-22(e)(13), the Commission would
explicitly require a covered clearing agency's policies and procedures
to be reasonably designed to ensure that the covered clearing agency
has the authority and operational capacity to contain losses and
liquidity demands in a timely manner and to continue to meet its
obligations by, among other things, addressing the allocation of credit
losses the covered clearing agency may face. Rules proposed by the
Board and adopted by the CFTC do not include a comparable provision to
address the allocation of credit losses.\661\ The Commission
preliminarily believes this requirement is appropriate to help ensure
that credit losses a covered clearing agency may reasonably be expected
to experience are capable of allocation through pre-established
practices of the covered clearing agency. The proposed rule would also
facilitate the orderly handling of member defaults and provide
certainty and transparency by enabling members to understand their
obligations to the covered clearing agency in extreme circumstances ex
ante.
---------------------------------------------------------------------------
\661\ See 17 CFR 39.16; proposed Reg. HH, supra note 53, at
3680-81, 3692 (the Board proposing Sec. 234.3(a)(13)); see also DCO
Principles Release, supra note 53, at 69395-97, 69442 (CFTC adopting
Sec. 39.16).
---------------------------------------------------------------------------
In proposing Rule 17Ad-22(e)(18), the Commission would
explicitly require a covered clearing agency's policies and procedures
to be reasonably designed to require monitoring of compliance with
access and participation requirements. Rules proposed by the Board and
adopted by the CFTC do not include a comparable provision. The
Commission preliminarily believes this requirement is consistent with
Exchange Act provisions requiring registered clearing agencies to have
rules designed to not permit unfair discrimination in the admission of
participants because it helps ensure that a covered clearing agency
complies with its own membership requirements.
In proposing Rule 17Ad-22(e)(19), the Commission would
explicitly require a covered clearing agency's policies and procedures
to be reasonably designed to require regular review of its tiered
participation arrangements. Rules proposed by the Board and adopted by
the CFTC do not include a comparable provision. The
[[Page 29589]]
Commission preliminarily believes this requirement is consistent with
Exchange Act provisions requiring registered clearing agencies to have
rules designed to not permit unfair discrimination in the admission of
participants because it helps ensure that a covered clearing agency
periodically reconsiders whether in practice its membership
requirements may result in either an inappropriately broad or narrow
membership.
The following discussion provides examples of proposed rule
provisions that are representative of the differences between the
Commission's proposal and the Board's proposal and the CFTC's final
rules, where the Commission is proposing requirements that are more
general than those proposed by the Board or adopted by the CFTC:
In proposing Rule 17Ad-22(e)(2), the Commission would not
require a covered clearing agency's policies and procedures to be
reasonably designed to include requirements for disclosure of board
decisions, review of the performance of the board of directors and
individual directors, documentation and disclosure of governance
arrangements, procedures for managing conflicts of interests involving
board members, and oversight of the risk function. Rules adopted by the
CFTC include such requirements.\662\ The Commission preliminarily
believes that such requirements would in part be duplicative of
existing Exchange Act requirements applicable to covered clearing
agencies grounded in the broad definition of the term ``rules of a
clearing agency'' in Section 3(a)(27) of the Exchange Act,\663\ and
otherwise have been contemplated by the Commission's proposed
Regulation MC.\664\ Accordingly any further requirements in this
respect would be considered by the Commission separately.
---------------------------------------------------------------------------
\662\ See DCO Int'l Standards Release, supra note 53, at 72480-
81, 72515 (CFTC adopting Sec. 39.30).
\663\ See 15 U.S.C. 78c(a)(27).
\664\ See supra note 111 (discussing rules for governance
arrangements proposed by the Commission to, among other things,
mitigate conflicts of interest at registered clearing agencies that
provide CCP services for security-based swaps).
---------------------------------------------------------------------------
In proposing Rules 17Ad-22(e)(4) and (e)(7), the
Commission would not require a covered clearing agency's policies and
procedures for stress testing its financial resources and liquid
resources, respectively, to cover specific stress scenarios, as rules
adopted by the CFTC do.\665\ The Commission preliminarily believes it
is appropriate to provide discretion to the covered clearing agencies
to identify the stress scenarios most appropriate for their needs given
their status as SROs subject to the Commission's oversight, and to rely
upon other tools available to the Commission through its supervisory
and examination programs to ensure the responsibilities of covered
clearing agencies in this regard are fulfilled.
---------------------------------------------------------------------------
\665\ See DCO Int'l Standards Release, supra note 53, at 72492-
93, 72520 (CFTC adopting Sec. 39.36(c)).
---------------------------------------------------------------------------
In proposing Rule 17Ad-22(e)(5), the Commission would not
specifically require, as the CFTC does in its rules, a covered clearing
agency's policies and procedures to be reasonably designed to (i)
establish prudent valuation practices and develop haircuts that are
tested regularly and take into account stressed market conditions
(including to reduce the need for procyclical adjustments); (ii) avoid
concentrated holdings of certain assets where it could significantly
impair the ability to liquidate such assets quickly without significant
adverse price effects; and (iii) use a collateral management system
that is well designed and operationally flexible, such that it, among
other things, accommodates changes in the ongoing monitoring and
management of collateral; and (iv) allow for the timely valuation of
collateral and execution of any collateral or margin calls.\666\ While
the Commission preliminarily agrees that these requirements may
facilitate prudent practices, the Commission preliminarily observes
that consideration of these practices would fall within the general
responsibilities of a covered clearing agency and its board of
directors. The Commission therefore preliminarily believes that
proposed Rule 17Ad-22(e)(5) strikes the appropriate balance in
establishing policies and procedures requirements with respect to
collateral management.
---------------------------------------------------------------------------
\666\ See 17 CFR 39.11, 39.13; see also DCO Principles Release,
supra note 53 (CFTC adopting Secs. 39.11 and 39.13).
---------------------------------------------------------------------------
In proposing Rule 17Ad-22(e)(6), the Commission also would
not require a covered clearing agency's policies and procedures to be
reasonably designed to determine the appropriate historic time period
for the margin methodology based on the characteristics of each
product, spread, account, or portfolio or to require specifying minimum
liquidation periods for different types of derivatives. Rules adopted
by the CFTC include such requirements.\667\ While the Commission
preliminarily agrees that these requirements may facilitate prudent
practices, the Commission preliminarily observes that consideration of
these practices would fall within the general responsibilities of a
covered clearing agency and its board of directors. The Commission
therefore preliminarily believes that proposed Rule 17Ad-22(e)(6)
strikes the appropriate balance in establishing policies and procedures
requirements with respect to risk management.
---------------------------------------------------------------------------
\667\ See 17 CFR 39.13(g)(2); see also DCO Principles Release,
supra note 53, at 69364-79, 69438 (CFTC adopting Sec. 39.13(g)(2)).
---------------------------------------------------------------------------
These differences between the Commission's proposal and the Board's
proposed rules and the CFTC's final rules are provided here as examples
of the differences observed between the respective rule sets and do not
constitute an exhaustive list. In preliminarily formulating the
specific requirements of the proposed rules in furtherance of Section
17A of the Exchange Act, the Commission was guided by its experience in
supervising registered clearing agencies, including through the SRO
rule filing process under Section 19(b) of the Exchange Act and Rule
19b-4, periodic inspections and examinations, and other monitoring of
the activities of registered clearing agencies.\668\ The Commission
also took into account the particular circumstances of the U.S.
securities markets, including but not limited to business models of and
current practices at covered clearing agencies, characteristics of the
products cleared, the nature of the covered clearing agencies'
participant base, and other factors. The Commission preliminarily
believes the differences between its proposal and the Board's proposed
rules and the CFTC's final rules are appropriate for the reasons noted
above. The Commission further preliminarily notes that some of the
differences between the Commission's proposal and the CFTC's final
rules is attributable to differences between the scope of the
Commission's and the CFTC's regulatory authority.\669\
---------------------------------------------------------------------------
\668\ See supra Part I.A and note 96 (describing the
Commission's framework for regulation of SROs and the SRO rule
filing process).
\669\ For example, the Commission is proposing Rules 17Ad-
22(e)(11) and (12) to establish requirements for covered clearing
agencies that provide CSD services and for exchange-of-value
settlement systems. See supra Parts II.B.8-9 and infra Part VII
(discussing the proposed rules and providing rule text,
respectively). The CFTC has not proposed comparable rules because
CSDs and securities settlement systems do not fall within the scope
of its regulatory authority.
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Further, CPSS-IOSCO members are also in various stages of
implementing the standards set forth in the PFMI Report into their own
regulatory regimes, and the Commission preliminarily believes that
proposing a set of requirements generally consistent with the relevant
international standards would result in diminished likelihood that
participants in cleared markets would restructure and operate
[[Page 29590]]
in less-regulated markets.\670\ Additionally, international standards
such as the Basel III framework could create complications for U.S.
clearing agencies not subject to regulations based on the standards set
in the PFMI Report as a result of the Basel III framework's treatment
of QCCPs. In particular, if U.S. clearing agencies do not obtain QCCP
status from foreign banking regulators who have adopted rules
conforming to the Basel III framework because, for instance, the
regulatory framework is not consistent with the standards set forth in
the PFMI Report, foreign bank members of U.S. clearing agencies may
have incentives to move their clearing business to clearing agencies in
jurisdictions where they might obtain lower capital requirements under
the Basel III framework.\671\
---------------------------------------------------------------------------
\670\ See supra note 53 (citing the Board's proposal and the
CFTC's final rules).
\671\ See supra note 48 and infra Part IV.C.1.e (discussing the
Basel III capital requirements and the economic effect of QCCP
status under the Basel III capital requirements, respectively).
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Failure to maintain consistency with other regulators may disrupt
cleared markets in a number of ways. Significant differences across
regulatory regimes may encourage participants to restructure their
operations in order to avoid a particular regulatory regime.\672\ Such
differences may reduce the liquidity of cleared products in certain
markets if they result in an undersupply of clearing services. Further,
inconsistency in regulation across jurisdictions may increase the
likelihood that restructuring by market participants in response such
inconsistency results in concentrating clearing activity in regimes
with a weaker commitment to policies and procedures for sound risk
management.
---------------------------------------------------------------------------
\672\ See, e.g., Arnoud W.A. Boot, Silva Dez[otilde]elan, & Todd
T. Milbourn, Regulatory Distortions in a Competitive Financial
Services Industry, 16 J. Fin. Serv. Res. 249 (2000) (showing that,
in a simple industrial organization model of bank lending, a change
in the cost of capital resulting from regulation results in a
greater loss of profits when regulated banks face competition from
non-regulated banks than when regulations apply equally to all
competitors); Victor Fleischer, Regulatory Arbitrage, 89 Tex. L.
Rev. 227 (2010) (discussing how, when certain firms are able to
choose their regulatory structure, regulatory costs are shifted onto
those entities that cannot engage in regulatory arbitrage).
---------------------------------------------------------------------------
In the case of clearing agency standards, there are additional
motivations for consistency with other regulatory requirements. The
Commission preliminarily believes that such consistency would prevent
the application of inconsistent regulatory burdens and thereby reduce
the likelihood that participants in cleared markets would restructure
and operate in less-regulated markets. Additionally, such consistency
would allow foreign bank clearing members and foreign bank customers of
clearing members of covered clearing agencies to be subject to lower
capital requirements under the Basel III framework.\673\
---------------------------------------------------------------------------
\673\ See Basel III capital requirements, supra note 48.
---------------------------------------------------------------------------
d. Concentration
The economic effects associated with the proposed rules may also be
partially determined by the economic characteristics of clearing
agencies. Generally, the economic characteristics of FMIs, including
clearing agencies, include specialization, economies of scale, barriers
to entry, and a limited number of competitors.\674\ Such
characteristics, coupled with the particulars of an FMI's legal
mandate, could result in market power, leading to lower levels of
service, higher prices, and under-investment in risk management
systems.\675\
---------------------------------------------------------------------------
\674\ See supra note 49 (defining ``financial market
infrastructure'').
\675\ Cf. PFMI Report, supra note 1, at 11.
---------------------------------------------------------------------------
The centralization of clearing activities in a relatively small
number of clearing agencies somewhat insulated from market forces may
result in a reduction in their incentives to innovate and to invest in
the development of appropriate risk management practices on an ongoing
basis, particularly when combined with the cost reduction pressures
noted above in Part IV.A.\676\ However, the Commission notes that the
inverse may not necessarily hold. In other words, additional
competition in the market for clearing services may not necessarily
result in improved risk management. For instance, aggressive price-
cutting in a ``race to the bottom'' may result in clearing agencies
accepting lower-quality collateral, requiring lower margin and default
fund contributions, lowering access requirements, or holding lower
reserves, potentially undermining their risk management efforts.\677\
---------------------------------------------------------------------------
\676\ Kenneth J. Arrow, Economic Welfare and the Allocation of
Resources for Invention 609-626, in The Rate and Direction of
Inventive Activity: Economic and Social Factors (NBER, 1962),
available at http://www.nber.org/chapters/c2144.pdf.
\677\ See CPSS, Market Structure Development in the Clearing
Industry: Implications for Financial Stability, at sec. 5 (Nov.
2010), available at http://www.bis.org/publ/cpss92.pdf; see also
Siyi Zhu, Is There a `Race to the Bottom' in Central Counterparties
Competition?--Evidence from LCH.Clearnet SA, EMCF and EuroCCP, DNB
Occasional Studies, Vol. 9, No. 6 (2011); John Kiff et al., Credit
Derivatives: Systemic Risks and Policy Options (IMF Working Paper
No. 254, Nov. 2009), available at http://www.imf.org/external/pubs/ft/wp/2009/wp09254.pdf.
---------------------------------------------------------------------------
Market power may raise particular issues with respect to the
allocation of benefits and costs flowing from these proposed rules and
precipitate changes in the structure of the financial networks that are
served by covered clearing agencies. For example, as a result of
limited competition,\678\ existing covered clearing agencies may easily
pass the incremental costs associated with enhanced standards on to
their members, who may share these costs with their customers,
potentially resulting in increased transaction costs in cleared
securities.
---------------------------------------------------------------------------
\678\ See generally Nadia Linciano, Giovanni Siciliano &
Gianfranco Trovatore, The Clearing and Settlement Industry:
Structure Competition and Regulatory Issues (Italian Secs. & Exch.
Comm'n Research Paper 58, May 2005), available at http://www.ssrn.com/abstract=777508 (concluding in part that the core
services offered by the clearance and settlement industry tend
toward natural monopolies because the industry can be characterized
as a network industry, where consumers buy systems rather than
single goods, consumption externalities exist, costs lock-in
consumers once they choose a system, and production improves with
economies of scale); Heiko Schmiedel, Markku Malkam[auml]ki & Juha
Tarkka, Economies of Scale and Technological Development in
Securities Depository and Settlement Systems, at 10 (Bank of Fin.
Discussion Paper 26, Oct. 2002), available at http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0226.pdf. (``The overall results of this study reveal the
existence of substantial economies of scale among depository and
settlement institutions. On average, the centralized U.S. system is
found to be the most cost effective settlement system and may act as
the cost saving benchmark.'').
---------------------------------------------------------------------------
If incremental increases in costs lead clearing agencies to charge
higher prices for their services, then certain clearing members may
choose to terminate membership and cease to clear transactions for
their customers. Should this occur the result may be further
concentration among clearing members, where each remaining member
clears a higher volume of transactions. In this case, clearing agencies
and the financial markets they serve would be more exposed to these
larger clearing members. These remaining clearing members may, however,
each internalize more of the costs their activity in cleared markets
imposes on the financial system.
The increased importance of a small set of clearing members, in
turn, may result in firms not previously systemically important
increasing in systemic importance. This is particularly true for
clearing members that participate in multiple markets, both cleared and
not cleared.\679\ However, adequate regulation of capital levels and
margin amounts at surviving clearing members could mean that, though
shocks to these members may be
[[Page 29591]]
larger, the propagation of shocks may be limited to a smaller set of
entities and their equity holders.
---------------------------------------------------------------------------
\679\ See, e.g., Roe, supra note 172 (arguing that counterparty
risk concentrated within CCPs may be transferred to the broader
financial system through links between clearing members and their
clients).
---------------------------------------------------------------------------
e. Qualifying CCP Status and Externalities on Clearing Members
An effect of the proposed amendments to Rule 17Ad-22 is that
covered clearing agencies required to comply with the proposed rules
may be more likely to qualify as QCCPs in non-U.S. jurisdictions that
have adopted the Basel III framework's QCCP definition. Under the Basel
III framework, a QCCP is defined as an entity operating as a CCP that
is prudentially supervised in a jurisdiction where the relevant
regulator has established, and publicly indicated that it applies to
the CCP on an ongoing basis, domestic rules and regulations that are
consistent with the standards set forth in the PFMI Report.\680\
Because the proposed amendments to Rule 17Ad-22 are intended to be in
line with the standards set forth in the PFMI Report, the Commission
preliminarily believes that foreign bank clearing members of certain
covered clearing agencies and foreign banks clearing indirectly through
clearing members of covered clearing agencies may benefit from covered
clearing agencies obtaining QCCP status. In particular, bank clearing
members and bank indirect participants of covered clearing agencies
that could attain QCCP status would face lower capital requirements
with respect to cleared derivatives and repurchase agreement
transactions because, under the Basel III framework, capital
requirements for bank exposures to QCCPs are lower than capital
requirements for bank exposures to non-qualifying CCPs for these
products. Although the Board and the Office of the Comptroller of the
Currency have already adopted rules implementing the Basel III capital
requirements that would identify all covered clearing agencies (with
the exception of ICEEU) as QCCPs for the purposes of applying risk
weights to assets at U.S. banks,\681\ the proposed amendments to Rule
17Ad-22 may result in non-U.S. bank clearing members experiencing lower
capital requirements related to exposures against covered clearing
agencies relative to a baseline scenario in which foreign banking
regulators do not determine that a covered clearing agency is a
QCCP.\682\
---------------------------------------------------------------------------
\680\ See supra note 48 (discussing the Basel III capital
requirements).
\681\ See infra Part IV.C.1.e.
\682\ The Commission notes that benefits to banks that may arise
as a result of the proposed rules may be contingent upon regulators
in other jurisdictions taking action to recognize the QCCP status of
covered clearing agencies.
---------------------------------------------------------------------------
The Basel III framework affects capital requirements for bank
exposures to central counterparties in two important ways. The first
relates to trade exposures, defined under the Basel III capital
requirements as the current and potential future exposure of a clearing
member or indirect participant in a CCP arising from OTC derivatives,
exchange-traded derivatives transactions, and securities financing
transactions. If these exposures are held against a QCCP, they will be
assigned a risk weight of 2%. In contrast, exposures against non-
qualifying CCPs do not receive lower capital requirements relative to
bilateral exposures and are assigned risk weights between 20% and 100%,
depending on counterparty credit risk. Second, the Basel III capital
requirements impose a cap on risk weights applied to default fund
contributions, limiting risk-weighted assets (subject to a 1250% risk
weight) to a cap of 20% of a clearing member's trade exposures against
a QCCP. This is in contrast to treatment of exposures against non-
qualifying CCPs, which are uncapped and subject to a 1250% risk weight.
Because QCCP status generally impacts capital treatment, any benefits
of attaining QCCP status will likely accrue, at least in part, to
foreign clearing members or foreign indirect participants subject to
the Basel III capital requirements.\683\ As a result of lower risk
weights applied to exposures and a cap on capital requirements against
default fund obligations, clearing members of QCCPs subject to Basel
III capital requirements may experience an improved capital position
relative to bank members of non-QCCPs. This may lower the costs of debt
capital for bank members of QCCPs.\684\
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\683\ For a discussion of the effects of QCCP status on
competition between bank and non-bank clearing members, see Part
IV.C.2.a.
\684\ See supra note 593 (noting that the Commission currently
expects the lower capital treatment under the Basel III framework to
affect registered clearing agencies FICC, ICEEU, and OCC, each of
which would meet the definition of a ``covered clearing agency''
under the proposed rules).
---------------------------------------------------------------------------
Non-U.S. banks that are constrained by Basel III tier one capital
requirements would face a shock to risk-weighted assets once capital
rules come into force.\685\ The size of the shock depends on
regulators' determinations with regard to QCCP status. Regardless of
the size of the shock and in order to come into compliance with capital
rules, however, affected banks will have to raise capital or reduce
leverage. In the absence of perfect markets, these banks may incur
ongoing costs as a result.
---------------------------------------------------------------------------
\685\ As discussed above, the Board and Office of Comptroller of
the Currency have adopted rules implementing capital requirements
under Basel III that make capital treatment for exposures to CCPs
independent of the proposed rules for U.S. banks regulated by these
two agencies, and therefore the Commission preliminarily believes no
benefits would accrue to U.S. bank clearing members of FICC and OCC.
---------------------------------------------------------------------------
In quantifying the benefits of achieving QCCP status, the
Commission based its estimate on publicly available information with
regard to OCC.\686\ To estimate the upper bound for the potential
benefits accruing to bank clearing members at OCC as a result of QCCP
status, the Commission identified a sample of 20 bank clearing members
at OCC and, for each bank, collected information about total assets,
risk weighted assets, net income and tier one capital ratio at the
holding company level for 2012.\687\ The Commission then allocated
trade exposures and default fund exposures across the sample of bank
clearing members based on the level of risk-weighted assets.\688\ The
Commission measured the impact on risk-weighted assets for non-U.S.
bank clearing members under two different capital treatment regimes.
The first regime is in the absence of QCCP status, assuming a 100% risk
weight applied to trade exposures and 1250% risk weight applied to
default fund exposures for non-U.S. members. In the second regime, OCC
obtains QCCP status, and banks are allowed to apply a 2% risk
[[Page 29592]]
weight applied to trade exposures and a 1250% risk weight to default
fund exposures up to a total exposure cap of 20% of trade
exposures.\689\ If OCC is determined to be a QCCP, then the increase in
risk weighted assets will be smaller in magnitude, implying a smaller
adjustment at lower cost. The Commission preliminarily estimates that
benefits associated with OCC obtaining QCCP status stemming from lower
capital requirements against trade exposures to QCCPs as a result of
the proposed rules to have an upper bound of $600 million per year, or
approximately 0.60% of the total 2012 net income reported by bank
clearing members at OCC.
