[Federal Register Volume 79, Number 214 (Wednesday, November 5, 2014)]
[Rules and Regulations]
[Pages 65543-65562]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-26090]



[[Page 65543]]

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FEDERAL RESERVE SYSTEM

12 CFR Part 234

[Regulation HH; Docket No. R-1477]
RIN No. 7100-AE09


Financial Market Utilities

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board of Governors of the Federal Reserve System (Board) 
is publishing a final rule revising the risk-management standards in 
its Regulation HH, Designated Financial Market Utilities. The Board is 
replacing the existing two sets of risk-management standards for 
payment systems and for central securities depositories and central 
counterparties with a common set of risk-management standards for all 
types of designated financial market utilities (FMUs) and making 
conforming changes to the definitions. The new common set of risk-
management standards and the definitions are based on the Principles 
for Financial Market Infrastructures (PFMI), which were developed by 
the Committee on Payment and Settlement Systems (CPSS) and the 
Technical Committee of the International Organization of Securities 
Commissions (IOSCO) and published in April 2012.

DATES: This final rule is effective December 31, 2014. Designated FMUs 
must be in compliance with the rule by the effective date, with the 
exception of establishing plans for recovery and orderly wind-down, set 
forth in Sec.  234.3(a)(3)(iii); addressing uncovered credit losses, 
set forth in Sec.  234.3(a)(4)(vi); addressing liquidity shortfalls, 
set forth in Sec.  234.3(a)(7)(viii); maintaining sufficient liquid net 
assets funded by equity and a viable capital plan, set forth in Sec.  
234.3(a)(15)(i) and (ii); managing risks arising in tiered 
participation arrangements, set forth in Sec.  234.3(a)(19); and 
providing comprehensive public disclosure, set forth in Sec.  
234.3(a)(23)(iv), which have a compliance date of December 31, 2015.

FOR FURTHER INFORMATION CONTACT: Jennifer A. Lucier, Deputy Associate 
Director (202) 872-7581, Paul Wong, Manager (202) 452-2895, or Emily A. 
Caron, Senior Financial Services Analyst (202) 452-5261, Division of 
Reserve Bank Operations and Payment Systems; Christopher W. Clubb, 
Special Counsel (202) 452-3904, Legal Division; for users of 
Telecommunications Device for the Deaf (TDD) only, contact (202) 263-
4869.

SUPPLEMENTARY INFORMATION:

I. Background

    Title VIII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act or Act), titled the ``Payment, Clearing, 
and Settlement Supervision Act of 2010,'' was enacted to mitigate 
systemic risk in the financial system and to promote financial 
stability, in part, through an enhanced supervisory framework for FMUs 
that have been designated systemically important (designated FMUs) by 
the Financial Stability Oversight Council (Council).\1\ Section 803(6) 
of the Act defines an FMU as a person that manages or operates a 
multilateral system for the purposes of transferring, clearing, or 
settling payments, securities, or other financial transactions among 
financial institutions or between financial institutions and the 
person. Pursuant to section 805(a)(1)(A) of the Act, the Board is 
required to prescribe risk-management standards governing the 
operations related to the payment, clearing, and settlement activities 
of certain designated FMUs.\2\
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    \1\ The Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376, was 
signed into law on July 21, 2010.
    \2\ The risk-management standards promulgated by the Board under 
section 805(a)(1)(A) apply to designated FMUs for which the Board is 
the Supervisory Agency. The term ``Supervisory Agency'' is defined 
in Title VIII as the ``Federal agency that has primary jurisdiction 
over a designated financial market utility under Federal banking, 
securities, or commodity futures laws'' (12 U.S.C. 