---------------------------------------------------------------------------
\686\ Under the Basel III framework ICCEU and FICC's repurchase
agreement segment would also be eligible for QCCP status. However,
FICC does not report counterparties to repo agreements, and ICEEU
does not separately report exposures related to security-based swap
clearing, so we are currently unable to quantify potential benefits
related to QCCP status for these entities.
\687\ The Commission used the set of entities it identified as
banks on OCC's member list, available at http://www.optionsclearing.com/membership/member-information/. For U.S.
bank holding companies, 2012 total assets, risk weighted assets, net
income, and tier 1 capital ratios were collected from Y-9C reports
available at the National Information Center, http://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For non-U.S. bank holding companies,
Commission staff obtained corresponding data from financial
statements and supplementary financial materials posted to bank Web
sites. Where necessary, values were converted back to U.S. dollars
at appropriate exchange rates obtained from Thomson Reuters
Datastream and the Federal Reserve, http://www.federalreserve.gov/releases/h10/hist/.
\688\ For example, one bank in the sample, with 6.25% of total
risk-weighted assets, was assigned 6.25% of the total trade and
default fund exposures while another bank in the sample, with 3.43%
of total risk weighted assets, was assigned 3.43% of these
exposures. Because trade exposures of OCC members against OCC are
nonpublic, the Commission used the balance of OCC margin deposits
and deposits in lieu of margin held at OCC, $57.48 billion, as a
proxy for trade exposures. OCC's 2012 clearing fund deposits were
valued at $2.66 billion. See OCC, 2012 Annual Report, available at
http://www.optionsclearing.com/components/docs/about/annual-reports/occ_2012_annual_report.pdf.
\689\ The Basel III framework allows banks to compute default
fund exposures in two ways. Method 1 involves computing capital
requirements for each member proportional to its share of an
aggregate capital requirement for all clearing members in a scenario
where to average clearing members default. The Commission currently
lacks data necessary to compute default fund exposures under this
approach, instead we use Method 2, which caps overall exposure to a
QCCP at 20% of trade exposures. See Basel III framework, supra note
48, Annex 4, paras. 121-25 (outlining two methods for computing
default fund exposures).
---------------------------------------------------------------------------
The Commission's analysis is limited in several respects and relies
on several assumptions. First, a limitation of our proxy for trade
exposures and our use of OCC's clearing fund is that the account
balances include deposits by bank clearing members, who would
experience lower capital requirements under the Basel III framework,
and non-bank clearing members who would not. The Commission
preliminarily assumes, for the purposes of establishing an upper bound
for the benefits to market participants that are associated with QCCP
status for OCC under the proposed rules, that the balance of both OCC's
margin account and OCC's default fund are attributable only to bank
clearing members. Additionally, we assume an extreme case where, in the
absence of QCCP status, trade exposures against a CCP would be assigned
a 100% risk weight, causing the largest possible shock to risk-weighted
assets for affected banks.
Concluding that lower capital requirements on trade exposures to
OCC would produce effects in the real economy also requires that
certain conditions exist. Agency problems, taxes, or other capital
market imperfections could result in banks targeting a particular
capital structure. Further, capital constraints on bank clearing
members subject to the Basel III framework should bind so that higher
capital requirements on bank clearing members subject to the Basel III
framework in the absence of QCCP status would cause these banks to
exceed capital constraints if they chose to redistribute capital to
shareholders or invest capital in projects with returns that exceed
their cost of capital. Using publically available data, however, it is
not currently possible to determine whether capital constraints will
bind for bank clearing members when rules applying Basel III capital
requirements come into force, so to estimate an upper bound for the
effects of QCCP status on bank clearing members we assume that tier one
capital constraints for all bank clearing members of OCC would bind in
an environment with zero weight placed on bank exposures to CCPs.\690\
---------------------------------------------------------------------------
\690\ The Commission notes that, at present, no bank in its
sample of bank clearing members of OCC is bound by capital
requirements under the Basel III framework. Bank holding company
risk-weighted assets, adjusted total assets, and capital ratio data
have been taken from http://www2.fdic.gov/SDI/. The Commission used
data from 2009-2012 for its sample of bank clearing members and
assumed no bank-specific countercyclical capital buffers for these
banks. This suggests a minimum tier 1 capital ratio of 9.6%,
exceeding the Basel III minimum by 1.1%. The same analysis suggests
a minimum total capital ratio of 12.3%, exceeding the Basel III
minimum by 1.8%.
---------------------------------------------------------------------------
For the purposes of quantifying potential benefits from QCCP
status, the Commission has also assumed that banks choose to adjust to
new capital requirements by deleveraging. In particular, the Commission
assumed that banks would respond by reducing risk-weighted assets
equally across all risk classes until they reach the minimum tier one
capital ratio under the Basel framework of 8.5%. We measure the ongoing
costs to each non-U.S. bank by multiplying the implied change in total
assets by each bank's return on assets, estimated using up to 12 years
of annual financial statement data.\691\
---------------------------------------------------------------------------
\691\ This data has been taken from Compustat. Due to data
limitations, for certain banks a shorter window was used for this
calculation. The minimum sample window was nine years.
---------------------------------------------------------------------------
The Basel III capital requirements for exposures to CCPs yield
additional benefits for QCCPs that the Commission is currently unable
to quantify due to lack of data concerning client clearing arrangements
by banks. For client exposures to clearing members, the Basel III
capital requirements allow participants to reflect the shorter close-
out period of cleared transactions in their capitalized exposures. The
Basel III framework's treatment of exposures to CCPs also applies to
client exposures to CCPs through clearing members. This may increase
the likelihood that bank clients of bank clearing members that are
subject to the Basel III capital requirements share some of the
benefits of QCCP status.
Furthermore, the fact that the Basel III capital requirements apply
to bank clearing members may have important implications for
competition and concentration. While the proposed rules may extend
lower capital requirements against exposures to CCPs to non-U.S. bank
clearing members of covered clearing agencies,\692\ the benefits of
QCCP status will still be limited to bank clearing members. However,
the costs associated with compliance with the proposed rules may be
borne by all clearing members, regardless of whether or not they are
supervised as banks. A potential consequence of this allocation of
costs and benefits may be ``crowding out'' of members of QCCPs that are
not banks and will not experience benefits with respect to the Basel
III framework. This may result in an unintended consequence of
increased concentration of clearing activity among bank clearing
members. As noted in Part IV.C.1.d, this increased concentration could
mean that each remaining clearing member becomes more important from
the standpoint of systemic risk transmission.
---------------------------------------------------------------------------
\692\ See supra note 599 and accompanying text (noting that
banks supervised by the Board and the Office of the Comptroller of
the Currency would treat covered clearing agencies as QCCPs for the
purposes of calculating regulatory capital ratios).
---------------------------------------------------------------------------
In addition to benefits for bank clearing members, certain benefits
resulting from QCCP status may also accrue to covered clearing
agencies. If banks value lower capital requirements attributable to
QCCP status, bank clearing members may prefer membership at QCCPs to
membership at CCPs that are not QCCPs. A flight of clearing members
from covered clearing agencies in the absence of QCCP status would
result in default-related losses being mutualized across a narrower
member base. If the flight from covered clearing agencies results in
lower transactional volume at these clearing agencies, then economies
of scale may be lost, resulting in higher clearing fees and higher
transaction costs in cleared products.
2. Effect on Competition, Efficiency, and Capital Formation
The proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2
have the potential to affect competition, efficiency, and capital
formation. As with the rest of the benefits and costs associated with
the proposed amendments to Rule 17Ad-22, the Commission preliminarily
believes that several of the effects described below only occur to the
extent that covered clearing agencies do not already have operations
and governance mechanisms
[[Page 29593]]
that conform to the requirements in proposed Rule 17Ad-22(e).
Additionally, the Commission preliminarily believes that consistency
with international regulatory frameworks, as embodied by the standards
set forth in the PFMI Report, which may promote the integrity of
cleared markets, could have substantial effects on competition,
efficiency, and capital formation.
a. Competition
Two important characteristics of the market for clearance and
settlement services are high fixed costs and economies of scale. Large
investments in risk management and information technology
infrastructure costs, such as financial data database and network
maintenance expenses, are components of high fixed costs for clearing
agencies. Consequently, the clearance and settlement industry exhibits
economies of scale in that the average total cost per transaction,
which includes fixed costs, diminishes with the increase in transaction
volume as high fixed costs are spread over a larger number of
transactions.
Furthermore, high fixed costs translate into barriers to entry that
preclude competition. Lower competition is an important source of
market power for clearing agencies. As a result, clearing agencies
possess the ability to exert market power and influence the fees
charged for clearance and settlement services in the markets they
serve.\693\ Any costs resulting from the proposed amendments may have
the effect of raising already high barriers to entry. As the potential
entry of new clearing agencies becomes more remote, existing clearing
agencies may be able to reduce service quality, restrict the supply of
services, or increase fees above marginal cost in an effort to earn
economic rents from participants in cleared markets.\694\
---------------------------------------------------------------------------
\693\ See, e.g., Clearing Agency Standards Release, supra note
5, at 66263.
\694\ See, e.g., Clearing Agency Standards Release, supra note
5, at 66263 n.481.
---------------------------------------------------------------------------
Even if they could not take advantage of a marginal increase in
market power, clearing agencies may use their market power to pass any
increases in costs that flow from the proposed amendments to their
members. This may be especially true in the cases of member-owned
clearing agencies, such as DTC, FICC, NSCC, and OCC, where members lack
the opportunity to pass costs through to outside equity holders.
Allowing clearing members to serve on the board of directors of a
covered clearing agency may align a covered clearing agency's
incentives with its membership. Certain complications may also arise,
however, when clearing members sit on boards of covered clearing
agencies as members of the board and may choose to allocate the costs
of enhanced risk management inefficiently across potential competitors,
in an effort to reduce their own share of these costs.
Members who are forced to internalize the costs of additional
requirements under the proposed rules may seek to terminate their
membership. Additionally, prospective clearing members may find it
difficult to join clearing agencies, given the additional costs they
must internalize.\695\ Remaining clearing members may gain market power
as a result, enabling them to extract economic rents from their
customers. Rent extraction could take the form of higher transaction
costs in cleared markets, thereby reducing efficiency, as discussed
below.
---------------------------------------------------------------------------
\695\ See supra Part IV.C.1.d (discussing concentration both in
the market for clearing services and among clearing members).
---------------------------------------------------------------------------
The Commission also acknowledges that proposed Rule 17Ad-22(e)(19)
may affect competition among firms that choose to become clearing
members, and those who provide clearing services indirectly, through a
clearing member. Monitoring and managing the risks associated with
indirect participation in clearing may be costly. If monitoring and
managing the risks associated with indirect participation in clearing
proves costly for clearing agencies and if clearing agencies are able
to pass the additional costs related to monitoring and managing risks
to clearing members, it may cause marginal clearing members unable to
absorb these additional costs to exit. While these exits may be
socially efficient, since they reflect the internalization of costs
otherwise imposed upon other participants in cleared markets through
increased probability of clearing agency default, they may nevertheless
result in lower competition among clearing members for market share,
potentially providing additional market power to the clearing members
that remain.
The Commission preliminarily believes, however, that management of
risks from indirect participation is important in mitigating the risks
that clearing agencies pose to financial stability. The tiered
participation risk exposures, including credit, liquidity, and
operational risks inherent in indirect participation arrangements, may
present risks to clearing agencies, their members, and to the broader
financial markets. For instance, if the size of an indirect
participant's positions is large relative to a clearing member's
capacity to absorb risks, this may increase the clearing member's
default risk. Consequently, a clearing agency with indirect
participation arrangements may be exposed to the credit risk of an
indirect participant through its clearing members. Similarly, a margin
call on, or a default by, an indirect participant could constrain
liquidity of its associated clearing members, making it more difficult
for these members to manage their positions at the clearing agency.
The consistency across regulatory frameworks contemplated by the
proposed rules may also affect competition. Financial markets in
cleared products are global, encompassing many countries and regulatory
jurisdictions. Consistency with international regulatory frameworks may
facilitate entry of clearing agencies into new markets. By contrast,
conflicting or duplicative regulation across jurisdictions, or even
within jurisdictions, may cause competitive friction that inhibits
entry and helps clearing agencies behave like local monopolists.
Consistency in regulation can facilitate competition among clearing
agencies so long as regulation is not so costly as to discourage
participation in any market. Additionally, the Commission preliminarily
believes that proposed Rule 17Ad-22(e)(23) may facilitate competition
among clearing agencies across jurisdictions by requiring public
disclosures that enable market participants to compare clearing
agencies more easily.
The consistency across regulatory requirements contemplated by the
proposed rules may affect competition among banks in particular.
Clearing derivative and repurchase agreement transactions through QCCPs
will result in lower capital requirements for banks under the Basel III
capital requirements. Therefore, consistency with the standards set
forth in the PFMI Report may allow banks that clear these products
through covered clearing agencies to compete on equal terms with banks
that clear through other clearing agencies accorded QCCP status. This
effect potentially countervails higher barriers to entry that enhanced
risk management standards may impose on clearing members by lowering
the marginal cost of clearing these transactions. Furthermore, covered
clearing agencies potentially compete with one another for volume from
clearing members. Since clearing members receive better treatment for
exposures against QCCPs, clearing
[[Page 29594]]
members will find it less costly to deal with QCCPs. Failure to
establish requirements consistent with the standards set forth in the
PFMI Report may place U.S. covered clearing agencies at a competitive
disadvantage globally.
The ability of covered clearing agencies to obtain QCCP status may
also affect competition among clearing agencies. Under the Basel III
framework, QCCP status would have practical relevance only for covered
clearing agencies providing CCP services for derivatives, security-
based swaps, and securities financing transactions. To the extent that
the proposed rules increase the likelihood that banking regulators that
have implemented the Basel III framework in their jurisdiction
recognize covered clearing agencies as QCCPs, banks that clear at
covered clearing agencies will experience lower capital requirements.
Since clearing agencies may compete for volume from clearing members
that are also banks, the proposed rules may remove a competitive
friction between covered clearing agencies and other clearing agencies
that enjoy recognition as QCCPs by banking regulators. As a corollary,
the proposed rules could potentially disadvantage any registered
clearing agencies that are not covered clearing agencies.\696\ The
Commission also preliminarily notes that the ability of registered
clearing agencies to voluntarily apply for covered clearing agency
status under proposed Rule 17Ab2-2(a) may potentially allow entrants to
achieve QCCP status if the Commission determines they should receive
covered clearing agency status and they otherwise meet the requirements
of the Basel III framework.
---------------------------------------------------------------------------
\696\ See supra note 593 (noting that the Commission currently
expects the lower capital treatment under the Basel III framework to
affect registered clearing agencies FICC, ICEEU, and OCC, each of
which would meet the definition of a ``covered clearing agency''
under the proposed rules).
---------------------------------------------------------------------------
Further competitive effects may flow from the proposal as a result
of the determinations under proposed Rule 17Ab2-2 for clearing agencies
engaged in activities with a more complex risk profile and clearing
agencies that are systemically important in multiple jurisdictions.
These entities will be responsible for maintaining additional financial
resources sufficient to cover the default of the two participant
families that would potentially cause the largest aggregate credit
exposures in extreme but plausible market conditions as well as
undertake an annual feasibility analysis for extending liquidity risk
management from ``cover one'' to ``cover two.'' These clearing agencies
will have to collect these resources from participants, either through
higher margin requirements or guaranty fund contributions, or
indirectly through third-party borrowing arrangements secured by member
resources. Regardless of how clearing agencies obtain these additional
resources, the requirement to do so potentially raises the costs to use
services provided by covered clearing agencies which could, at the
margin, shift transactional volume to clearing agencies that fall
outside the scope determined by proposed Rule 17Ab2-2, where competing
clearing agencies exist, or opt out of clearing altogether.
b. Efficiency
The proposed amendments to Rule 17Ad-22 may affect efficiency in a
number of ways, though as discussed previously, most of these effects
will only flow to the extent that covered clearing agencies do not
already comply with the proposed amendments. First, because the
proposed amendments result in general consistency with the standards
set forth in the PFMI Report and requirements proposed by the Board and
adopted by the CFTC, consistency likely fosters efficiency by reducing
the risk that covered clearing agencies will be faced with conflicting
or duplicative regulation when clearing financial products across
multiple regulatory jurisdictions.
Consistency across regulatory regimes in multiple markets may also
result in efficiency improvements. Fully integrated markets would allow
clearing agencies to more easily exploit economies of scale because
clearing agencies tend to have low marginal costs and, thus, could
provide clearance and settlement services over a larger volume of
transactions at a lower average cost. Differences in regulation, on the
other hand, may result in market fragmentation, allowing clearing
agencies to operate as local monopolists. The resulting potential for
segmentation of clearing and settlement businesses along jurisdictional
lines may lead to overinvestment in the provision of clearing services
and reductions in efficiency as clearing agencies open and operate
solely within jurisdictional boundaries. If market segmentation
precludes covered clearing agencies from clearing transactions for
customers located in another jurisdiction with a market too small to
support a local clearing agency, fragmentation may result in under-
provisioning of clearing and settlement services in these areas, in
turn reducing the efficiency with which market participants share risk.
The proposed amendments may also affect efficiency directly if they
mitigate covered clearing agencies' incentives to underinvest in risk
management and recovery and wind-down procedures. CCP default and
liquidation is likely a costly event, so to the extent that the
proposed rules mitigate the risk of CCP default and prescribe rules for
orderly recovery and wind-down, they will produce efficiency benefits.
Another direct effect on efficiency may come if registered clearing
agencies attempt to restructure their operations in ways that would
allow them to fall outside of the scope of proposed Rule 17Ad-22(e).
Finally, price efficiency and the efficiency of risk sharing among
market participants may be affected by the proposed amendments. On one
hand, the cost of a transaction includes costs related to counterparty
default that are typically unrelated to fundamental asset payoffs.
Academic research using credit default swap transaction data has
revealed a statistically significant, though economically small,
relationship between the credit risk of a counterparty and the spreads
implicit in transaction prices.\697\ Enhanced risk management by
clearing agencies may reduce this component of transaction costs. By
reducing deviations of prices from fundamental value, the proposed
amendments may increase price efficiency. If lower transaction costs or
reduced ambiguity facilitates participation in cleared markets by
investors who would benefit from opportunities for risk-sharing in
these markets,\698\ then this transmission channel may result in more
efficient allocation of risk. On the other hand, the proposed
amendments may have adverse implications for price efficiency in
cleared markets if they drive up transaction costs as higher costs of
risk management enter asset prices. An increase in transaction costs
could cause certain market participants to avoid trading altogether,
reducing liquidity in
[[Page 29595]]
cleared products and opportunities for risk sharing among investors in
these markets.
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\697\ See e.g., Navneet Arora, Priyank Gandhi & Francis
Longstaff, Counterparty Credit Risk and the Credit Default Swap
Market, 103 J. Fin. Econ. 280 (2012). Using transaction prices and
quotes by 14 different CDS dealers, the authors identified how
dealers' credit risk affects transaction prices. They observed a
relationship between spreads and credit risk implying that a 645-
basis-point increase in a dealer's credit spread would produce a
one-basis-point increase in transaction prices. They explain the
magnitude of this relationship by noting that their sample included
transactions that were mostly collateralized, which would diminish
the sensitivity of transaction prices to counterparty credit risk.
\698\ If investors who might benefit from risk-sharing in
cleared markets are ambiguity-averse, then regulation that addresses
payoffs in times of financial strain may induce their participation.
See supra note 655 and accompanying text.
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c. Capital Formation
The implications for capital formation that flow from these
proposed rules stem mainly from incremental costs that result from
compliance with more specific standards and benefits in the form of
more efficient risk sharing.
In cases where current practice falls short of the proposed
amendments, covered clearing agencies may have to invest in
infrastructure or make other expenditures to come into compliance,
which may divert capital from other uses. In line with our previous
discussion of cost allocation in the market for clearing services,
these resources may come from clearing members and their
customers.\699\
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\699\ See supra Part IV.C.1 (discussing the economic effects of
the proposed rules on the market for clearing services generally).
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At the same time, the Commission preliminarily believes that the
standards contemplated under the proposed rules may foster capital
formation. As mentioned earlier, clearing agencies that are less prone
to failure may help reduce transaction costs in the markets they
clear.\700\ Conceptually, the component of transaction costs that
reflects counterparty credit risk insures one counterparty against the
default of another.\701\ Reductions in counterparty default risk allow
the corresponding portion of transaction costs to be allocated to more
productive uses by market participants who otherwise would bear these
costs.
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\700\ See supra Part IV.C.1.a (discussing the general economic
effects of the proposed rules on systemic risk).
\701\ See supra note 697.
---------------------------------------------------------------------------
If, on balance, the proposed amendments cause transaction costs to
decrease in cleared markets, then the expected value of trade may
increase. Counterparties that are better able to diversify risk through
participation in cleared markets may be more willing to invest in the
real economy rather than choosing to engage in precautionary savings.
3. Effect of Proposed Amendments to Rule 17Ad-22 and Proposed Rule
17Ab2-2
The discussion below outlines the costs and benefits preliminarily
considered by the Commission as they relate to the rules being proposed
today. These specific costs and benefits are in addition to the more
general costs and benefits anticipated under the Commission's proposal
discussed in Part IV.C.1 and include, in particular, the costs and
benefits stemming from the availability of QCCP status under the Basel
III capital requirements. Many of the costs and benefits discussed
below are difficult to quantify. This is particularly true where
clearing agency practices are anticipated to evolve and adapt to
changes in technology and other market developments. The difficulty in
quantifying costs and benefits of the proposed rules is further
exacerbated by the fact that in some cases the Commission lacks
information regarding the specific practices of clearing agencies that
could assist in quantifying certain costs. For example, as noted in
Part IV.C.3.a.iv(4), without detailed information about the composition
of illiquid assets held by clearing agencies and their members, the
Commission cannot provide reasonable estimates of costs associated with
satisfying substantive requirements under proposed Rules 17Ad-
22(e)(7)(i) and (ii). Another example, discussed in Part
IV.C.3.a.iv(5), is testing and validation of financial risk models,
where the Commission is only able to estimate that costs will fall
within a range. In this case, the costs associated with substantive
requirements under the proposed rules may depend on the types of risk
models employed by clearing agencies, which are, in turn, dictated by
the markets they serve. As a result, much of the discussion is
qualitative in nature, though where possible, the costs and benefits
have been quantified.
a. Proposed Rule 17Ad-22(e)
The Commission recognizes that the scope of the proposed rules is
an important determinant of their economic effect. Having considered
the anticipated costs associated with the proposed rules, the
Commission preliminarily believes that it is appropriate to limit the
application of proposed Rule 17Ad-22(e) to covered clearing agencies,
as these are the registered clearing agencies for which the benefits of
the proposed rules are the greatest. In particular, as discussed below,
the Commission preliminarily believes that an important benefit
resulting from the enhanced risk management requirements in the
proposed rules is a reduction in the risk of a failure of a covered
clearing agency. For example, for designated clearing agencies these
benefits may be significant due to their size, exposure to, and
interconnectedness with market participants, and the effect their
failure may have on markets, market participants, and the broader
financial system. For complex risk profile clearing agencies,
significant benefits may flow as a result of their higher baseline
default risk.
As an alternative, the Commission could have proposed to extend the
scope of proposed Rule 17Ad-22(e) to cover all registered clearing
agencies. The Commission preliminarily acknowledges, however, that
costs of compliance with the proposed rules may represent barriers to
entry for clearing agencies. By continuing to apply Rule 17Ad-22(d) to
registered clearing agencies that are not covered clearing agencies,
the Commission preliminary believes that the proposed scope Rule 17Ad-
22(e) appropriately preserves the potential for innovation in the
establishment and operation of registered clearing agencies.\702\
Moreover, including CME and ICE in the set of covered clearing agencies
would potentially subject them to requirements that would be
duplicative of CFTC requirements.
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\702\ The Commission notes that under proposed Rule 17Ab2-2(a),
a registered clearing agency that is not involved in activities with
a more complex risk profile and is not a designated clearing agency
may apply for covered clearing agency status, which would subject
them to the requirements of Rule 17Ad-22(e). The Commission
preliminarily believes that this may occur if the registered
clearing agency believes such status may credibly signal the quality
of the services it provides or if it is seeking to obtain QCCP
status under the Basel III framework.
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i. Proposed Rule 17Ad-22(e)(1): Legal Risk
Because, as noted above, proposed Rule 17Ad-22(e)(1) would require
substantially the same set of policies and procedures as Rule 17Ad-
22(d)(1),\703\ the Commission preliminarily believes that proposed Rule
17Ad-22(e)(1) would likely impose limited material additional costs on
covered clearing agencies and produce limited benefits, in line with
the general economic considerations discussed in Part IV.C.1.
---------------------------------------------------------------------------
\703\ See supra note 107; supra Part II.B.1 (discussing the full
set of requirements under proposed Rule 17Ad-22(e)(1)); supra Part
IV.B.3.a.i (discussing current practices among registered clearing
agencies regarding legal risk); see also 17 CFR 240.17Ad-22(d)(1).
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ii. Proposed Rule 17Ad-22(e)(2): Governance
Each covered clearing agency has a board of directors that governs
its operations and oversees its senior management. Proposed Rule 17Ad-
22(e)(2) would establish more detailed requirements for governance
arrangements at covered clearing agencies relative to those imposed on
[[Page 29596]]
registered clearing agencies under Rule 17Ad-22(d)(8).\704\
---------------------------------------------------------------------------
\704\ See supra Part II.B.2 (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(2) and its relationship
to Rule 17Ad-22(d)(8)); see also supra note 119 (discussing how the
proposed rule would complement other proposed requirements
concerning governance at clearing agencies that may apply
separately).
---------------------------------------------------------------------------
The Commission understands that any covered clearing agency subject
to the proposed rule has policies and procedures in place that clearly
prioritize the risk management and efficiency of the clearing agency.
However, the Commission preliminarily believes that covered clearing
agencies do not already have in place policies and procedures with
respect to other requirements under proposed Rule 17Ad-22(e)(2). Based
on its supervisory experience, the Commission preliminarily believes
that some covered clearing agencies may need to update their policies
and procedures to comply with proposed Rule 17Ad-22(e)(2)(iv). These
updates will entail certain basic compliance costs, and covered
clearing agencies may also incur assessment costs related to analyzing
current governance arrangements in order to determine the extent to
determine which they do not meet the requirements of the proposed
amendments. The estimated costs in terms of paperwork are discussed in
Part III.D.1. If, as a result of new policies and procedures, a covered
clearing agency is required to recruit new directors, the Commission
preliminarily estimates a cost per director of $73,000.\705\
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\705\ The Commission estimated a cost per director of $68,000 in
proposing Regulation MC. See Exchange Act Release No. 34-63107 (Oct.
14, 2010), 75 FR 65881, 65921 & n.215 (Oct. 26, 2010). The $73,000
estimate reflects this amount in 2013 dollars, using consumer price
inflation data provided by the Bureau of Labor Statistics.
---------------------------------------------------------------------------
While there are potential costs associated with compliance, the
Commission preliminarily believes that benefits would potentially
accrue from these requirements. Specifically, the Commission
preliminarily believes that enhanced governance arrangements would
further promote safety and efficiency at the clearing agency--motives
that may not be part of a clearing agency's governance arrangements in
the absence of regulation. Policies and procedures required under the
proposed rules would also reinforce governance arrangements at covered
clearing agencies by requiring board members and senior management to
have appropriate experience and skills to discharge their duties and
responsibilities.
Compliance with these proposed requirements could reduce the risk
that insufficient internal controls within a covered clearing agency
endanger broader financial stability. While the benefits of compliance
are difficult to quantify, the Commission preliminarily believes that
they flow predominantly from a reduced probability of covered clearing
agency default.
iii. Proposed Rule 17Ad-22(e)(3): Comprehensive Framework for the
Management of Risks
The Commission preliminarily believes that proposed Rule 17Ad-
22(e)(3) would aid covered clearing agencies in implementing a
systematic process to examine risks and assess the probability and
impact of those risks.\706\ Proposed Rule 17Ad-22(e)(3)(i) specifies
that a risk management framework include policies and procedures
reasonably designed to identify, measure, monitor, and manage the range
of risks that arise in or are borne by the covered clearing agency.
Critically, these policies and procedures would be subject to review on
a specified basis and approval by the board of directors annually. A
sound framework for comprehensive risk management under regular review
would have the benefits of providing covered clearing agencies with a
better awareness of the totality of risks they face in the dynamic
markets they serve. In addition, the requirement to have policies and
procedures that provide for an independent audit committee of the board
and that provide internal audit and risk management functions with
sufficient resources, authority, and independence from management, as
well as access to risk and audit committees of the board, would
reinforce governance arrangements directly related to risk management
at covered clearing agencies. A holistic approach to risk management
could help ensure that policies and procedures that covered clearing
agencies adopt pursuant to the proposed rules work in tandem with one
another. For example, such an approach could result in risk-based
membership standards under proposed Rule 17Ad-22(e)(18) that are
consistent with policies and procedures related to the allocation of
credit losses under proposed Rule 17Ad-22(e)(13)(i). The Commission
preliminarily believes ensuring that a covered clearing agency's risk
management activities fit within a unified framework could mitigate the
risk of financial losses to covered clearing agencies' members and
participants in the markets they serve.
---------------------------------------------------------------------------
\706\ See supra Part II.B.3 (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(3)).
---------------------------------------------------------------------------
Additionally, the proposed rule extends requirements under Rules
17Ad-22(d)(4) and 17Ad-22(d)(11) by requiring plans for recovery and
wind-down.\707\ To the extent that covered clearing agencies do not
already have such plans in place, they may incur additional incremental
costs. Plans for recovery and wind-down benefit both clearing members
and, more generally, participants in markets where products are
cleared. Many of the costs and benefits of such plans depend critically
on the specific recovery and wind-down tools that covered clearing
agencies choose to include in their rules. The presence of such plans
could reduce uncertainty over the allocation of financial losses to
clearing members in the event that a covered clearing agency faces
losses due to member default or for other reasons that exceed its
prefunded default resources. Further, recovery and wind-down plans that
detail the circumstances under which clearing services may be suspended
or terminated may mitigate the risk of market disruption in periods of
financial stress. Market participants who face the possibility that the
assets they trade may no longer be cleared and settled by a CCP may be
unwilling to trade such assets at times when risk sharing is most
valuable. While the effects are difficult to quantify, the Commission
preliminarily believes that recovery and wind-down plans may support
liquidity in times of financial stress.
---------------------------------------------------------------------------
\707\ See supra Part II.B.3.b (discussing the requirements for
recovery and orderly wind-down plans under proposed Rule 17Ad-
22(e)(3)(ii)).
---------------------------------------------------------------------------
Based on its supervisory experience, the Commission preliminarily
believes that all covered clearing agencies have an independent audit
committee of the board and most covered clearing agencies already have
some rules governing recovery and wind-down of clearing operations but
have plans that vary in their degree of formality. As a result, the
benefits and costs associated with these requirements will likely be
limited to incremental changes associated with covered clearing
agencies' review of their policies and procedures for recovery and
wind-down and to registered clearing agencies that move into the set of
covered clearing agencies.
[[Page 29597]]
iv. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management
(1) Proposed Rule 17Ad-22(e)(4): Credit Risk
Proposed Rule 17Ad-22(e)(4) would establish requirements for credit
risk management by covered clearing agencies.\708\ Based on its
supervisory experience, the Commission preliminarily believes that all
entities that would be covered clearing agencies are already in
compliance with proposed Rules 17Ad-22(e)(4)(i) through (iv). Pursuant
to Rule 17Ad-22(b)(3), registered clearing agencies that provide CCP
services currently maintain additional financial resources to meet the
``cover one'' requirement, and registered clearing agencies that would
be complex risk profile clearing agencies under the proposed rules
currently maintain financial resources to meet the ``cover two''
requirement.\709\ All covered clearing agencies exclude resources that
are not prefunded when calculating this coverage.\710\ As a result, the
Commission preliminarily believes little or no additional direct costs
or benefits will result from these requirements unless registered
clearing agencies were to become covered clearing agencies and include
resources that are not prefunded towards their resource requirements.
The requirement to include only prefunded resources when calculating
the financial resources available to meet the standards under proposed
Rules 17Ad-22(e)(4)(i) through (iii) potentially reduces the risk that
covered clearing agencies request financial resources from their
members in times of financial stress, when members are least able to
provide these resources.
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\708\ See supra Part II.B.4.c (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(4)).
\709\ The Commission also notes that no covered clearing agency
would be systemically important in multiple jurisdictions unless and
until the Commission made such a determination pursuant to proposed
Rule 17Ab2-2. See supra Part II.C and infra Part VII (discussing the
determinations process under proposed Rule 17Ab2-2 and providing
proposed rule text, respectively).
\710\ See supra Part IV.B.3.b.i (discussing current practices
regarding credit risk management at registered clearing agencies).
---------------------------------------------------------------------------
While requiring ``cover two'' for complex risk profile clearing
agencies and for covered clearing agencies designated systemically
important in multiple jurisdictions would place additional burdens on
the affected clearing agencies, the Commission preliminarily believes
that the requirement is appropriate because disruption to these
entities due to member default carries relatively higher expected costs
than for other covered clearing agencies. These relatively higher
expected costs arise from the fact that covered clearing agencies
designated systemically important in multiple jurisdictions are exposed
to foreign financial markets and may serve as a conduit for the
transmission of risk; for complex risk profile clearing agencies, high
expected costs may arise from discrete jump-to-default price changes in
the products they clear and higher correlations in the default risk of
members.\711\
---------------------------------------------------------------------------
\711\ Cf. PFMI Report, supra note 1, at 43 (discussing Principle
4, Explanatory Note 3.4.19).
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(4)(vi) and (vii) would also impose
additional costs by requiring additional measures to be taken with
respect to the testing of a covered clearing agency's financial
resources and model validation of a covered clearing agency's credit
risk models. These requirements do not currently exist as part of the
standards applied to registered clearing agencies.\712\ Covered
clearing agencies may incur additional costs under expanded and more
frequent testing of total financial resources if the formal requirement
that results of monthly testing be reported to appropriate decision
makers is a practice not currently used by covered clearing agencies. A
range of costs for these new requirements is discussed in Part
IV.C.3.a.iv(5).
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\712\ Rule 17Ad-22(b)(4) requires a registered clearing agency's
policies and procedures be reasonably designed to provide for an
annual validation of its margin models and the related parameters
and assumptions. See 17 CFR 240.17Ad-22(b)(4).
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Frequent monitoring and stress testing of total financial
resources, conforming model validations, and reporting of results of
the monitoring and testing to appropriate personnel within the clearing
agency could help rapidly identify any gaps in resources required to
ensure stability, even in scenarios not anticipated on the basis of
historical data. Moreover, the requirement to test and, when necessary,
update the assumptions and parameters supporting models of credit risk
will support the adjustment of covered clearing agency financial
resources to changing financial conditions, and mitigate the risk that
covered clearing agencies will strategically manage updates to their
risk models in support of cost reduction or profit maximization.
(2) Proposed Rule 17Ad-22(e)(5): Collateral
Proposed Rule 17Ad-22(e)(5) would require a covered clearing agency
to have policies and procedures reasonably designed to limit the assets
it accepts as collateral to those with low credit, liquidity, and
market risks, and to set and enforce appropriately conservative
haircuts and concentration limits. Collateral haircut and concentration
limit models would be subject to a not-less-than-annual review of their
sufficiency.\713\ Rule 17Ad-22(d)(3) currently requires registered
clearing agencies to have policies and procedures reasonably designed
to hold assets in a manner that minimizes risk of loss or risk of delay
in access to them and invest assets in instruments with minimal credit,
market, and liquidity risk.
---------------------------------------------------------------------------
\713\ See supra Part II.B.4.d (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(5)).
---------------------------------------------------------------------------
By focusing on the nature of assets and not on accounts, the
Commission preliminarily believes the proposed rule may allow covered
clearing agencies the ability to manage collateral more efficiently. In
particular, under the proposed rule, a covered clearing agency would
have the option of accepting collateral that is riskier than cash and
holding this collateral at commercial banks, potentially increasing
default risk exposure. On the other hand, the requirement to regularly
review concentration limits and haircuts mitigates the risk that a
covered clearing agency's collateral policies fail to respond to
changing economic conditions. Based on its supervisory experience, the
Commission understands that all registered clearing agencies that would
meet the definition of a covered clearing agency already conform to the
requirements under the proposed rule related to the nature of assets
they may accept as collateral and the haircuts and concentration limits
they apply to collateral assets, so the associated costs and benefits
that would result from these requirements would apply only if
registered clearing agencies not already in compliance were to become
covered clearing agencies.
As a result of the proposed rule, these covered clearing agencies
and registered clearing agencies that become covered clearing agencies
may experience additional costs as a result of the proposed annual
review requirements for the sufficiency of collateral haircut and
concentration limit models. Based on its supervisory experience, the
Commission preliminarily believes that many clearing agencies that
require collateral would need to develop policies and procedures to
review haircuts and concentration limits annually. Enforcement of the
proposed
[[Page 29598]]
haircut requirement would also require additional resources. A range of
costs for these new requirements is discussed in Part IV.C.3.a.iv(5).
Adherence to the new requirements by these entrants could extend the
benefits of prompt loss coverage, incentive alignment, and systemic
risk mitigation to a larger volume of cleared transactions.
(3) Proposed Rule 17Ad-22(e)(6): Margin
Proposed Rule 17Ad-22(e)(6) would require a covered clearing agency
that provides CCP services to have policies and procedures reasonably
designed to require it to cover credit exposures using a risk-based
margin system and to establish minimum standards for such a system. It
would require these policies and procedures to cover daily collection
of variation margin. The proposed rule also requires a set of policies
and procedures generally designed to support a reliable margin system.
Among these are policies and procedures to ensure the use of reliable
price data sources and appropriate methods for measuring credit
exposure, which could improve margin system accuracy. Finally, covered
clearing agencies would be required to have policies and procedures
related to the testing and verification of margin models.\714\ Proposed
Rules 17Ad-22(a)(6) and (14) support these requirements by addressing
the means of verification for margin models and the level of coverage
required of a margin system against potential future exposures,
respectively. Based on its supervisory experience, however, the
Commission understands that all current covered clearing agencies have
policies and procedures that conform to the requirements under proposed
Rules 17Ad-22(e)(6)(i) through (v) and (vii), and some will have to
update their policies and procedures to comply with proposed Rule 17Ad-
22(e)(6)(vi).
---------------------------------------------------------------------------
\714\ See supra Part II.B.4.e (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(6)).
---------------------------------------------------------------------------
Similar to proposed Rules 17Ad-22(e)(4) and (7), covered clearing
agencies that do not already engage in backtesting of margin resources
at least once each day or engage in a monthly analysis of assumptions
and parameters, as well as registered clearing agencies that enter into
the set of covered clearing agencies in the future, may incur
incremental compliance costs as a result of the proposed rule. Since
margin plays a key role in clearing agency risk management, however,
requiring that margin be periodically verified and modified as a result
of changing market conditions may mitigate the risks posed by covered
clearing agencies to financial markets in periods of financial stress.
Further, periodic review of model specification and parameters reduces
the likelihood that covered clearing agencies opportunistically update
margin models in times of low volatility and fail to update margin
models in times of high volatility. A range of costs for verification
and modification of margin models is discussed in Part IV.C.3.a.iv(5).
Further, since risk-based initial margin requirements may cause market
participants to internalize some of the costs borne by the CCP as a
result of large or risky positions,\715\ ensuring that margin models
are well-specified and correctly calibrated with respect to economic
conditions will help ensure that they continue to align the incentives
of clearing members with the goal of financial stability.
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\715\ See e.g., Philipp Haene & Andy Sturm, Optimal Central
Counterparty Risk Management (Swiss Nat'l Bank Working Paper, June
2009) (addressing the tradeoff between margin and default fund,
considering collateral costs, clearing member default probability,
and the extent to which margin requirements are associated with risk
mitigating incentives).
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(4) Proposed Rule 17Ad-22(e)(7): Liquidity Risk
Proposed Rule 17Ad-22(e)(7) would require a covered clearing agency
to have policies and procedures reasonably designed to effectively
monitor, measure, and manage liquidity risk.\716\ Parties to securities
and derivatives transactions rely on clearing agencies for prompt
clearance and settlement of transactions. Market participants in
centrally cleared and settled markets are often linked to one another
through intermediation chains in which one party may rely on proceeds
from sales of cleared products to meet payment obligations to another
party. If insufficient liquidity causes a clearing agency to fail to
meet settlement or payment obligations to its members, consequences
could include the default of a clearing member who may be depending on
these funds to make a payment to another market participant, with
losses then transmitted to others that carry exposure to this market
participant if the market participant is depending on payments from the
clearing members to make said payments to others. Therefore, the
benefits related to liquidity risk management generally flow from the
reduced risk of systemic risk transmission by covered clearing agencies
as a result of liquidity shortfalls, either in the normal course of
operation or as a result of member default.
---------------------------------------------------------------------------
\716\ See supra Part II.B.4.f (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(7)).
---------------------------------------------------------------------------
Enhanced liquidity risk management may produce additional benefits.
Clearing members would face less uncertainty over whether a covered
clearing agency has the liquidity resources necessary to make prompt
payments which would reduce any need to hedge the risk of nonpayment.
Potential benefits from enhanced liquidity risk management may also
extend beyond members of covered clearing agencies or markets for
centrally cleared and settled securities. Clearing members are often
members of larger financial networks, and the ability of a covered
clearing agency to meet payment obligations to its members can directly
affect its members' ability to meet payment obligations outside of the
cleared market. Thus, management of liquidity risk may mitigate the
risk of contagion between asset markets.
Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies would need to create new
policies and procedures, or update existing policies and procedures, to
meet requirements under the various subsections of proposed Rule 17Ad-
22(e)(7). These actions would entail compliance costs, as noted in Part
III.B.2. Further, the Commission preliminarily believes that for some
covered clearing agencies the proposed requirements would require them
to establish new practices. The cost of adherence to the proposed rule
would likely be passed on to market participants in cleared markets, as
discussed in more detail below.
Under proposed Rule 17Ad-22(e)(7)(i), a covered clearing agency
would be required to have policies and procedures reasonably designed
to require maintaining sufficient resources to achieve ``cover one''
for liquidity risk. This requirement mirrors the ``cover one''
requirement for credit risk in proposed Rule 17Ad-22(e)(4)(iii). Based
on its supervisory experience, the Commission preliminarily believes
that many covered clearing agencies do not currently meet a ``cover
one'' requirement for liquidity and thus will likely incur costs to
comply with this proposed rule. As discussed earlier, whether covered
clearing agencies choose to gather liquidity directly from members or
instead choose to rely on third-party arrangements, the costs of
liquidity may be passed on to other market participants, eventually
[[Page 29599]]
increasing transaction costs.\717\ The requirement may, however, reduce
the procyclicality of covered clearing agencies' liquidity demands,
which may reduce costs to market participants in certain situations.
For instance, the requirement would reduce the likelihood that a
covered clearing agency would have to call on its members to contribute
additional liquidity in periods of financial stress, when liquidity may
be most costly.
---------------------------------------------------------------------------
\717\ See supra Part IV.C.1.d (discussing the effect of the
proposed rules on concentration in the market for clearing services
and among clearing members).
---------------------------------------------------------------------------
Under proposed Rule 17Ad-22(e)(7)(ii), a covered clearing agency
would be required to have policies and procedures reasonably designed
to ensure that it meets the minimum liquidity resource requirement in
proposed Rule 17Ad-22(e)(7)(i) with qualifying liquid resources.\718\
Qualifying liquid resources would include cash held at the central bank
or at a creditworthy commercial bank, assets that are readily converted
into cash pursuant to committed lines of credit, committed foreign
exchange swaps, committed repurchase agreements or other highly
reliable prearranged funding agreements, or assets that may be pledged
to a central bank in exchange for cash (if the covered clearing agency
has access to routine credit at a central bank). The Commission notes
that the proposed rules allow covered clearing agencies some measure of
flexibility in managing qualifying liquid resources and that covered
clearing agencies would be able to use creditworthy commercial bank
services where appropriate.
---------------------------------------------------------------------------
\718\ See proposed Rule 17Ad-22(a)(15), infra Part VII (defining
``qualifying liquid resources'').
---------------------------------------------------------------------------
Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies currently do not meet the
proposed liquidity requirements with qualifying liquid resources. As an
alternative to the proposed rules, the Commission could have restricted
the definition of qualifying liquid resources to assets held by covered
clearing agencies. These covered clearing agencies and the markets they
serve would benefit from the proposed minimum requirements for
liquidity resources in terms of the reduced risk of liquidity
shortfalls and associated contagion risks described above. However,
qualifying liquid resources may be costly for covered clearing agencies
to maintain on their own balance sheets. Such resources carry an
opportunity cost. Assets held as cash are, by definition, not available
for investment in less liquid assets that may be more productive uses
of capital. This cost may ultimately be borne by clearing members who
contribute liquid resources to covered clearing agencies to meet
minimum requirements under proposed Rule 17Ad-22(e)(7)(ii) and their
customers.
The Commission notes that, under the proposed rules, covered
clearing agencies have flexibility to meet their qualifying liquid
resource requirements in a number of ways. In perfect capital markets,
maintaining on-balance-sheet liquidity resources should be no more
costly than entering into committed lines of credit or prearranged
funding agreements backed by less-liquid assets that would allow these
assets to be converted into cash. However, market frictions, such as
search frictions, may enable banks to obtain liquidity at lower cost
than other firms. In the presence of such frictions, obtaining
liquidity using committed and uncommitted funding arrangements provided
by banks may prove a less costly option for some covered clearing
agencies than holding additional liquid resources on their balance
sheets. In particular, the Commission preliminarily believes that
requiring covered clearing agencies to enter into committed or
uncommitted funding arrangements would decrease the costs that would be
experienced by them in the event they sought to liquidate securities
holdings during periods of market disruptions and increase the
likelihood that they meet funding obligations to market participants by
reducing the risk of delay in converting non-cash assets into cash.
The Commission notes that committed or uncommitted funding
arrangements would only count towards minimum requirements to the
extent that covered clearing agencies had securities available to post
as collateral, so use of these facilities may require covered clearing
agencies to require their members to contribute more securities. If
these securities are costly for clearing members to supply, then
additional required contributions to meet minimum requirements under
proposed Rule 17Ad-22(e)(7)(ii) may impose burdens on clearing members
and their customers. Similarly, prearranged funding arrangements may
entail implicit costs to clearing members. Prearranged funding
arrangements could impose costs on clearing members if they are
obligated to contribute securities towards a collateral pool that the
covered clearing agency would use to back borrowing. Alternatively,
clearing members may be obligated under a covered clearing agency's
rules to act as counterparties to repurchase agreements. Under the
latter scenario, clearing members would bear costs associated with
accepting securities in lieu of cash. Additionally, the Commission
notes certain explicit costs specifically associated with these
arrangements outlined below.
Counterparties to committed arrangements allowable under proposed
Rule 17Ad-22(a)(15) charge covered clearing agencies a premium to
provide firm liquidity commitments and additional out-of-pocket
expenses will be incurred establishing and maintaining committed
liquidity arrangements. The Commission preliminarily estimates that the
total cost of committed funding arrangements will be approximately 30
basis points per year, including upfront fees, legal fees, commitment
fees, and collateral agent fees.\719\ Furthermore, the Commission is
aware of other potential consequences of these arrangements. In some
instances, they may cause entities outside of a covered clearing agency
to bear risks ordinarily concentrated within the covered clearing
agency, while, in others, these arrangements may result in increased
exposure of covered clearing agencies to certain members.\720\
Financial intermediaries that participate in committed credit
facilities may be those least able to provide liquidity in times of
financial stress, so these commitments may represent a route for risk
transmission.\721\ Finally, the Commission notes that covered clearing
agencies may face constraints in the size of credit facilities
available to them. Recent market statistics have estimated the total
size of the committed credit facility market in the U.S. at $1.2
trillion with only 12 of 1800 facilities exceeding $10 billion in
size.\722\ Given the volume of activity at covered clearing agencies,
it is possible that they may only be able to use committed credit
facilities to meet a portion of their liquidity
[[Page 29600]]
requirements under proposed Rule 17Ad-22(e)(7)(ii).
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\719\ See Letter from Kim Taylor, President, CME Clearing, to
Melissa Jurgens, Office of the Secretariat, CFTC, Sept. 16, 2013, at
13 & n.48 (noting CME's assumption that the cost of committed
liquidity or committed repurchase facilities is approximately $3
million for every $1 billion of required committed facilities,
including upfront fees, commitment fees, legal fees, and collateral
agent fees).
\720\ See id. at 11.
\721\ See Letter from Robert C. Pickel, CEO, ISDA to Secretary,
CFTC, Sept. 16, 2013, at 4 (discussing collateral and liquidity
requirements); see also Craig Pirrong, Clearing and Collateral
Mandates: A New Liquidity Trap?, 24 J. Applied Corp. Fin. 67 (2012).
\722\ See Bloomberg, Global Syndicated Loans, 1st Half 2013
League Tables (July 1, 2013), available at http://www.bloomberg.com/professional/files/2012/08/Global-Syndicated-Loans-2012.pdf.
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A covered clearing agency may alternatively use a prearranged
funding arrangement determined to be highly reliable in extreme but
plausible market conditions to raise liquid resources backed by non-
cash assets but that does not require firm commitments from liquidity
providers. This strategy would avoid certain of the explicit fees
associated with firm commitments, while incurring costs related to the
annual review and maintenance of such arrangements. Based on its
supervisory experience and discussions with market participants, the
Commission preliminarily believes the cost associated with commitment
fees to be between 5 and 15 basis points per year. Given the 30 basis
point cost associated with committed funding arrangements, mentioned
above, uncommitted facilities could entail costs of between 15 and 25
basis points.\723\ Prearranged funding arrangements may ultimately
prove less costly than holding cash and may be more widely available
than committed arrangements, while still reducing the likelihood of
delay faced by covered clearing agencies that attempt to market less-
liquid assets. As mentioned above in the context of committed credit
facilities, the Commission acknowledges that financial institutions who
offer to provide liquidity to covered clearing agencies on an
uncommitted basis may be least able to do so in times of financial
stress, when access to liquidity is most needed by the covered clearing
agency. Without a commitment in place, counterparties retain the option
to fail to provide liquidity during stressed conditions, when liquidity
is most valuable to clearing agencies and the markets they serve. To
the extent covered clearing agencies may establish requirements for
clearing members to provide liquidity to ensure compliance with the
Commission's proposed rules, the costs experienced by members
indirectly may exceed those associated with committed credit
facilities.
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\723\ Subtracting the lower bound of commitment fees (5 basis
points) from the estimated total cost of a committed facility (30
basis points) yields an estimate of the upper bound of the fees
associated with an uncommitted facility (30 - 5 = 25 basis points).
We estimate the lower bound of fees associated with an uncommitted
facility analogously (30 - 15 = 15 basis points).
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Finally, covered clearing agencies that have access to routine
credit at a central bank could meet the qualifying liquid resources
requirement with assets that are pledgeable to a central bank. The
Commission notes that this may represent the lowest cost option for
covered clearing agencies, but understands that this latter provision
would represent an advantage only if and when a covered clearing agency
receives the benefit of access to routine central bank borrowing. The
Commission anticipates that at such future time access to routine
credit at a central bank would provide covered clearing agencies with
additional flexibility with respect to resources used to comply with
the liquidity risk management requirements of proposed Rules 17Ad-
22(e)(7)(i) and (ii).
The total cost of maintaining qualifying liquid resources pursuant
to proposed Rules 17Ad-22(e)(7)(i) and (ii) is composed of the cost of
each liquidity source including assets held by covered clearing
agencies, committed credit facilities and prearranged funding
agreements, multiplied by the quantity of each of these liquidity
sources held by covered clearing agencies. The Commission is unable to
quantify the cost of cash held by clearing agencies and securities
required to back credit facilities since such estimates would require
detailed information about additional required contributions of
clearing members under the proposed rules, as well as clearing members'
best alternative to holding cash and securities.\724\ As mentioned
above, however, the Commission has limited information about the costs
associated with committed and uncommitted credit facilities. Based on
this information, we are able to quantify the costs associated with
committed credit facilities that will result from the requirement to
maintain qualifying liquid resources. The Commission preliminarily
estimates that the cost of compliance with the proposed rules will be
between $133 million and $225 million per year as a result of the
requirement to enter into prearranged funding agreements for non-cash
assets used to meet liquidity requirements under proposed Rules 17Ad-
22(e)(7)(i) and (ii). This analysis assumes that covered clearing
agencies will enter into such agreements at arm's length on an
uncommitted basis. Based on staff discussions with market participants,
the Commission understands that alternative arrangements between
covered clearing agencies and their members may be obtained at lower
cost, though these arrangements may come with increased wrong-way
risk.\725\
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\724\ Covered clearing agencies may choose to allocate liquidity
burdens based on a number of factors related to the markets they
serve and their membership. See, e.g., Exchange Act Release No. 34-
70999 (Dec. 5, 2013), 78 FR 75400 (Dec. 11, 2013) (Commission order
approving NSCC rule change to institute supplemental liquidity
deposits to its clearing fund designed to increase liquidity
resources to meet its liquidity needs).
\725\ To produce this range, the Commission used a combination
of publicly available information from SRO rule filings, comment
letters, and 2012 annual financial statements, and non-public
information gathered as a result of its regulatory role. For each
covered clearing agency, the Commission assumed that the covered
clearing agency's guaranty fund represents the sole source of
liquidity used to satisfy its minimum liquidity requirements under
the proposed rules. To compute the level of qualifying liquid
resources currently held by each covered clearing agency, the
Commission assumed that cash in the covered clearing agency's
guaranty fund remains fixed at current levels and added to this any
amount from credit facilities that could be backed by the value of
securities held in the covered clearing agency's guaranty funds.
Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
the ``cover one'' guaranty fund requirement over all covered
clearing agencies results in the total shortfall relative to minimum
requirements under proposed Rules 17Ad-22(e)(7)(i) and (ii). The
Commission further assumed that covered clearing agencies would
cover this shortfall using prearranged funding agreements backed by
additional securities posted to guaranty funds by clearing members.
Finally, the Commission multiplied the total prearranged funding
amount by between 0.15% and 0.25% to arrive at a range of ongoing
costs.
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U.S. Treasury securities would not fall under the proposed
definition of qualifying liquid resources. The Commission understands
that U.S. Treasury markets represent some of the largest and most
liquid markets in the world, see Part IV.B.3.f.ii, and that, in
``flights to quality'' and ``flights to liquidity'' in times of
financial stress, U.S. Treasuries trade at a premium to other
assets.\726\ If, as an alternative to the proposed rules, the
Commission included U.S. government securities in the definition of
qualifying liquid resources, the Commission preliminarily estimates the
cost of complying with requirements under proposed Rule 17Ad-
22(e)(7)(i) and (ii) would be reduced by between $9
[[Page 29601]]
million and $225 million per year.\727\ The Commission preliminarily
believes, however, that there are benefits to including government
securities only if prearranged funding agreements exist. In particular,
given the quantity of these securities financed by the largest
individual dealers, fire-sale conditions could materialize if
collateral is liquidated in a disorderly manner, which could prevent
covered clearing agencies from meeting payment obligations.\728\
---------------------------------------------------------------------------
\726\ See Alessandro Beber, Michael W. Brandt & Kenneth A.
Kavajecz, Flight-to-Quality or Flight-to-Liquidity? Evidence from
the Euro-Area Bond Market, 22 Rev. Fin. Stud. 925 (2009)
(decomposing sovereign yield spreads into credit and liquidity
components and showing that credit quality matters for bond
valuation but that, in times of market stress, investors chase
liquidity, not quality); Markus K. Brunnermeier & Lasse Heje
Pedersen, Market Liquidity and Funding Liquidity, 22 Rev. Fin. Stud.
2201 (2009) (showing, in a theoretical model, how with low wealth
shocks, demand for illiquid assets falls off more sharply than
demand for liquid assets); Francis A. Longstaff, The Flight-to-
Liquidity Premium in U.S. Treasury Bond Prices, 77 J. Bus 511 (2004)
(estimating the liquidity premium associated with U.S. Treasuries
relative to close substitutes); Dimitri Vayanos Flight to Quality,
Flight to Liquidity, and the Pricing of Risk (NBER Working Paper No.
10327, Feb. 2004) (showing, in a theoretical model, that during
volatile times, assets' liquidity premia increase), available at
http://www.nber.org/papers/w10327.pdf.
\727\ The Commission re-estimated the level of prearranged
funding agreements required to meet requirements under proposed
Rules 17Ad-22(e)(7)(i) and (ii) using the data and methodology
described in note 725, except in this case the Commission assumed
that all non-defaulting member resources applied to funding
obligations were a mix of cash and U.S. Treasuries for a lower
bound, and assumed that all resources applied to funding obligations
were a mix of cash and U.S. Treasuries for an upper bound.
Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
cover one guaranty fund requirement over all covered clearing
agencies results in the total shortfall relative to minimum
requirements under proposed Rules 17Ad-22(e)(7)(i) and (ii) if U.S.
government and agency securities were considered qualifying liquid
resources. As above, the Commission further assumed that covered
clearing agencies would cover this shortfall using prearranged
funding agreements backed by additional securities posted to
guaranty funds by clearing members and multiplied this amount by
between 0.15% and 0.25% to arrive at a range of ongoing costs.
\728\ Brian Begalle et al., The Risk of Fire Sales in the Tri-
Party Repo Market, at 19 & n.37 (FRBNY Staff Report No. 616, May
2013), available at http://www.newyorkfed.org/research/staff_reports/sr616.pdf.
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Proposed Rule 17Ad-22(e)(7)(iii) concerns access to accounts and
services at a central bank, when available and where practical.\729\
The Commission preliminarily believes that it may be beneficial for
covered clearing agencies to use central bank account services because
doing so would reduce exposure to commercial bank default risk.
Moreover, for some covered clearing agencies, central bank services may
represent the lowest-cost admissible funding arrangement under the
proposed rule. The Commission understands, however, that central bank
services are only currently available to a subset of covered clearing
agencies, and the proposed rule only requires policies and procedures
to ensure use of central bank accounts and services when practical and
available.
---------------------------------------------------------------------------
\729\ See proposed Rule 17Ad-22(e)(7)(iii), infra Part VII.
---------------------------------------------------------------------------
Proposed Rules 17Ad-22(e)(7)(iv) and (v) address relations between
covered clearing agencies and their liquidity providers. The Commission
preliminarily believes that a key benefit of these proposed rules would
be an increased level of assurance that liquidity providers would be
able to supply liquidity to covered clearing agencies on demand. Such
assurance is especially important because of the possibility that
covered clearing agencies may rely on outside liquidity providers to
convert non-cash assets into cash using prearranged funding
arrangements or committed facilities, pursuant to proposed Rule 17Ad-
22(e)(7)(ii) and the definition of qualifying liquid resources in
proposed Rule 17Ad-22(a)(15). The required policies and procedures
would ensure the covered clearing agency undertakes due diligence to
confirm that it has a reasonable basis to believe each of its liquidity
providers understand the liquidity risk borne by the liquidity
provider, and that the liquidity provider would have the capacity to
provide liquidity under commitments to the covered clearing agency.
Finally, covered clearing agencies would be required, under the
proposed rule, to maintain and test the covered clearing agency's
procedures and operational capacity for accessing liquidity under their
agreements. The Commission preliminarily believes that, besides the
costs associated with new or updated policies and procedures discussed
in Part III.B.2, covered clearing agencies and liquidity providers may
experience costs associated with the proposed rules as a result of the
requirement to test liquidity resources, such as, for example, fees
associated with conducting test draws on a covered clearing agency's
credit lines. Costs associated with ongoing monitoring and compliance
related to testing are included in the Commission's estimate of
quantifiable costs presented in Part IV.C.3.d.
Proposed Rules 17Ad-22(e)(7)(vi) and (vii) may impose costs on
covered clearing agencies as a result of requirements for testing the
sufficiency of liquidity resources and validating models used to
measure liquidity risk. The testing and model validation requirements
of these proposed rules are similar to requirements for testing and
model validation for credit risk in proposed Rules 17Ad-22(e)(4)(vi)
and (vii), and the Commission preliminarily believes that these
proposed rules would yield similar benefits. Frequent monitoring and
testing liquidity resources could help rapidly identify any gaps in
resources required to meet payment obligations. Moreover, the
requirement to test and, when necessary, update the assumptions and
parameters supporting models of liquidity risk will support the
adjustment of covered clearing agency liquidity resources to changing
financial conditions and mitigate the risk that covered clearing
agencies will strategically manage updates to their liquidity risk
models in support of cost-reduction or profit-maximization.
Proposed Rule 17Ad-22(e)(7)(viii) addresses liquidity shortfalls at
a covered clearing agency, and the Commission preliminarily believes
the proposed rule would reduce ambiguity related to settlement delays
in the event of liquidity shocks. Among other things, by requiring
procedures that seek to avoid delay of settlement payments, this
proposed rule would require covered clearing agencies to address
liquidity concerns in advance rather than relying on strategies of
delaying accounts payable in the event of liquidity shocks. As
discussed previously, effective liquidity risk management by covered
clearing agencies that serves to eliminate uncertainty on the part of
clearing members that payments by the covered clearing agency will be
made on time may allow these clearing members to allocate their
liquidity resources to more efficient uses than holding precautionary
reserves.\730\ The Commission preliminarily believes the proposed rule
may reduce some of the flexibility covered clearing agencies have in
the absence of the proposed rule, which could impose additional burdens
on these clearing agencies as discussed in Part IV.C.1.b.
---------------------------------------------------------------------------
\730\ See supra Part IV.C.2.b.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(ix) would require a covered clearing
agency to have policies and procedures reasonably designed to describe
its process for replenishing any liquid resources that it may employ
during a stress event.\731\ The ability to replenish liquidity
resources is critical to ensure that covered clearing agencies are able
to continue operations after a stress event. Beyond the general
benefits associated with liquidity risk management noted earlier, this
proposed rule would yield particular benefits insofar as it would
reduce uncertainty about covered clearing agency liquidity resources at
precisely those times when information about liquidity may be most
important to market participants.
---------------------------------------------------------------------------
\731\ See proposed Rule 17Ad-22(e)(7)(ix), infra Part VII.
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-22(e)(7)(x) would require a covered
clearing agency that provides CCP services and is either systemically
important in multiple jurisdictions or is a clearing agency involved in
activities with a more complex risk profile to conduct a feasibility
analysis for ``cover
[[Page 29602]]
two.'' \732\ The primary cost associated with this rule will be an
annual analysis by the affected covered clearing agencies. Costs
associated with a feasibility study would likely include the cost of
staffing and consulting, which will depend on the scope of products
cleared and the particular approach taken by each covered clearing
agencies. The costs associated with this requirement are included in
Part IV.C.3.d.
---------------------------------------------------------------------------
\732\ See proposed Rule 17Ad-22(e)(7)(x), infra Part VII.
---------------------------------------------------------------------------
(5) Testing and Validation of Risk Models
Proposed Rules 17Ad-22(e)(4) through (7) include requirements for
covered clearing agencies to have policies and procedures reasonably
designed to test and validate models related to financial risks.
Covered clearing agencies may incur additional costs under expanded and
more frequent testing of financial resources if the proposed
requirements for testing and validation do not conform to practices
currently used by covered clearing agencies.\733\ These costs are
composed of two portions. The first encompasses startup costs related
to collection and storage of data elements necessary to implement
testing and validation, along with investments in software tools and
human capital to support these functions. The second portion of costs
includes the ongoing, annual costs of conducting testing and validation
under the proposed rules.
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\733\ The Commission notes that while the stress testing
provisions in proposed Rules 17Ad-22(e)(4) through (7) include new
requirements for covered clearing agencies, Rule 17Ad-22(b)(4)
requires registered clearing agencies that provide CCP services for
security-based swaps to have policies and procedures for a general
margin model validation requirement. See supra note 712.
---------------------------------------------------------------------------
Based on its supervisory experience and discussions with industry
participants, the Commission preliminarily believes that startup costs
to support testing and validation of credit risk, margin, and liquidity
risk models at covered clearing agencies could fall in the range of $5
million to $25 million for each covered clearing agency. This range
primarily reflects investments in information technology to process
data already available to covered clearing agencies for stress testing
and validation purposes. The range's width reflects differences in
markets served by, as well as the scope of operations of, each covered
clearing agency. Based on its supervisory experience and discussions
with industry participants, the Commission estimates a lower bound of
$1 million per year for ongoing costs related to testing of risk
models.
Should each covered clearing agency choose to hire external
consultants for the purposes of performing model validation required
under proposed Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) through written
policies and procedures, the Commission preliminarily estimates the
ongoing cost associated with hiring such consultants would be
approximately $4,388,160 in the aggregate.\734\
---------------------------------------------------------------------------
\734\ This figure was calculated as follows: 2 Consultants for
40 hours per week at $653 per hour = $52,240 x 12 weeks = $626,880
per clearing agency x 7 covered clearing agencies = $4,388,160. The
$653 per hour figure for a consultant was calculated using
www.payscale.com, modified by Commission staff to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits, and overhead.
The Commission previously estimated that ongoing costs
associated with hiring external consultants to fulfill the
requirements of Rule 17Ad-22(b)(4) would be approximately $3.9
million per year. See Clearing Agency Standards Release, supra note
5, at 66261.
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The Commission acknowledges that it could have, as an alternative,
proposed rules that would require testing and validation of financial
risk models at covered clearing agencies at different frequencies. For
example, the Commission could have required backtesting of margin
resources less frequently than daily. Such a policy could imply less
frequent adjustments in margin levels that may result in over- or
under-margining. The Commission preliminarily believes that the
frequencies of testing and validation of financial risk models that it
has proposed are appropriate given the risks faced by covered clearing
agencies and current market practices related to frequency of meetings
of risk management committees and boards of directors at covered
clearing agencies.
v. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement and Physical
Delivery
Proposed Rules 17Ad-22(e)(8) through (10) require covered clearing
agencies to have policies and procedures reasonably designed to address
settlement risk. Many of the issues raised by settlement are similar to
those raised by liquidity. Uncertainty in settlement may make it
difficult for clearing members to fulfill their obligations to other
market participants within their respective financial networks if they
hold back precautionary reserves, as discussed above. Based on its
supervisory experience, the Commission preliminarily believes that the
benefits and costs for the majority of covered clearing agencies will
likely be limited. Registered clearing agencies that enter into the set
of covered clearing agencies in the future, by contrast, may bear more
significant costs as a result of the enhanced standards.
Settlement finality is important to market participants for a
number of reasons. Reversal of transactions can be costly to
participants. For example, if transactions are reversed, buyers and
sellers of securities may be exposed to additional market risk as they
attempt to reestablish desired positions in cleared products.
Similarly, reversal of transactions may render participants expecting
to receive payment from the covered clearing agency unable to fulfill
payment obligations to their counterparties, exposing these additional
parties to the transmitted credit risk. Finally, settlement finality
can help facilitate default management procedures by covered clearing
agencies since they improve transparency of members' positions. Unless
settlement finality is established by covered clearing agencies, market
participants may attempt to hedge reversal risk for themselves. This
could come at the cost of efficiency if it means that, on the margin,
participants are less likely to use cleared products as collateral in
other financial transactions.
In addition, settlement in central bank money, where available and
determined to be practical by the board of directors of the covered
clearing agency, as the proposed rules would require, greatly reduces
settlement risk related to payment agents. Using central bank accounts
to effect settlement rather than settlement banks removes a link from
the intermediation chain associated with clearance and settlement. As a
result, a covered clearing agency would be less exposed to the default
risk of its settlement banks. In cases where settlement banks maintain
links to other covered clearing agencies, for example as liquidity
providers or as members, reducing exposure to settlement bank default
risk may be particularly valuable.
As in the case of proposed Rule 17Ad-22(e)(7)(iii), the Commission
acknowledges there may be circumstances in which covered clearing
agencies either do not have access to central bank account services or
the use of such services is impractical. Accordingly, the Commission
preliminarily believes it is appropriate to allow covered clearing
agencies the flexibility to also use commercial bank account services
to effect settlement, subject to a requirement that covered clearing
agencies monitor and manage the risks associated with such
arrangements.
[[Page 29603]]
vi. Proposed Rule 17Ad-22(e)(11): CSDs
CSDs play a key role in modern financial markets. For many issuers,
many transactions in their securities involve no transfer of physical
certificates.
Paperless trade generally improves transactional efficiency. Book-
entry transfer of securities may facilitate conditional settlement
systems required by proposed Rule 17Ad-22(e)(12). For example, book-
entry transfer in a delivery versus payment system allows securities to
be credited to an account immediately upon debiting the account for the
payment amount. Institutions and individuals may elect to no longer
hold and exchange certificates that represent their ownership of
securities. An early study showed that the creation of DTC resulted in
a 30-35% reduction in the physical movement of certificates.\735\ Among
other benefits, to the extent that delays in exchanging paper
certificates result in settlement failures, immobilization and
dematerialization of shares reduces the frequency of these
failures.\736\
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\735\ See Neal L. Wolkoff & Jason B. Werner, The History of
Regulation of Clearing in the Securities and Futures Markets, and
Its Impact on Competition, 30 Rev. Banking & Fin. L. 313, 323
(2010).
\736\ See Commission, Study of Unsafe and Unsound Practices of
Brokers and Dealers, H.R. Doc. No. 231, 92nd Cong., 1st Sess. 13, at
168 (1971) (suggesting that the delivery and transfer process for
paper certificates were a principal cause of failures to deliver and
receive during the ``paperwork crisis'' of the late 1960s).
---------------------------------------------------------------------------
For markets to realize the transactional benefits of paperless
trade, however, requires confidence that CSDs can correctly account for
the number of securities in their custody and for the book entries that
allocate these securities across participant accounts. In order to
realize these benefits, the proposed rules also require covered CSDs to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to ensure the integrity of securities
issues, minimize the risks associated with transfer of securities, and
protect assets against custody risk. Based on its supervisory
experience, the Commission preliminarily believes that registered CSDs
already have infrastructure in place to meet these requirements.
However, CSDs may face incremental compliance costs in instances where
they must modify their rules in order to implement appropriate
controls. Compliance costs may be higher for potential new CSDs that
are determined to be covered clearing agencies in the future.
vii. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems
Clearance and settlement of transactions between two parties to a
trade involves an exchange of one obligation for another. Regarding
transactions in securities, these claims can be securities or payments
for securities. A particular risk associated with transactions is
principal risk, which is the risk that only one obligation is
successfully transferred between counterparties. For example, in a
purchase of common stock, a party faces principal risk if, despite
successfully paying the counterparty for the purchase, the counterparty
may fail to deliver the shares.
The proposed requirements under Rule 17Ad-22(e)(12) are
substantially the same as those in Rule 17Ad-22(d)(13).\737\ As a
result, covered clearing agencies that have been in compliance with
Rule 17Ad-22(d)(13) face no substantially new requirements under
Proposed Rule 17Ad-22(e)(12). The Commission preliminary expects the
proposed rule would likely impose limited material additional costs on
covered clearing agencies. It would also produce benefits in line with
the general economic considerations discussed in Part IV.C.1. The
economic effects may differ for registered clearing agencies that enter
into the set of covered clearing agencies in the future.
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\737\ See supra note 274; supra Part II.B.9 (discussing the full
set of requirements under proposed Rule 17Ad-22(e)(13)); supra Part
IV.B.3.d.ii (discussing current practices among registered clearing
agencies regarding exchange-of-value settlement systems); see also
17 CFR 240.17Ad-22(d)(13).
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viii. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and
Procedures
Proposed Rule 17Ad-22(e)(13) would require covered clearing
agencies to have policies and procedures for participant default with
additional specificity relative to current requirements for registered
clearing agencies under Rule 17Ad-22(d)(11). In particular, proposed
Rule 17Ad-22(e)(13) requires policies and procedures that address the
allocation of credit losses that exceed default resources, repayment of
liquidity providers, replenishment of financial resources, and testing
and review of default procedures.
Based on its supervisory experience, the Commission preliminarily
believes all covered clearing agencies currently test and review
default procedures at least annually, so the costs of this requirement
would apply only to registered clearing agencies that may enter into
the set of covered clearing agencies in the future. Most covered
clearing agencies, however, will be required to update their policies
and procedures as a result of proposed Rules 17Ad-22(e)(13)(i) and
(ii). Clearing members may experience benefits from proposed Rule 17Ad-
22(e)(13)(i), which requires covered clearing agencies to provide
disclosure to members regarding the allocation of default losses when
these losses exceed the level of financial resource it has available.
As a result of this additional transparency, clearing members may
experience an improved ability to manage their expectations of
potential obligations against the covered clearing agency, which may
increase the likelihood of orderly wind-downs in the event of member
default. Crafting such allocation plans by covered clearing agencies
may entail certain compliance costs, as previously discussed in Part
III.D.5.a and as discussed further in Part IV.C.3.d. Further, covered
clearing agencies may allocate default losses in a number of ways that
may themselves have implications for participation, competition, and
systemic risk.\738\ For example, if, as a part of a default resolution
plan, selective tear-up is contemplated after a failed position
auction, then clearing members who expect low loss exposure in the
tear-up may not have adequate incentives to participate in the position
auction, even if they are better able to absorb losses than clearing
members who expect high exposure in the tear-up plan. This would
increase the chances of a failed auction and the chances of a
protracted and more disruptive wind-down. Thus, the total costs of any
loss allocation plan may depend largely on the particular choices
embedded in covered clearing agencies' plans.
---------------------------------------------------------------------------
\738\ See, e.g., Elliot, supra note 617 (discussing various
loss-allocation rules and CCP recovery and wind-down).
---------------------------------------------------------------------------
As an alternative to the proposed rules, the Commission could have
proposed more prescriptive requirements for default procedures at
covered clearing agencies. The Commission preliminarily believes that
differences in cleared assets and in the characteristics of clearing
members supports allowing each covered clearing agency flexibility in
choosing its own default procedures pursuant to proposed Rule 17Ad-
22(e)(13).
In addition to loss allocation plans, proposed Rule 17Ad-22(e)(13)
contains new provisions related to the replenishment of financial
resources and testing and review of default procedures that do not
appear in Rule
[[Page 29604]]
17Ad-22(d)(11). The Commission preliminarily believes that proposed
rules related to replenishment of financial resources may reduce the
potential for systemic risk and contagion in cleared markets, as they
facilitate covered clearing agencies' prompt access to these resources
in times of financial stress. The Commission also preliminarily
believes that broad-based participation in the testing of default
procedures could reduce disruption to cleared markets in the event of
default. However, to the extent that testing of these procedures
requires participation by members of covered clearing agencies,
members' customers, and other stakeholders, these parties may bear
costs under the proposed rules. The Commission is unable to quantify
the economic effects of participation in these tests at this time.
ix. Proposed Rule 17Ad-22(e)(14): Segregation and Portability
Segregation and portability of customer positions serves a number
of useful purposes in cleared markets. In the normal course of
business, the ability to efficiently identify and move an individual
customer's positions and collateral between clearing members enables
customers to easily terminate a relationship with one clearing member
and initiate a relationship with another. This may facilitate
competition between clearing members by ensuring customers are free to
move their accounts from one clearing member to another based on their
preferences, without being unduly limited by operational barriers.\739\
---------------------------------------------------------------------------
\739\ See, e.g., Paul Klemperer, Competition When Consumers Have
Switching Costs: An Overview with Applications to Industrial
Organization, Macroeconomics, and International Trade, 62 Rev. Econ.
Stud. 515 (1995) (presenting an overview of switching costs and
their effects on competition).
---------------------------------------------------------------------------
Segregation and portability may be especially important in the
event of participant default. By requiring that customer collateral and
positions remain segregated, covered clearing agencies can facilitate,
in the event of a clearing member's insolvency, the recovery of
customer collateral and the movement of customer positions to one or
more other clearing members. Further, portability of customer positions
may facilitate the orderly wind down of a defaulting member if customer
positions may be moved to a non-defaulting member. Porting of positions
in a default scenario may yield benefits for customers if the
alternative is closing-out positions at one clearing member and
reestablishing them at another clearing member. The latter strategy
would cause customers to bear transactions costs, which might be
especially high in times of financial stress.
The Commission notes that, in its preliminary view, these proposed
rules are flexible in their approach to implementing segregation and
portability requirements. The most efficient means of implementing
these requirements may depend on the products that a covered clearing
agency clears as well as other business practices at a covered clearing
agency. For example, a clearing agency's decision whether or not to
collect margin on a gross or net basis may bear on its decision to port
customer positions and collateral on an individual or omnibus basis,
and while an individual account structure may provide a higher degree
of protection from a default by another customer, it may be
operationally and resource intensive for a covered clearing to
implement and may reduce the efficiency of its operations.
As a result, the costs and benefits of proposed Rule 17Ad-22(e)(14)
will depend on specific rules implemented by covered clearing agencies
as well as how much these rules differ from current practice. Based on
its supervisory experience, the Commission preliminarily believes that
the current practices at covered clearing agencies to which the
proposed rule would apply already meets segregation requirements under
the proposed rule, so any costs and benefits for covered clearing
agencies would flow from implementing portability requirements, though
it potentially raises a barrier to entry for security-based swap
clearing agencies or clearing agencies involved in activities with a
more complex risk profile that seek to become covered clearing
agencies.
x. Proposed Rule 17Ad-22(e)(15): General Business Risk
While proposed Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) require that
covered clearing agencies have policies and procedures reasonably
designed to address credit risk and liquidity risk, proposed Rule 17Ad-
22(e)(15) requires that covered clearing agencies have policies and
procedures reasonably designed to address general business risk. The
Commission preliminarily believes that general business losses
experienced by covered clearing agencies represent a distinct risk to
cleared markets, given limited competition and specialization of
clearing agencies. In this regard, the loss of clearing services due to
general business losses would likely result in major market disruption.
The proposed rule requires a covered clearing agency to have policies
and procedures reasonably designed to mitigate the risk that business
losses result in the disruption of clearing services. Under these
policies and procedures covered clearing agencies would hold sufficient
liquid resources funded by equity to cover potential general business
losses, which at a minimum would constitute six months of operating
expenses. The Commission preliminarily believes that the benefits of
such policies and procedures would flow primarily from covered clearing
agencies that would be required to increase their holdings of liquid
net assets funded by equity, enabling them to sustain their operations
for sufficient time and achieve orderly wind-down if such action is
eventually necessary.
The Commission could have proposed a higher or lower minimum level
of resources, for example, corresponding to one quarter of operating
expenses or one year of operating expenses. The Commission
preliminarily believes, however, that the rules, as proposed, afford
covered clearing agencies sufficient flexibility in determining the
level of resources to hold while maintaining a minimum standard that
supports continued operations in the event of general business losses.
As another alternative, the Commission could have allowed covered
clearing agencies additional flexibility in determine the nature of the
financial resources held to mitigate the effects of general business
risk or the means by which these resources are funded. The Commission
preliminarily believes, however, that by specifying that these
resources be liquid in nature, the proposed rule would limit any delays
by covered clearing agencies that suffer business losses from paying
expenses required for continued operations. Additionally, by
specifically requiring that a covered clearing agency draw liquid net
resources from members as equity capital, the proposed rules may also
encourage members to more closely monitor the business operations of a
covered clearing agency, which may reduce the likelihood of losses.
Based on its supervisory experience Commission preliminarily
believes that certain covered clearing agencies would be required to
establish and maintain policies and procedures providing for specified
levels of equity capital and higher levels of liquid net assets than
they would in the absence of proposed Rule 17Ad-22(e)(15).\740\ Table 2
contains summary information from five
[[Page 29605]]
registered clearing agencies and estimates, solely for purposes of
evaluating the costs and benefits of proposed Rule 17Ad-22(e)(15), the
amount of additional capital these entities would be required to
establish and maintain to comply with the proposed rule. As the
Commission has not previously had such a capital requirement, the
estimate is based on one half of the average annual operating expenses
for each covered clearing agency as reflected in their annual financial
statements over the five-year period ending December 31, 2012.\741\
---------------------------------------------------------------------------
\740\ Additional equity capital may be raised through share
issuance or by retaining earnings.
\741\ In the case of DTCC, to obtain an estimate of annual
operating expense, the Commission made minor adjustments to the
total expense by excluding expenses not related to DTCC's core
operations, since its annual income statement does not explicitly
show the operating expense.
---------------------------------------------------------------------------
Table 2 identifies cash and cash equivalents as liquid assets and
averages this over the same five-year period. A key shortcoming of
using publicly available financial data is the difficulty in
determining how much of a firm's cash and cash equivalents are funded
by either equity or liabilities, or both. To this end, the Commission
considered two different cases.\742\ In Case 1, the Commission assumed
that cash on each clearing agency's balance sheet was funded by
liabilities first, with the residual funded by equity. In Case 2, the
Commission assumed that cash on each clearing agency's balance sheet
was funded pro-rata by equity and liabilities.\743\ This procedure
likely yields an upper bound for estimates of additional equity
necessary to meet the minimum reserve requirements.
---------------------------------------------------------------------------
\742\ The Commission notes that these two cases are provided as
estimates of cash and cash equivalents funded by equity for existing
covered clearing agencies for limited purposes of the economic
analysis but are not methods the Commission would necessarily accept
if used by a covered clearing agency to comply with proposed Rule
17Ad-22(e)(15). Nor should the two cases presented be viewed as
interpretive guidance regarding proposed Rule 17Ad-22(e)(15).
\743\ For example, in Case 2, for DTC we arrive at a pro-rata
allocation of cash by computing the ratio of Average Equity to the
sum of Average Equity and Average Liabilities (282/3646 = 7.73%,)
and applying this to Average Cash and Cash Equivalents (7.73% x 3151
= 243.71) to arrive at a proxy of the level of liquid net assets
funded by equity.
---------------------------------------------------------------------------
Table 2. Hypothetical Additional Equity Necessary to Meet
Requirements Under Proposed Rule 17Ad-22(e)(15), in Millions of
Dollars, Based on Years 2008-2012.\744\
---------------------------------------------------------------------------
\744\ The figures in Table 2 are based on financial data taken
from the 2008-2012 annual reports of DTC, FICC, ICEEU, NSCC, and
OCC. The Commission notes that these figures are presented for the
limited purposes of conducting this economic analysis and do not
represent methods the Commission would necessarily accept if used by
a covered clearing agency to comply with proposed Rule 17Ad-
22(e)(15).
----------------------------------------------------------------------------------------------------------------
DTC FICC ICEEU NSCC OCC
----------------------------------------------------------------------------------------------------------------
Average Six Months Operating Expense..................... 166 62 41 94 68
Average Cash and Cash Equivalents........................ 3,151 8,259 129 3,838 64
Average Liabilities...................................... 3,364 8,471 84 3,833 155
Cash Funded by Equity.................................... 0 0 45 5 0
Average Total Equity..................................... 282 97 192 125 15
Average Net Income................................... 21 16 119 26 2
------------------------------------------------------
Case 1, Additional Equity Needed......................... 166 62 0 89 68
Case 2, Additional Equity Needed......................... 0 0 0 0 63
----------------------------------------------------------------------------------------------------------------
Absent market frictions, a change in capital structure should have
no effect on the value of a covered clearing agency.\745\ The
Commission acknowledges that market imperfections such as asymmetric
information, moral hazard, and regulation may imply that covered
clearing agencies that would need to raise additional equity capital
incur opportunity costs for holding this additional capital rather than
investing it in projects or distributing it back to equity holders who
might, in turn, invest in projects.
---------------------------------------------------------------------------
\745\ See Franco Modigliani & Merton H. Miller, The Cost of
Capital, Corporation Finance and the Theory of Investment, 48 Am.
Econ. Rev. 261 (1958) (showing the irrelevance of capital structure
in perfect markets).
---------------------------------------------------------------------------
To estimate these costs, the Commission applied the capital asset
pricing model to observed returns for CME and ICE, two clearing
agencies that have publicly-traded equity outstanding.\746\ This
methodology yielded an estimate of the cost of equity for these two
clearing agencies of approximately 10%. Applying estimated cost of
equity to the lower bound of additional equity required under the
proposed rule suggests an annual cost of $16 million, while applying
this cost to the upper bound of additional equity needed suggests an
annual cost of $50 million.\747\ These estimates are subject to a
number of caveats. In particular, this exercise does not take into
account the possibility that equity finance may reduce the cost of
equity due to the resulting decrease in leverage, \748\ or that
clearing agencies might simultaneously raise equity while reducing
liabilities. Both of these possibilities would likely reduce the cost
to covered clearing agencies of increased equity capital. Finally, this
analysis presumes that covered clearing agencies will choose to comply
with the requirements in proposed Rule 17Ad-22(e)(15)(iii) at the lower
bound of six months' operating expenses.
---------------------------------------------------------------------------
\746\ See Eugene F. Fama & Kenneth R. French, The Cross-Section
of Expected Stock Returns, 47 J. Fin. 427 (1992). For CME, the
Commission used monthly return data from January 2003 to December
2012, and for ICE, from December 2005 to December 2012.
The Commission calculated this data using Daily/Monthly U.S.
Stock Files(copyright) 2012 Center for Research in Security Prices
(CRSP), The University of Chicago Booth School of Business, and
Thomson Reuters Datastream.
\747\ The Commission based this estimate on the 2012 financial
statements for DTC, CME, FICC, ICE, NSCC, and OCC. To ensure
comparability, the Commission estimated leverage ratios for each of
these clearing agencies by adjusting assets for clearing and
guaranty funds and dividing by shareholders' equity. While DTC,
NSCC, FICC, ICE, and CME all have estimated leverage ratios of
between 1 and 2, the Commission computed a higher leverage ratio of
5 for OCC. As a result, the Commission computed OCC's cost of
capital by first ``unlevering'' CME's estimated beta of 1.14 using
2012 financial statement information to arrive at an unlevered beta
of 0.87 and levering this using OCC's 2012 financial statement
information to arrive at a levered beta of 3.36. Finally, the
Commission applied the current Fama-French monthly risk premium at a
10-year horizon, annualized, and added the current 10 year risk-free
rate to arrive at a levered cost of equity of approximately 26% for
OCC.
\748\ See e.g., Anat R. Admati, Peter M. DeMarzo, Martin F.
Hellwig & Paul Pfleiderer, Fallacies, Irrelevant Facts, and Myths in
the Discussion of Capital Regulation: Why Bank Equity is Not
Expensive (Working Paper, Mar. 23, 2011), available at http://www.coll.mpg.de/pdf_dat/2010_42online.pdf (addressing the
statement that ``[i]ncreased bank equity requirements increase the
funding costs for banks because they must use more equity, which has
a higher required return'').
---------------------------------------------------------------------------
Clearing agencies that issue equity in order to satisfy the new
requirements would additionally face costs related to issuance. The
Commission preliminarily recognizes that the cost of maintaining
additional equity resembles an insurance premium against the losses
[[Page 29606]]
associated by market disruption in the absence of clearing services.
xi. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks
Proposed Rule 17Ad-22(e)(16) requires a covered clearing agency to
have policies and procedures reasonably designed to safeguard both
their own assets as well as the assets of participants, broadening the
requirement applicable to registered clearing agencies in Rule 17Ad-
22(d)(3) to the protection of participants' assets.
The Commission preliminarily believes that this may have benefits
in terms of protecting against systemic risk, to the extent that
covered clearing agencies to this point have treated their own assets
differently by applying greater safeguards to those assets than with
respect to assets of their members and members' clients. Protection of
member assets is important to cleared markets because, for example, the
assets of a member in default serve as margin and represent liquidity
supplies that a covered clearing agency may access to cover losses. If
covered clearing agencies can quickly access these liquidity sources,
they may be able to limit losses to non-defaulting members.
Participants may benefit from proposed Rule 17Ad-22(e)(16) in other
ways. Requiring a covered clearing agency's policies and procedures to
safeguard its assets and participant assets and to invest in assets
with minimal credit, liquidity, and market risk may reduce uncertainty
in the value of participant assets and participants' exposure to
mutualized losses. This may allow participants to deploy their own
capital more efficiently. Furthermore, easy access to their own capital
enables members to more freely terminate their participation in covered
clearing agencies.
Based on its supervisory experience, the Commission preliminarily
believes that current practices at covered clearing agencies meet the
requirements under proposed Rule 17Ad-22(e)(16) in most cases, so the
additional costs and benefits flowing from these requirements would be
generally limited to registered clearing agencies that may enter the
set of covered clearing agencies in the future.
xii. Proposed Rule 17Ad-22(e)(17): Operational Risk Management
Because, as noted above, proposed Rule 17Ad-22(e)(17) would require
substantially the same set of policies and procedures as Rule 17Ad-
22(d)(4),\749\ the Commission preliminarily believes that proposed Rule
17Ad-22(e)(17) would likely impose limited material additional costs on
covered clearing agencies and produce limited benefits, in line with
the general economic considerations discussed in Part IV.C.1.
---------------------------------------------------------------------------
\749\ See supra Part II.B.14 (discussing the full set of
requirements under proposed Rule 17Ad-22(e)(17)); see also 17 CFR
240.17Ad-22(d)(4).
---------------------------------------------------------------------------
xiii. Proposed Rules 17Ad-22(e)(18) Through (20): Membership
Requirements, Tiered Participation, and Linkages
As discussed earlier, covered clearing agencies play an important
role in the markets they serve. They often enjoy a central place in
financial networks that enables risk sharing, but may also enable them
to serve as conduits for the transmission of risk throughout the
financial system. Proposed Rules (18) through (20) require covered
clearing agencies to have policies and procedures reasonably designed
to explicitly consider and manage the risks associated with the
particular characteristics of their network of direct members, the
broader community of customers, and other parties that rely on the
services provided by the covered clearing agencies or other partners
that the covered clearing agency is connected to through relevant
linkages. The Commission preliminarily believes that these efforts
carry benefits insofar as they reduce the extent to which covered
clearing agencies may impose negative externalities on financial
markets.
As economies of scale contribute to the business dynamics of
clearing and settlement, there is often only one clearing agency or a
small number of clearing agencies for a particular class of security.
Consequently, membership in a clearing agency may influence competitive
dynamics between members and indirect participants, such as
intermediaries, in cleared markets. Members and indirect participants
may compete for the same set of customers, but indirect participants
must have relationships with members to access clearing services.
Members, therefore, may have incentives in place to extract economic
rents from indirect participants by imposing higher fees or restricting
access to clearing services.
Permitting fair and open access to clearing agencies and their
services may promote competition among market participants and may
result in lower costs and efficient clearing and settlement services.
Open access to clearing agencies may reduce the likelihood that credit
and liquidity risk become concentrated among a small number of clearing
members, each of which retain a large number of indirect participants
through tiered arrangements. Further, links between clearing agencies
may facilitate risk management across multiple security classes and
improve the efficiency of collateral arrangements.
(1) Proposed Rule 17Ad-22(e)(18): Member Requirements
While fair and open access to clearing agencies may promote
competition and enhance the efficiency of clearing and settlement
services, these improvements should not come at the expense of prudent
risk management. The soundness of clearing members contributes directly
to the soundness of a clearing agency and mutualization of losses
within clearing agencies expose each clearing member to the default
risk of every other clearing member. Accordingly, it is important for
clearing agencies to control and effectively manage the risks to which
they are exposed by their direct and indirect participants by
establishing risk-related requirements for participation.
Based on its supervisory experience, the Commission preliminarily
believes that current practices among most covered clearing agencies
involve a mix of objective financial and business requirements
stipulated in publicly-available rulebooks and discretion exercised by
the covered clearing agency. As a result and based on its supervisory
experience, the Commission preliminarily believes that some changes to
policies and procedures at covered clearing agencies may be required
under the proposed rule.
(2) Proposed Rule 17Ad-22(e)(19): Tiered Participation Arrangements
The Commission preliminarily believes that proposed Rule 17Ad-
22(e)(19) may improve covered clearing agencies' ability to manage its
exposure to market participants that are not clearing members, but
access payment, clearing, or settlement facilities through their
relationships with clearing members. A covered clearing agency that is
able to effectively manage its exposure to its members but fails to
identify, monitor, and manage its exposures to non-member firms may
overlook dependencies that are critical to the stability of cleared
markets. This is particularly true if indirect participants in the
covered clearing agency are large and might potentially precipitate the
default of one or more direct members.
[[Page 29607]]
The data necessary to compute summary statistics that would be
helpful in quantifying the costs and benefits of the proposed rule,
including those that would indicate the size of indirect participants
and the volume of transactions in which they are involved, are not
available. Nevertheless, the Commission is sensitive to the fact that
costs associated with the proposed rules may result in concentration of
clearing services among fewer clearing members. Part of this process of
consolidation may mean an increase in the volume of trading activity
that involves indirect members, making identification of risks
associated with indirect members even more critical. Based on its
supervisory experience, however, the Commission preliminarily believes
that certain covered clearing agencies already have policies and
procedures in place that would satisfy the requirements of the proposed
rule even in the absence of such explicit requirements under existing
rules. Costs and benefits from the proposed rule would come from those
other registered clearing agencies that require updates to their
policies and procedures to come into compliance with the proposed rule.
The Commission is sensitive to the fact that indirect participants
play a key role in maintaining competition in markets for
intermediation of trading in securities insofar as they offer investors
a broader choice of intermediaries to deal with in centrally cleared
and settled securities markets. If elements of policies and procedures
under this rule make indirect participation marginally more costly,
then transactions costs for investors may increase.
(3) Proposed Rule 17Ad-22(e)(20): Links
Links between clearing agencies and their members are only one way
that clearing agencies interface with the financial system. A clearing
agency may also establish links with other clearing agencies and FMUs
through a set of contractual and operational arrangements. For a
clearing agency, the primary purpose of establishing a link would be to
expand its clearing and settlement services to additional financial
instruments, markets, and institutions. Established links among
clearing agencies and FMUs may enable direct and indirect market
participants to have access to a broader spectrum of clearing and
settlement services.
Sound linkages between clearing agencies that provide CCP services
may also provide their customers with more efficient collateral
arrangements and cross-margining benefits. Cross-margining potentially
relaxes liquidity constraints in the financial system by reducing total
required margin collateral. Resources that would otherwise be posted as
margin may be allocated to more productive investment opportunities.
A clearing agency that establishes a link or multiple links may
also impose costs on participants in markets it clears by indirectly
exposing them to systemic risk from linked entities. The Commission
acknowledges that clearing agencies that form linkages may be exposed
to additional risks, including credit and liquidity risks, as a
consequence of these links. Links may, however, produce benefits for
members to the extent that diversification and hedging across their
combined portfolio reduces their margin requirements. At the same time,
because such an agreement requires the linked clearing agencies to each
guarantee cross-margining participants' obligations to the other
clearing agency, cross-margining potentially exposes members of one
clearing agency to default risk from members of the other.
By requiring that covered clearing agencies have policies and
procedures reasonably designed to identify, monitor, and manage risks
related to any link, proposed Rule 17Ad-22(e)(20), like Rule 17Ad-
22(d)(7), reduces the likelihood that such links serve as channels for
systemic risk transmission. Because proposed Rule 17Ad-22(e)(20)
differs only marginally from Rule 17Ad-22(d)(7), the Commission
preliminarily believes that the costs and benefits flowing from the
proposed rule will be incremental, to the extent that the additional
specificity in proposed Rule 17Ad-22(e)(20) causes covered clearing
agencies to modify current practices. The Commission has aggregated
these costs below.
xiv. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness
Proposed Rule 17Ad-22(e)(21) would impose on covered clearing
agencies requirements in addition to those currently applied to
registered clearing agencies under Rule 17Ad-22(d)(6) by also requiring
covered clearing agencies to have policies and procedures that ensure
that a covered clearing agency's management review efficiency and
effectiveness in four key areas:
Efficiency and effectiveness in clearing and settlement
arrangements may reduce participants' transaction costs and enhance
liquidity by reducing the amount of collateral that customers must
provide for transactions and the opportunity cost associated with
providing such collateral. Where appropriate, net settlement
arrangements can reduce collateral requirements. Similarly, clearing
arrangements that include a broad scope of products enable clearing
members to take advantage of netting efficiencies across positions.
Efficient and effective operating structures, including
risk management policies, procedures, and systems, may reduce the
likelihood of failures that may lead to impairment of a clearing
agency's capacity to complete settlement and interfering with its
ability to monitor and manage credit exposures.
An efficient scope of products that a clearing agency
clears, settles, or records may provide its participants and customers
with more efficient collateral arrangements and cross-margining
benefits that ultimately reduce transaction costs and improve liquidity
in cleared markets.
Efficient and effective use of technology and
communication procedures facilitates effective payment, clearing and
settlement, and recordkeeping.
The Commission preliminarily believes that requirements related to
efficient operation of covered clearing agencies are appropriate given
the market power enjoyed by these entities, as discussed in Part
IV.C.1.d. Limited competition in the market for clearing services may
blunt incentives for covered clearing agencies to cost effectively
provide high quality services to market participants in the absence of
regulation.
Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies would be required to make
updates to their policies and procedures as a result of the proposed
rule. As a result, the Commission expects incremental costs and
benefits to flow from the proposed rule only to the extent that this
additional specificity causes covered clearing agencies to modify
current practices.
xv. Proposed Rule 17Ad-22(e)(22): Communication Procedures and
Standards
Based on its supervisory experience, the Commission preliminarily
believes that some changes to policies and procedures would be
necessary to meet requirements under proposed Rule 17Ad-22(e)(22).\750\
These costs are included as a part of implementation costs, as
discussed below. However, the Commission understands that covered
[[Page 29608]]
clearing agencies already accommodate internationally accepted
communication procedures and standards and preliminarily anticipates
only incremental costs resulting from the proposed rule, in addition to
the above discussed benefits. Registered clearing agencies that may
enter into the set of covered clearing agencies in the future may need
to conform their practices to internationally accepted communication
procedures and standards, as well as adopt new policies and procedures
as a result of the proposed rule, resulting in more substantial costs.
---------------------------------------------------------------------------
\750\ See supra Parts II.B.19 and VII (discussing the
requirements for communication procedures and standards under Rule
17Ad-22(e)(22) and providing the rule text, respectively).
---------------------------------------------------------------------------
xvi. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures,
and Market Data
Enhanced disclosure may also improve the efficiency of transactions
in cleared products and improve financial stability more generally by
improving the ability of members of covered clearing agencies to manage
risks and assess costs. Additional information would reduce the
potential for uncertainty on the part of clearing members regarding
their obligations to covered clearing agencies. Proposed Rule 17Ad-
22(e)(23) requires a covered clearing agency to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to require specific disclosures. As in Rules 17Ad-22(d)(9) and
(11), covered clearing agencies would be required under proposed Rule
17Ad-22(e)(23) to disclose default procedures to the public and
disclose sufficient information to participants to allow them to manage
the risks, fees, and other material costs associated with membership.
Under proposed Rule 17Ad-22(e)(23), a covered clearing agency must
establish, implement, maintain and enforce written policies and
procedures reasonably designed to update, on a biannual basis, public
disclosures that describe the covered clearing agency's market and
activities, along with information about the agency's legal,
governance, risk management, and operating frameworks, including
specifically covering material changes since the last disclosure, a
general background on the covered clearing agency, a rule-by-rule
summary of compliance with proposed Rules 17Ad-22(e)(1) through (22),
and an executive summary. The proposed rule adds a new requirement,
relative to existing requirements for registered clearing agencies
under Rule 17Ad-22(d)(9), to update the disclosure biannually and to
include, among other things, specific data elements, including details
about system design and operations, transaction values and volumes,
average intraday exposure to participants, and statistics on
operational reliability.
Additional transparency may have benefits for participants and
cleared markets more generally. For example, if information about the
systems that support a covered clearing agency is public, investors may
be more certain that the market served by this agency is less prone to
disruption and more accommodating of trade. Furthermore, public
disclosure of detailed operating data may facilitate evaluation of each
covered clearing agency's operating record by market participants.
Further, under proposed Rule 17Ad-22(e)(23)(iv), these disclosures
would be made about specific categories that potentially facilitate
comparisons between covered clearing agencies. Additional availability
of information on operations may increase the likelihood that clearing
agencies compete to win market share from participants that value
operational stability. This additional market discipline may provide
additional incentives for covered clearing agencies to maintain
reliability. Finally, updating the public disclosure every two years or
more frequently following certain changes as required pursuant to
proposed Rule 17Ad-22(e)(23)(v) would support the benefits of enhanced
public disclosures by ensuring that information provided to the public
remains up-to-date. The Commission preliminarily believes this would
reduce the likelihood that market participants are forced to evaluate
covered clearing agencies on the basis of stale data.
Clearing members, in particular, may benefit from additional
disclosure of risk management and governance arrangements. These
details potentially have significant bearing on clearing members' risk
management because they may remove uncertainty surrounding members'
potential obligations to a covered clearing agency. In certain
circumstances, additional disclosures may reveal to members that the
expected costs of membership exceed the expected benefits of
membership, and that exit from the clearing agency may be privately
optimal. In addition to the costs of concentration among members
discussed in earlier sections, the Commission also recognizes the
potential for systemic benefits from termination. Member exit on the
basis of more precise information may reduce the risk posed to other
financial market participants by members who, given additional
information, might prefer to terminate their membership, due to an
inability to manage the risks to which a covered clearing agency
exposes them. While exit from clearing agencies may have consequences
for competition among clearing members, the Commission preliminarily
believes that encouraging the participation of firms that are not able
to bear the risks of membership is not an appropriate means of
mitigating the effects of market power on participants in cleared
markets.
Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies will require changes to
policies and procedures as a result of the proposed rules. Compliance
costs associated with changes to policies and procedures, biannual
review and disclosure of additional data are included in implementation
costs, below.
b. Proposed Rule 17Ab2-2
Proposed Rule 17Ad-22(e) would subject covered clearing agencies to
requirements that are in many instances more specific than requirements
under Rule 17Ad-22(d) and in some cases produce new obligations to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to test, report, and disclose key
elements of a covered clearing agency's performance, risk management,
and operations.
Proposed Rule 17Ab2-2 provides procedures for the Commission to
determine on its own initiative, or upon voluntary application by a
registered clearing agency, whether a registered clearing agency is a
covered clearing agency and therefore is subject to proposed Rule 17Ad-
22(e). It also provides procedures for the Commission to determine
whether a covered clearing agency is systemically important in multiple
jurisdictions or has a complex risk profile and therefore should be
subject to stricter risk management standards under proposed Rule 17Ad-
22(e).
Proposed Rule 17Ab2-2(a) provides procedures for the Commission to
determine whether a registered clearing agency that is otherwise not a
designated clearing agency or a complex risk profile clearing agency is
a covered clearing agency on the basis of the products it clears or
other characteristics the Commission may deem appropriate under the
circumstances. While the Commission preliminarily believes the current
scope of proposed Rule 17Ad-22(e) is appropriate,\751\ proposed Rule
17Ab2-
[[Page 29609]]
2(a) would provide the Commission with latitude in adjusting the scope
of proposed Rule 17Ad-22(e) in response to financial innovation and
changing economic circumstances. Proposed Rule 17Ab2-2(a) contemplates
voluntary application of registered clearing agencies to become covered
clearing agencies.
---------------------------------------------------------------------------
\751\ See supra Part IV.C.3.a (discussing the appropriateness of
the proposed scope of Rule 17Ad-22(e)).
---------------------------------------------------------------------------
Proposed Rule 17Ab2-2(b) includes criteria the Commission may
consider in determining whether a covered clearing agency is
systemically important in multiple jurisdictions. Two of these criteria
are based on input from a set of other bodies comprised of FSOC and
regulators in other jurisdictions. As a result, it is possible that the
flow of costs and benefits from proposed Rule 17Ad-22(e) may be
partially determined by the decisions of other regulatory bodies.
Proposed Rule 17Ab2-2(c), by contrast, suggests characteristics of
the financial products that a clearing agency clears as a basis upon
which the Commission may determine that a clearing agency's activity
has a complex risk profile.
The impact of proposed rules that determine the application of
enhanced requirements could have direct costs on registered clearing
agencies in the form of legal or consulting costs incurred as a result
of seeking a determination from the Commission. In instances where
these clearing agencies choose to apply to the Commission for status as
a covered clearing agency under proposed Rule 17Ab2-2(a), the
Commission preliminarily believes that a registered clearing agency's
voluntary application would suggest that the applicant's private
benefits from regulation under proposed Rule 17Ad-22(e) justify its
costs.
Quantifiable costs related to determinations under proposed Rule
a17Ab2-2 are noted in Part IV.C.3.d.
Indirect effects of the determination process may have important
economic effects on the ultimate volume of clearing activity, beyond
the economic effects of the proposed requirements themselves. An
important feature of proposed Rule 17Ab2-2 is providing transparency
for the determinations process. On one hand, transparency may allow
clearing agencies to plan for new obligations under proposed Rule 17Ad-
22(e); on the other, transparency may allow clearing agencies to
restructure their business to avoid falling within the scope of
proposed Rule 17Ad-22(e).
To the extent that proposed Rule 17Ad-22(e), if adopted as
proposed, may increase costs relative to their peers for covered
clearing agencies, clearing agencies whose activities have a more
complex risk profile, and clearing agencies systemically important in
multiple jurisdictions, clearing agencies may have incentives to
restructure their businesses strategically to avoid these Commission
determinations or otherwise exit any services made prohibitively
expensive by such determinations. Such potential consequential effects
would be among the considerations for the Commission to review in
connection with any specific decision under proposed Rule 17Ab2-2.
Restructuring may involve spinning off business lines into separate
entities, limiting the scope of clearing activities to certain markets,
or limiting the scale of clearing activities within a single
market.\752\
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\752\ See Exchange Act Release No. 34-63107 (Oct. 14, 2010), 75
FR 65881, 65919 & n.206 (Oct. 26, 2010).
---------------------------------------------------------------------------
Any one of these responses could result in inefficiencies. As
suggested in Part IV.C.2.b, registered clearing agencies may incur
costs as a result of attempts to restructure. Clearing agencies that
break up along product lines or fail to consolidate when consolidation
is efficient may fail to take advantage of economies of scope and
result in inefficient use of collateral.\753\ Similarly, clearing
agencies that limit their scale may provide lower levels of clearing
services to the markets that they serve.
---------------------------------------------------------------------------
\753\ See, e.g., Darrell Duffie & Haoxiang Zhu, Does a Central
Clearing Counterparty Reduce Counterparty Risk?, 1 Rev. Asset
Pricing Stud. 74 (2011) (addressing potential inefficiencies
resulting from fragmented clearing along product lines).
---------------------------------------------------------------------------
c. Proposed Rule 17Ad-22(f)
Proposed Rule 17Ad-22(f) includes a provision that specifies
Commission authority over designated clearing agencies for which it is
the supervisory agency. Since this provision codifies existing
statutory authority, the Commission does not anticipate any economic
effects from this proposed rule.
d. Quantifiable Costs and Benefits
As discussed above, the proposed amendments to Rule 17Ad-22 and
proposed Rule 17Ab2-2 would impose certain costs on covered clearing
agencies. As discussed in Part IV.C.3.a.ii, if a covered clearing
agency is required to recruit new directors, the Commission
preliminarily estimates a cost per director of $73,000.\754\ As
discussed in Part IV.C.3.a.iv(4), the Commission preliminarily
estimates costs associated with liquidity resources under proposed
Rules 17Ad-22(e)(7) and (a)(15) would likely fall between $133 million
and $225 million per year across all covered clearing agencies. As
discussed in Part IV.C.3.a.iv(5), the Commission preliminarily believes
that startup costs related to financial risk management systems for
existing covered clearing agencies, related to new testing and model
validation requirements to be between $5 million to $25 million. The
Commission also estimates a lower bound on ongoing costs related to
these requirements of $1 million per year. If covered clearing agencies
were to hire external consultants for the purposes of performing model
validation required under proposed Rules 17Ad-22(e)(4) and (7) through
policies and procedures, the Commission preliminarily estimates the
ongoing cost associated with hiring such consultants would be about
$4,388,160 in the aggregate.\755\ As discussed in Part IV.C.3.a.x, the
Commission expects quantifiable economic costs as a result of proposed
Rule 17Ad-22(e)(15) to be between $16 million and $50 million per year
across covered clearing agencies.
---------------------------------------------------------------------------
\754\ See supra note 705.
\755\ See supra Part IV.C.3.a.iv(5), in particular note 734.
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In addition, proposed Rules 17Ad-22(e)(3), (4), (6), (7), (15) and
(21) all include elements of review by either a covered clearing
agency's board or its management on an ongoing basis. The Commission
preliminarily estimates the cost of ongoing review for these proposed
rules at approximately $39,312 per year.\756\ The proposed rules would
also impose certain implementation burdens and related costs on covered
clearing agencies.\757\
[[Page 29610]]
These costs generally include assessment costs to determine compliance
with the proposed rules and costs related to new policies and
procedures and updates to existing policies and procedures required by
the proposed rules. In Part III, the Commission estimated the burdens
of these implementation requirements for covered clearing agencies.
---------------------------------------------------------------------------
\756\ To monetize the cost of board review, the Commission used
a recent report by Bloomberg stating that the average director works
250 hours and earns $251,000, resulting in an estimated $1000 per
hour for board review. As a proxy for the cost of management review,
the Commission is estimating $457 per hour, based upon the Director
of Compliance cost data from the SIFMA table, see infra note 778.
The Commission estimates the total cost of review for each clearing
agency as follows: ((Board Review for 32 hours at $1000 per hour) +
(Management Review for 16 hours at $457 per hour)) = $39,312. The
Commission requests comment on this estimate.
\757\ To monetize the internal costs the Commission staff used
data from the SIFMA publications, Management and Professional
Earnings in the Security Industry--2012, and Office Salaries in the
Securities Industry--2012, modified by the Commission staff to
account for an 1800 hour work-year and multiplied by 5.35
(professionals) or 2.93 (office) to account for bonuses, firm size,
employee benefits and overhead. Commission staff also estimated an
hourly rate for a Chief Financial Officer. The Web site
www.salary.com reports that median CFO annual salaries in 2012 were
$307,554. A Grant Thornton LLP survey estimated that in 2012 public
company CFOs received an average annual salary of $286,500. Using an
approximate midpoint of these two estimates of $300,000 per year,
and dividing by an 1800-hour work year and multiplying by the 5.35
factor which normally is used to include benefits but here is used
as an approximation to offset the fact that New York salaries are
typically higher than the rest of the country, the result is $892
per hour. The Commission requests comment on this estimate.
---------------------------------------------------------------------------
For a new entrant into the set of covered clearing agencies from
the set of registered clearing agencies, the Commission preliminarily
estimates the startup compliance costs associated with policies and
procedures to be $592,215,\758\ and compliance costs associated with
the determinations process under proposed Rule 17Ab2-2 to be
$9,148.\759\ Based on its supervisory experience, the Commission
preliminarily believes that in many cases registered clearing agencies
are already in compliance with many of the requirements included in the
proposed rules, so this cost represents an upper bound on upfront
costs. Conditioned on its current understanding of current market
practice at covered clearing agencies, the Commission preliminarily
estimates that the total costs across all existing covered clearing
agencies will be $4,032,720.\760\ The Commission preliminarily
estimates that in the aggregate existing covered clearing agencies
would be subject to ongoing costs associated with the proposed rule in
the amount of approximately $801,980 per year.\761\
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\758\ The total initial cost for an entrant that is not a CSD
and does engage in activities with a more complex risk profile was
calculated as follows: ((Assistant General Counsel for 428 hours at
$467 per hour) + (Compliance Attorney for 365 hours at $310 per
hour) + (Administrative Assistant for 2 hours at $72 per hour) +
(Computer Operations Department Manager for 300 hours at $361 per
hour) + (Senior Business Analyst for 85 hours at $245 per hour) +
(Senior Risk Management Specialist for 114 hours at $249 per hour) +
(Chief Compliance Office for 102 hours at $441 per hour) + (Senior
Programmer for 53 hours at $282 per hour) + (Chief Financial Officer
for 50 hours at $892 per hour) + (Financial Analyst for 70 hours at
$245 per hour)) = $592,215.
\759\ The total cost associated with determinations under
proposed Rule 17Ab2-2 was calculated as follows: ((Assistant General
Counsel for 2 hours at $467 per hour) + (Compliance Attorney for 4
hours at $310 per hour) + (Outside Counsel for 6 hours at $400 per
hour)) x 2 registered clearing agencies = $9,148.
\760\ The total initial cost was calculated as follows:
((Assistant General Counsel for 2,906 hours at $467 per hour) +
(Compliance Attorney for 2,475 hours at $310 per hour) +
(Administrative Assistant for 14 hours at $72 per hour) + (Computer
Operations Department Manager for 2,030 hours at $361 per hour) +
(Senior Business Analyst for 565 hours at $245 per hour) + (Senior
Risk Management Specialist for 773 hours at $249 per hour) + (Chief
Compliance Office for 699 hours at $441 per hour) + (Senior
Programmer for 361 hours at $282 per hour) + (Chief Financial
Officer for 350 hours at $892 per hour) + (Financial Analyst for 490
hours at $245 per hour) + (Intermediate Accountant for 15 hours at
$155 per hour)) = $4,032,720.
\761\ The total ongoing cost was calculated as follows:
((Compliance Attorney for 1,851 hours at $310 per hour) +
(Administrative Assistant for 137 hours at $72 per hour) + (Senior
Business Analyst for 151 hours at $245 per hour) + (Senior Risk
Management Specialist for 70 hours at $249 per hour) + (Risk
Management Specialist for 1,251 hours at $131 per hour)) = $801,980.
---------------------------------------------------------------------------
A benefit of the proposed rules that the Commission is able to
quantify is the impact of QCCP status of OCC to non-U.S. bank clearing
members at OCC. This benefit comes as a result of lower capital
requirements against exposures to QCCPs relative to non-qualifying
CCPs. In Part IV.C.1.e, the Commission provided an estimate of the
upper bound of this benefit, $600 million per year, or 0.60% of the
aggregate 2012 net income reported by bank clearing members at OCC. The
Commission preliminarily believes that the actual benefits flowing from
QCCP status would likely be higher due to benefits for foreign bank
members of FICC and ICEEU, in addition to the benefits with respect to
OCC discussed above.\762\
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\762\ See supra note 686 and accompanying text.
---------------------------------------------------------------------------
The Commission preliminarily believes that the proposed rules will
result in an increase in financial stability insofar as they result in
minimum standards at covered clearing agencies that are higher than
those standards implied by current practices at covered clearing
agencies. Some of this increased stability may come as a result of
lower activity as the proposed rules cause participants to internalize
a greater proportion of the costs that their activity imposes on the
financial system, reducing the costs of default, conditional on a
default event occurring. Increased stability may also come as a result
of higher risk management standards at covered clearing agencies that
effectively lower the probability that either covered clearing agencies
or their members default.
The Commission preliminarily believes that clearance and settlement
of securities and security-based swaps is fundamental to the stability
of financial markets. As discussed above, clearing agencies may not
fully consider the costs they could impose on financial market
participants.\763\ As a result of the potential negative externalities
associated with their activities, enhanced risk management standards
are particularly important for those clearing agencies that pose the
greatest risk to financial markets and the U.S. financial system.
---------------------------------------------------------------------------
\763\ See Duffie, Li & Lubke, supra note 563 (noting that the
failure of a CCP could suddenly expose many major market
participants to losses); see also Cecchetti, Gyntelberg &
Hollanders, supra note 19 (``[A] CCP concentrates counterparty and
operational risks and the responsibilities for risk management.
Therefore it is critical that CCPs have both effective risk control
and adequate financial resources.''); supra note 278 and
accompanying text (asserting that delays and breakdowns in the
payments and clearance process and the perception that the clearing
system might not be able to meet obligations may have contributed to
price declines during the October 20, 1987 market crash).
---------------------------------------------------------------------------
D. Request for Comments
The Commission generally requests comment about its preliminary
analysis of the economic effects of the proposed rules and any
qualitative and quantitative data that would facilitate an evaluation
and assessment of the economic effects of this proposal. In addition,
the Commission requests comment on the following specific issues:
Has the Commission appropriately identified the relevant
costs and benefits associated with each requirement under proposed Rule
17Ad-22(e)? Why or why not?
Are there any provisions of proposed Rule 17Ad-22(e) for
which the costs of enhanced risk management standards appear
inappropriate relative to the benefits of such standards, particularly
given existing requirements under Rule 17Ad-22(d)? Please explain.
Would particular provisions of proposed Rule 17Ad-22(e)
improve or diminish competition between covered clearing agencies?
Which provisions are likely to have such effects and through what
transmission channels?
Would the scope of proposed Rule 17Ad-22(e) have
implications for competition between covered clearing agencies and
registered clearing agencies that are not covered clearing agencies?
Would particular provisions of proposed Rule 17Ad-22(e)
improve or diminish competition between members of covered clearing
agencies? Are there any provisions that would allow a subset of members
to compete on better terms than other members?
How would the effects of QCCP status will be allocated
across members? Can market participants provide any qualitative or
quantitative data to help the Commission evaluate the effects of QCCP
status on clearing members and any heterogeneity in trade exposures and
default fund exposures to covered
[[Page 29611]]
clearing agencies across bank and non-bank clearing members?
Would bank clearing members to be constrained by the Basel
III capital requirements? Do bank clearing members typically target
tier one or total capital ratios as a business practice?
In areas where existing requirements under Rule 17Ad-22(d)
could be viewed as being consistent with the PFMI, and so could
potentially earn QCCP status for covered clearing agencies, do the
costs of additional requirements under proposed Rule 17Ad-22(e) appear
appropriate relative to benefits of these requirements, aside from QCCP
status? Please explain.
Does the Commission's proposed definition of qualifying
liquid resources adequately reflect the ability with which covered
clearing agency assets may be used to meet funding obligations? Has the
Commission adequately assessed the costs and benefits of requiring
funding arrangements before considering non-cash resources
``qualifying''?
What would be the potential costs and benefits of
requiring covered clearing agencies to hold liquid net assets in
accordance with proposed Rule 17Ad-22(e)(15)? Can you provide
qualitative and quantitative data to aid the Commission in evaluating
these potential costs and benefits?
Has the Commission adequately assessed the risks posed by
indirect participation at covered clearing agencies? Can you provide
qualitative and quantitative data to aid the Commission in evaluating
the level of indirect participation in cleared markets, the
heterogeneity of indirect participation across clearing members and the
implications for networks of exposures in cleared markets?
V. Regulatory Flexibility Act Certification
The Regulatory Flexibility Act (``RFA'') requires the Commission,
in promulgating rules, to consider the impact of those rules on small
entities.\764\ Section 603(a) of the Administrative Procedure Act,\765\
as amended by the RFA, generally requires the Commission to undertake a
regulatory flexibility analysis of all proposed rules to determine the
impact of such rulemaking on ``small entities.'' \766\ Section 605(b)
of the RFA states that this requirement shall not apply to any proposed
rule which, if adopted, would not have a significant economic impact on
a substantial number of small entities.\767\
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\764\ See 5 U.S.C. 601 et seq.
\765\ 5 U.S.C. 603(a).
\766\ Section 601(b) of the RFA permits agencies to formulate
their own definitions of ``small entities.'' See 5 U.S.C. 601(b).
The Commission has adopted definitions for the term ``small entity''
for the purposes of rulemaking in accordance with the RFA. These
definitions, as relevant to this proposed rulemaking, are set forth
in Rule 0-10, 17 CFR 240.0-10.
\767\ See 5 U.S.C. 605(b).
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A. Registered Clearing Agencies
The proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2
would apply to covered clearing agencies, which would include
registered clearing agencies that are designated clearing agencies,
complex risk profile clearing agencies, or clearing agencies that
otherwise have been determined to be covered clearing agencies by the
Commission. For the purposes of Commission rulemaking and as applicable
to the proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2, a
small entity includes, when used with reference to a clearing agency, a
clearing agency that (i) compared, cleared, and settled less than $500
million in securities transactions during the preceding fiscal year,
(ii) had less than $200 million of funds and securities in its custody
or control at all times during the preceding fiscal year (or at any
time that it has been in business, if shorter), and (iii) is not
affiliated with any person (other than a natural person) that is not a
small business or small organization.\768\
---------------------------------------------------------------------------
\768\ See 17 CFR 240.0-10(d).
---------------------------------------------------------------------------
Based on the Commission's existing information about the clearing
agencies currently registered with the Commission,\769\ the Commission
preliminarily believes that such entities exceed the thresholds
defining ``small entities'' set out above. While other clearing
agencies may emerge and seek to register as clearing agencies, the
Commission preliminarily does not believe that any such entities would
be ``small entities'' as defined in Exchange Act Rule 0-10.\770\ In any
case, clearing agencies can only become subject to the new requirements
under proposed Rule 17Ad-22(e) should they meet the definition of a
covered clearing agency, as described above. Accordingly, the
Commission preliminarily believes that any such registered clearing
agencies will exceed the thresholds for ``small entities'' set forth in
Exchange Act Rule 0-10.
---------------------------------------------------------------------------
\769\ In 2012, DTCC processed $1.6 quadrillion in financial
transactions, subsidiary DTC settled $110.3 trillion of securities
and held securities valued at $37.2 trillion, subsidiary NSCC
processed an average daily value of $742.7 billion in equity
securities, subsidiary FICC cleared $1.116 quadrillion in government
securities, and FICC's Mortgage-Backed Securities Division cleared
$104 trillion of transactions in agency mortgage-backed securities.
See DTCC, 2012 Annual Report, available at http://www.dtcc.com/about/annual-report.aspx and http://www.dtcc.com/annuals/2012/br-settlement-and-asset-services.html; FSOC, 2013 Annual Report, supra
note 39, at 99.
In addition, OCC cleared more than 4 billion contracts and held
margin of $78.8 billion at the end of 2012. See OCC, 2012 Annual
Report, available at http://www.optionsclearing.com/components/docs/about/annual-reports/occ_2012_annual_report.pdf. CME Group had
total contract volume of 2.89 billion contracts (in round turn
trades) with a total notional value of $806 trillion. See CME Group,
2012 Annual Report, available at http://files.shareholder.com/downloads/CME/2635449816x0x653543/02DB7C7F-ACF0-4D73-9AD7-1ACCEF68559A/CME_Group_2012_Annual_Report.pdf. ICE and ICEEU
together cleared CDS with a total notional value of $10.24 trillion.
See Intercontinental Exchange, Inc., 2012 Annual Report, available
at http://files.shareholder.com/downloads/ICE/2623237906x0x649669/DFB49A9C-152C-4287-848C-7CCDDA42D61E/ICE_2012_Annual_Report_FINAL.pdf.
\770\ See 17 CFR 240.0-10(d). The Commission based this
determination on its review of public sources of financial
information about registered clearing agencies and lifecycle event
service providers for OTC derivatives.
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B. Certification
For the reasons described above, the Commission certifies that the
proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2 would not
have a significant economic impact on a substantial number of small
entities for purposes of the RFA. The Commission requests comment
regarding this certification. The Commission requests that commenters
describe the nature of any impact on small entities, including clearing
agencies and counterparties to security and security-based swap
transactions, and provide empirical data to support the extent of the
impact.
VI. Small Business Regulatory Enforcement Fairness Act
Under the Small Business Regulatory Enforcement Fairness Act of
1996,\771\ a rule is considered ``major'' where, if adopted, it results
or is likely to result in (i) an annual effect on the economy of $100
million or more (either in the form of an increase or a decrease); (ii)
a major increase in costs or prices for consumers or individual
industries; or (iii) significant adverse effect on competition,
investment, or innovation. The Commission requests comment on the
potential impact of the proposed amendments to Rule 17Ad-22 and
proposed Rule 17Ab2-2 on the economy on an annual basis, any potential
increase in costs or prices for consumers or individual industries, and
any potential effect on competition, investment, or innovation.
Commenters are requested to provide empirical data
[[Page 29612]]
and other factual support for their views to the extent possible.
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\771\ Public Law 104-121, 110 Stat. 857 (1996) (codified in
various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
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VII. Statutory Authority and Text of Amended Rule 17Ad-22 and Proposed
Rule 17Ab2-2
Pursuant to the Exchange Act, particularly Section 17A thereof, 15
U.S.C. 78q-1, and Section 805 of the Clearing Supervision Act, 12
U.S.C. 5464, the Commission proposes to amend Rule 17Ad-22 and proposes
new Rule 17Ab2-2.
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Text of Amendment
In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is proposed to be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE
0
1. The general authority citation for Part 240 continues to read, and
the sectional authority for Sec. 240.17Ad-22 is revised to read, as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78d, 78e, 78f, 78g, 78i, 78j,
78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 78p, 78q, 78q-
1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37,
80b-3, 80b-4, 80b-11, and 7201 et. seq.; 18 U.S.C. 1350; and 12
U.S.C. 5221(e)(3), unless otherwise noted.
* * * * *
Section 240.17Ad-22 is also issued under 12 U.S.C. 5461 et seq.
* * * * *
0
2. Section 240.17Ab2-2 is added to read as follows:
Sec. 240.17Ab2-2 Determinations affecting covered clearing agencies.
(a) The Commission may, if it deems appropriate, upon application
by any clearing agency or member of a clearing agency, or on its own
initiative, determine whether a registered clearing agency should be
considered a covered clearing agency. In determining whether a clearing
agency should be considered a covered clearing agency, the Commission
may consider:
(1) Characteristics such as the clearing of financial instruments
that are characterized by discrete jump-to-default price changes or
that are highly correlated with potential participant defaults; or
(2) Such other characteristics as it deems appropriate in the
circumstances.
(b) The Commission may, if it deems appropriate, upon application
by any clearing agency or member of a clearing agency, or on its own
initiative, determine whether a covered clearing agency is systemically
important in multiple jurisdictions. In determining whether a covered
clearing agency is systemically important in multiple jurisdictions,
the Commission may consider:
(1) Whether the covered clearing agency is a designated clearing
agency;
(2) Whether the clearing agency has been determined to be
systemically important by one or more jurisdictions other than the
United States through a process that includes consideration of whether
the foreseeable effects of a failure or disruption of the designated
clearing agency could threaten the stability of each relevant
jurisdiction's financial system; or
(3) Such other factors as it may deem appropriate in the
circumstances.
(c) The Commission may, if it deems appropriate, determine whether
any of the activities of a clearing agency providing central
counterparty services, in addition to clearing agencies registered with
the Commission for the purpose of clearing security-based swaps, have a
more complex risk profile. In determining whether a clearing agency's
activity has a more complex risk profile, the Commission may consider:
(1) Characteristics such as the clearing of financial instruments
that are characterized by discrete jump-to-default price changes or
that are highly correlated with potential participant defaults; or
(2) Such other characteristics as it deems appropriate in the
circumstances, as factors supporting a finding of a more complex risk
profile.
(d) The Commission shall publish notice of its intention to
consider making a determination under paragraph (a), (b), or (c) of
this section, together with a brief statement of the grounds under
consideration therefor, and provide at least a 30-day public comment
period prior to any such determination, giving all interested persons
an opportunity to submit written data, views, and arguments concerning
such proposed determination. The Commission may provide the clearing
agency subject to the proposed determination opportunity for hearing
regarding the proposed determination.
(e) Notice of determinations under paragraph (a), (b), or (c) of
this section shall be given by prompt publication thereof, together
with a statement of written reasons therefor.
(f) For purposes of this rule, the terms central counterparty,
covered clearing agency, designated clearing agency, and systemically
important in multiple jurisdictions shall have the meanings set forth
in Sec. 240.17Ad-22(a).
0
3. Amend Sec. 240.17Ad-22 by:
0
a. Revising paragraph (a) and the introductory text of paragraph (d);
and
0
b. Adding paragraphs (e) and (f).
The revisions and additions read as follows:
Sec. 240.17Ad-22 Standards for clearing agencies.
(a) Definitions. For purposes of this section:
(1) Backtesting means an ex-post comparison of actual outcomes with
expected outcomes derived from the use of margin models.
(2) Central counterparty means a clearing agency that interposes
itself between the counterparties to securities transactions, acting
functionally as the buyer to every seller and the seller to every
buyer.
(3) Central securities depository services means services of a
clearing agency that is a securities depository as described in Section
3(a)(23)(A) of the Exchange Act (15 U.S.C. 78c(a)(23)(A)).
(4) Clearing agency involved in activities with a more complex risk
profile means a clearing agency registered with the Commission under
Section 17A of the Exchange Act (15 U.S.C. 78q-1) and that:
(i) Provides central counterparty services for security-based
swaps;
(ii) Has been determined by the Commission to be involved in
activities with a more complex risk profile at the time of its initial
registration; or
(iii) Is subsequently determined by the Commission to be involved
in activities with a more complex risk profile pursuant to Sec.
240.17Ab2-2(c).
(5) Conforming model validation means an evaluation of the
performance of each material risk management model used by a covered
clearing agency (and the related parameters and assumptions associated
with such models), including initial margin models, liquidity risk
models, and models used to generate clearing or guaranty fund
requirements, performed by a qualified person who is free from
influence from the persons responsible for the development or operation
of the models or policies being validated.
(6) Conforming sensitivity analysis means a sensitivity analysis
that:
(i) Considers the impact on the model of both moderate and extreme
changes in a wide range of inputs, parameters, and assumptions,
including correlations of price movements or returns if relevant, which
reflect a variety of historical and hypothetical market
[[Page 29613]]
conditions. Sensitivity analysis must use actual and hypothetical
portfolios that reflect the characteristics of proprietary positions
and, where applicable, customer positions;
(ii) When performed by or on behalf of a covered clearing agency
involved in activities with a more complex risk profile, considers the
most volatile relevant periods, where practical, that have been
experienced by the markets served by the clearing agency; and
(iii) Tests the sensitivity of the model to stressed market
conditions, including the market conditions that may ensue after the
default of a member and other extreme but plausible conditions as
defined in a covered clearing agency's risk policies.
(7) Covered clearing agency means a designated clearing agency, a
clearing agency involved in activities with a more complex risk profile
for which the Commodity Futures Trading Commission is not the
Supervisory Agency as defined in Section 803(8) of the Payment,
Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5461 et
seq.), or any clearing agency determined to be a covered clearing
agency by the Commission pursuant to Sec. 240.17Ab2-2.
(8) Designated clearing agency means a clearing agency registered
with the Commission under Section 17A of the Exchange Act (15 U.S.C.
78q-1) that is designated systemically important by the Financial
Stability Oversight Council pursuant to the Payment, Clearing, and
Settlement Supervision Act of 2010 (12 U.S.C. 5461 et seq.) and for
which the Commission is the supervisory agency as defined in Section
803(8) of the Payment, Clearing, and Settlement Supervision Act of 2010
(12 U.S.C. 5461 et seq.).
(9) Financial market utility has the same meaning as defined in
Section 803(6) of the Payment, Clearing, and Settlement Supervision Act
of 2010 (12 U.S.C. 5462(6)).
(10) Link means, for purposes of paragraph (e)(20) of this section,
a set of contractual and operational arrangements between two or more
clearing agencies, financial market utilities, or trading venues that
connect them directly or indirectly for the purposes of participating
in settlement, cross margining, expanding their services to additional
instruments or participants, or for any other purposes material to
their business.
(11) Net capital as used in paragraph (b)(7) of this section means
net capital as defined in Sec. 240.15c3-1 for broker-dealers or any
similar risk adjusted capital calculation for all other prospective
clearing members.
(12) Normal market conditions as used in paragraphs (b)(1) and (2)
of this section means conditions in which the expected movement of the
price of cleared securities would produce changes in a clearing
agency's exposures to its participants that would be expected to breach
margin requirements or other risk control mechanisms only one percent
of the time.
(13) Participant family means that if a participant directly, or
indirectly through one or more intermediaries, controls, is controlled
by, or is under common control with, another participant then the
affiliated participants shall be collectively deemed to be a single
participant family for purposes of paragraphs (b)(3), (d)(14), (e)(4),
and (e)(7) of this section.
(14) Potential future exposure means the maximum exposure estimated
to occur at a future point in time with an established single-tailed
confidence level of at least 99% with respect to the estimated
distribution of future exposure.
(15) Qualifying liquid resources means, for any covered clearing
agency, the following, in each relevant currency:
(i) Cash held either at the central bank of issue or at
creditworthy commercial banks;
(ii) Assets that are readily available and convertible into cash
through prearranged funding arrangements without material adverse
change provisions, such as:
(A) Committed arrangements, including:
(1) Lines of credit,
(2) Foreign exchange swaps, and
(3) Repurchase agreements; or
(B) Other prearranged funding arrangements determined to be highly
reliable even in extreme but plausible market conditions by the board
of directors of the covered clearing agency following a review
conducted for this purpose not less than annually; and
(iii) Other assets that are readily available and eligible for
pledging to (or conducting other appropriate forms of transactions
with) a relevant central bank, if the covered clearing agency has
access to routine credit at such central bank that permits said pledges
or other transactions by the covered clearing agency.
(16) Security-based swap means a security-based swap as defined in
Section 3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68)).
(17) Sensitivity analysis means an analysis that involves analyzing
the sensitivity of a model to its assumptions, parameters, and inputs.
(18) Stress testing means the estimation of credit or liquidity
exposures that would result from the realization of extreme but
plausible price changes or changes in other valuation inputs and
assumptions.
(19) Systemically important in multiple jurisdictions means, with
respect to a covered clearing agency, a covered clearing agency that
has been determined by the Commission to be systemically important in
more than one jurisdiction pursuant to Sec. 240.17Ab2-2.
(20) Transparent means, for the purposes of paragraphs (e)(1), (2),
and (10) of this section, to the extent consistent with other statutory
and Commission requirements on confidentiality and disclosure, that
relevant documentation is disclosed, as appropriate, to the Commission
and to other relevant authorities, to clearing members and to customers
of clearing members, to the owners of the covered clearing agency, and
to the public.
* * * * *
(d) Each registered clearing agency that is not a covered clearing
agency shall establish, implement, maintain and enforce written
policies and procedures reasonably designed to, as applicable:
* * * * *
(e) Each covered clearing agency shall establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable:
(1) Provide for a well-founded, clear, transparent, and enforceable
legal basis for each aspect of its activities in all relevant
jurisdictions.
(2) Provide for governance arrangements that:
(i) Are clear and transparent;
(ii) Clearly prioritize the safety and efficiency of the covered
clearing agency;
(iii) Support the public interest requirements in Section 17A of
the Exchange Act (15 U.S.C. 78q-1) applicable to clearing agencies, and
the objectives of owners and participants; and
(iv) Establish that the board of directors and senior management
have appropriate experience and skills to discharge their duties and
responsibilities.
(3) Maintain a sound risk management framework for comprehensively
managing legal, credit, liquidity, operational, general business,
investment, custody, and other risks that arise in or are borne by the
covered clearing agency, which:
(i) Includes risk management policies, procedures, and systems
designed to identify, measure, monitor, and manage the range of risks
that arise in or are borne by the covered clearing agency,
[[Page 29614]]
that are subject to review on a specified periodic basis and approved
by the board of directors annually;
(ii) Includes plans for the recovery and orderly wind-down of the
covered clearing agency necessitated by credit losses, liquidity
shortfalls, losses from general business risk, or any other losses;
(iii) Provides risk management and internal audit personnel with
sufficient authority, resources, independence from management, and
access to the board of directors;
(iv) Provides risk management and internal audit personnel with a
direct reporting line to, and oversight by, a risk management committee
and an audit committee of the board of directors, respectively; and
(v) Provides for an independent audit committee.
(4) Effectively identify, measure, monitor, and manage its credit
exposures to participants and those arising from its payment, clearing,
and settlement processes, including by:
(i) Maintaining sufficient financial resources to cover its credit
exposure to each participant fully with a high degree of confidence;
(ii) To the extent not already maintained pursuant to paragraph
(e)(4)(i) of this section, for a covered clearing agency providing
central counterparty services that is either systemically important in
multiple jurisdictions or a clearing agency involved in activities with
a more complex risk profile, maintaining additional financial resources
at the minimum to enable it to cover a wide range of foreseeable stress
scenarios that include, but are not limited to, the default of the two
participant families that would potentially cause the largest aggregate
credit exposure for the covered clearing agency in extreme but
plausible market conditions;
(iii) To the extent not already maintained pursuant to paragraph
(e)(4)(i) of this section, for a covered clearing agency not subject to
paragraph (e)(4)(ii) of this section, maintaining additional financial
resources at the minimum to enable it to cover a wide range of
foreseeable stress scenarios that include, but are not limited to, the
default of the participant family that would potentially cause the
largest aggregate credit exposure for the covered clearing agency in
extreme but plausible market conditions;
(iv) Including prefunded financial resources, excluding assessments
for additional guaranty fund contributions or other resources that are
not prefunded, when calculating the financial resources available to
meet the standards under paragraphs (e)(4)(i) through (iii) of this
section, as applicable;
(v) Maintaining the financial resources required under paragraphs
(e)(4)(i) through (iii) of this section, as applicable, in combined or
separately maintained clearing or guaranty funds;
(vi) Testing the sufficiency of its total financial resources
available to meet the minimum financial resource requirements under
paragraphs (e)(4)(i) through (iii) of this section, as applicable, by:
(A) Conducting a stress test of its total financial resources once
each day using standard predetermined parameters and assumptions;
(B) Conducting a comprehensive analysis on at least a monthly basis
of the existing stress testing scenarios, models, and underlying
parameters and assumptions, and considering modifications to ensure
they are appropriate for determining the covered clearing agency's
required level of default protection in light of current and evolving
market conditions;
(C) Conducting a comprehensive analysis of stress testing
scenarios, models, and underlying parameters and assumptions more
frequently than monthly when the products cleared or markets served
display high volatility or become less liquid, and when the size or
concentration of positions held by the covered clearing agency's
participants increases significantly; and
(D) Reporting the results of its analyses under paragraphs
(e)(4)(iv)(B) and (C) of this section to appropriate decision makers at
the covered clearing agency, including but not limited to, its risk
management committee or board of directors, and using these results to
evaluate the adequacy of and adjust its margin methodology, model
parameters, models used to generate clearing or guaranty fund
requirements, and any other relevant aspects of its credit risk
management framework, in supporting compliance with the minimum
financial resources requirements set forth in paragraphs (e)(4)(i)
through (iii) of this section; and
(vii) Performing a conforming model validation for its credit risk
models to be performed not less than annually or more frequently as may
be contemplated by the covered clearing agency's risk management
framework established pursuant to paragraph (e)(3) of this section.
(5) Limit the assets it accepts as collateral to those with low
credit, liquidity, and market risks, and set and enforce appropriately
conservative haircuts and concentration limits if the covered clearing
agency requires collateral to manage its or its participants' credit
exposure; and require a review of the sufficiency of its collateral
haircuts and concentration limits to be performed not less than
annually.
(6) Cover, if the covered clearing agency provides central
counterparty services, its credit exposures to its participants by
establishing a risk-based margin system that, at a minimum:
(i) Considers, and produces margin levels commensurate with, the
risks and particular attributes of each relevant product, portfolio,
and market;
(ii) Marks participant positions to market and collects margin,
including variation margin or equivalent charges if relevant, at least
daily and includes the authority and operational capacity to make
intraday margin calls in defined circumstances;
(iii) Calculates margin sufficient to cover its potential future
exposure to participants in the interval between the last margin
collection and the close out of positions following a participant
default;
(iv) Uses reliable sources of timely price data and procedures and
sound valuation models for addressing circumstances in which pricing
data are not readily available or reliable;
(v) Uses an appropriate method for measuring credit exposure that
accounts for relevant product risk factors and portfolio effects across
products;
(vi) Is monitored by management on an ongoing basis and regularly
reviewed, tested, and verified by:
(A) Conducting backtests of its margin resources at least once each
day using standard predetermined parameters and assumptions;
(B) Conducting a conforming sensitivity analysis of its margin
resources and its parameters and assumptions for backtesting on at
least a monthly basis, and considering modifications to ensure the
backtesting practices are appropriate for determining the adequacy of
the covered clearing agency's margin resources;
(C) Conducting a conforming sensitivity analysis of its margin
resources and its parameters and assumptions for backtesting more
frequently than monthly during periods of time when the products
cleared or markets served display high volatility or become less
liquid, and when the size or concentration of positions held by the
covered clearing agency's participants increases or decreases
significantly; and
(D) Reporting the results of its analyses under paragraphs
(e)(6)(vi)(B) and (C) of this section to appropriate decision makers at
the covered clearing
[[Page 29615]]
agency, including but not limited to, its risk management committee or
board of directors, and using these results to evaluate the adequacy of
and adjust its margin methodology, model parameters, and any other
relevant aspects of its credit risk management framework; and
(vii) Requires a conforming model validation for the covered
clearing agency's margin system and related models to be performed not
less than annually, or more frequently as may be contemplated by the
covered clearing agency's risk management framework established
pursuant to paragraph (e)(3) of this section.
(7) Effectively measure, monitor, and manage the liquidity risk
that arises in or is borne by the covered clearing agency, including
measuring, monitoring, and managing its settlement and funding flows on
an ongoing and timely basis, and its use of intraday liquidity by, at a
minimum, doing the following:
(i) Maintaining sufficient liquid resources at the minimum in all
relevant currencies to effect same-day and, where appropriate, intraday
and multiday settlement of payment obligations with a high degree of
confidence under a wide range of foreseeable stress scenarios that
includes, but is not limited to, the default of the participant family
that would generate the largest aggregate payment obligation for the
covered clearing agency in extreme but plausible market conditions;
(ii) Holding qualifying liquid resources sufficient to meet the
minimum liquidity resource requirement under paragraph (e)(7)(i) of
this section in each relevant currency for which the covered clearing
agency has payment obligations owed to clearing members;
(iii) Using the access to accounts and services at a Federal
Reserve Bank, pursuant to Section 806(a) of the Payment, Clearing, and
Settlement Supervision Act of 2010 (12 U.S.C. 5465(a)), or other
relevant central bank, when available and where determined to be
practical by the board of directors of the covered clearing agency, to
enhance its management of liquidity risk;
(iv) Undertaking due diligence to confirm that it has a reasonable
basis to believe each of its liquidity providers, whether or not such
liquidity provider is a clearing member, has:
(A) Sufficient information to understand and manage the liquidity
provider's liquidity risks; and
(B) The capacity to perform as required under its commitments to
provide liquidity to the covered clearing agency;
(v) Maintaining and testing with each liquidity provider, to the
extent practicable, the covered clearing agency's procedures and
operational capacity for accessing each type of relevant liquidity
resource under paragraph (e)(7)(i) of this section at least annually;
(vi) Determining the amount and regularly testing the sufficiency
of the liquid resources held for purposes of meeting the minimum liquid
resource requirement under paragraph (e)(7)(i) of this section by, at a
minimum:
(A) Conducting a stress test of its liquidity resources at least
once each day using standard and predetermined parameters and
assumptions;
(B) Conducting a comprehensive analysis on at least a monthly basis
of the existing stress testing scenarios, models, and underlying
parameters and assumptions used in evaluating liquidity needs and
resources, and considering modifications to ensure they are appropriate
for determining the clearing agency's identified liquidity needs and
resources in light of current and evolving market conditions;
(C) Conducting a comprehensive analysis of the scenarios, models,
and underlying parameters and assumptions used in evaluating liquidity
needs and resources more frequently than monthly when the products
cleared or markets served display high volatility, become less liquid,
when the size or concentration of positions held by the clearing
agency's participants increases significantly and in other appropriate
circumstances described in such policies and procedures; and
(D) Reporting the results of its analyses under paragraphs
(e)(6)(vii)(B) and (C) of this section to appropriate decision makers
at the covered clearing agency, including but not limited to, its risk
management committee or board of directors, and using these results to
evaluate the adequacy of and adjust its liquidity risk management
methodology, model parameters, and any other relevant aspects of its
credit risk management framework;
(vii) Performing a conforming model validation of its liquidity
risk models not less than annually or more frequently as may be
contemplated by the covered clearing agency's risk management framework
established pursuant to paragraph (e)(3) of this section;
(viii) Addressing foreseeable liquidity shortfalls that would not
be covered by the covered clearing agency's liquid resources and seek
to avoid unwinding, revoking, or delaying the same-day settlement of
payment obligations;
(ix) Describing the covered clearing agency's process to replenish
any liquid resources that the clearing agency may employ during a
stress event; and
(x) Undertaking an analysis at least once a year that evaluates the
feasibility of maintaining sufficient liquid resources at a minimum in
all relevant currencies to effect same-day and, where appropriate,
intraday and multiday settlement of payment obligations with a high
degree of confidence under a wide range of foreseeable stress scenarios
that includes, but is not limited to, the default of the two
participant families that would potentially cause the largest aggregate
payment obligation for the covered clearing agency in extreme but
plausible market conditions if the covered clearing agency provides
central counterparty services and is either systemically important in
multiple jurisdictions or a clearing agency involved in activities with
a more complex risk profile.
(8) Define the point at which settlement is final no later than the
end of the day on which the payment or obligation is due and, where
necessary or appropriate, intraday or in real time.
(9) Conduct its money settlements in central bank money, where
available and determined to be practical by the board of directors of
the covered clearing agency, and minimize and manage credit and
liquidity risk arising from conducting its money settlements in
commercial bank money if central bank money is not used by the covered
clearing agency.
(10) Establish and maintain transparent written standards that
state its obligations with respect to the delivery of physical
instruments, and establish and maintain operational practices that
identify, monitor, and manage the risks associated with such physical
deliveries.
(11) When the covered clearing agency provides central securities
depository services:
(i) Maintain securities in an immobilized or dematerialized form
for their transfer by book entry, ensure the integrity of securities
issues, and minimize and manage the risks associated with the
safekeeping and transfer of securities;
(ii) Implement internal auditing and other controls to safeguard
the rights of securities issuers and holders and prevent the
unauthorized creation or deletion of securities, and conduct periodic
and at least daily reconciliation of securities issues it maintains;
and
[[Page 29616]]
(iii) Protect assets against custody risk through appropriate rules
and procedures consistent with relevant laws, rules, and regulations in
jurisdictions where it operates.
(12) Eliminate principal risk by conditioning the final settlement
of one obligation upon the final settlement of the other, regardless of
whether the covered clearing agency settles on a gross or net basis and
when finality occurs if the covered clearing agency settles
transactions that involve the settlement of two linked obligations.
(13) Ensure the covered clearing agency has the authority and
operational capacity to take timely action to contain losses and
liquidity demands and continue to meet its obligations by, at a
minimum, doing the following:
(i) Addressing allocation of credit losses the covered clearing
agency may face if its collateral and other resources are insufficient
to fully cover its credit exposures, including the repayment of any
funds the covered clearing agency may borrow from liquidity providers;
(ii) Describing the covered clearing agency's process to replenish
any financial resources it may use following a default or other event
in which use of such resources is contemplated; and
(iii) Requiring the covered clearing agency's participants and,
when practicable, other stakeholders to participate in the testing and
review of its default procedures, including any close-out procedures,
at least annually and following material changes thereto.
(14) Enable, when the covered clearing agency provides central
counterparty services for security-based swaps or engages in activities
that the Commission has determined to have a more complex risk profile,
the segregation and portability of positions of a participant's
customers and the collateral provided to the covered clearing agency
with respect to those positions and effectively protect such positions
and related collateral from the default or insolvency of that
participant.
(15) Identify, monitor, and manage the covered clearing agency's
general business risk and hold sufficient liquid net assets funded by
equity to cover potential general business losses so that the covered
clearing agency can continue operations and services as a going concern
if those losses materialize, including by:
(i) Determining the amount of liquid net assets funded by equity
based upon its general business risk profile and the length of time
required to achieve a recovery or orderly wind-down, as appropriate, of
its critical operations and services if such action is taken;
(ii) Holding liquid net assets funded by equity equal to the
greater of either (x) six months of the covered clearing agency's
current operating expenses, or (y) the amount determined by the board
of directors to be sufficient to ensure a recovery or orderly wind-down
of critical operations and services of the covered clearing agency, as
contemplated by the plans established under paragraph (e)(3)(ii) of
this section, and which:
(A) Shall be in addition to resources held to cover participant
defaults or other risks covered under the credit risk standard in
paragraph (b)(3) or paragraphs (e)(4)(i) through (iii) of this section,
as applicable, and the liquidity risk standard in paragraphs (e)(7)(i)
and (ii) of this section; and
(B) Shall be of high quality and sufficiently liquid to allow the
covered clearing agency to meet its current and projected operating
expenses under a range of scenarios, including in adverse market
conditions; and
(iii) Maintaining a viable plan, approved by the board of directors
and updated at least annually, for raising additional equity should its
equity fall close to or below the amount required under paragraph
(e)(15)(ii) of this section.
(16) Safeguard the covered clearing agency's own and its
participants' assets, minimize the risk of loss and delay in access to
these assets, and invest such assets in instruments with minimal
credit, market, and liquidity risks.
(17) Manage the covered clearing agency's operational risks by:
(i) Identifying the plausible sources of operational risk, both
internal and external, and mitigating their impact through the use of
appropriate systems, policies, procedures, and controls;
(ii) Establishing and maintaining policies and procedures
reasonably designed to ensure that systems have a high degree of
security, resiliency, operational reliability, and adequate, scalable
capacity; and
(iii) Establishing and maintaining a business continuity plan that
addresses events posing a significant risk of disrupting operations.
(18) Establish objective, risk-based, and publicly disclosed
criteria for participation, which permit fair and open access by direct
and, where relevant, indirect participants and other financial market
utilities, require participants to have sufficient financial resources
and robust operational capacity to meet obligations arising from
participation in the clearing agency, and monitor compliance with such
participation requirements on an ongoing basis.
(19) Identify, monitor, and manage the material risks to the
covered clearing agency arising from arrangements in which firms that
are indirect participants in the covered clearing agency rely on the
services provided by direct participants to access the covered clearing
agency's payment, clearing, or settlement facilities.
(20) Identify, monitor, and manage risks related to any link the
covered clearing agency establishes with one or more other clearing
agencies, financial market utilities, or trading markets.
(21) Be efficient and effective in meeting the requirements of its
participants and the markets it serves, and have the covered clearing
agency's management regularly review the efficiency and effectiveness
of its:
(i) Clearing and settlement arrangements;
(ii) Operating structure, including risk management policies,
procedures, and systems;
(iii) Scope of products cleared, settled, or recorded; and
(iv) Use of technology and communication procedures.
(22) Use, or at a minimum accommodate, relevant internationally
accepted communication procedures and standards in order to facilitate
efficient payment, clearing, and settlement.
(23) Maintain clear and comprehensive rules and procedures that
provide for the following:
(i) Publicly disclosing all relevant rules and material procedures,
including key aspects of its default rules and procedures;
(ii) Providing sufficient information to enable participants to
identify and evaluate the risks, fees, and other material costs they
incur by participating in the covered clearing agency;
(iii) Publicly disclosing relevant basic data on transaction volume
and values;
(iv) Providing a comprehensive public disclosure of its material
rules, policies, and procedures regarding governance arrangements and
legal, financial, and operational risk management, accurate in all
material respects at the time of publication, that includes:
(A) Executive summary. An executive summary of the key points from
paragraphs (e)(23)(iv)(B), (C), and (D) of this section;
(B) Summary of material changes since the last update of the
disclosure. A summary of the material changes since the last update of
paragraph (e)(23)(iv)(C) or (D) of this section;
[[Page 29617]]
(C) General background on the covered clearing agency. A
description of:
(1) The covered clearing agency's function and the markets it
serves,
(2) Basic data and performance statistics on the covered clearing
agency's services and operations, such as basic volume and value
statistics by product type, average aggregate intraday exposures to its
participants, and statistics on the covered clearing agency's
operational reliability, and
(3) The covered clearing agency's general organization, legal and
regulatory framework, and system design and operations; and
(D) Standard-by-standard summary narrative. A comprehensive
narrative disclosure for each applicable standard set forth in
paragraphs (e)(1) through (22) of this section with sufficient detail
and context to enable a reader to understand the covered clearing
agency's approach to controlling the risks and addressing the
requirements in each standard; and
(v) Updating the public disclosure under paragraph (e)(23)(iv) of
this section every two years, or more frequently following changes to
its system or the environment in which it operates to the extent
necessary to ensure statements previously provided under paragraph
(e)(23)(iv) of this section remain accurate in all material respects.
(f) For purposes of enforcing the Payment, Clearing, and Settlement
Supervision Act of 2010 (12 U.S.C. 5461 et seq.), a designated clearing
agency for which the Commission acts as supervisory agency shall be
subject to, and the Commission shall have the authority under, the
provisions of paragraphs (b) through (n) of Section 8 of the Federal
Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the
same extent as if such designated clearing agency were an insured
depository institution and the Commission were the appropriate Federal
banking agency for such insured depository institution.
By the Commission.
Dated: March 12, 2014.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-05806 Filed 3-25-14; 8:45 a.m.]
Editorial Note: Proposed rule document 2014-05806 was originally
published on pages 16865 through 16975 in the issue of Wednesday,
March 26, 2014. In that publication the footnotes contained
erroneous entries. The corrected document is republished in its
entirety.
[FR Doc. R1-2014-05806 Filed 5-21-14; 8:45 am]
BILLING CODE 1505-01-D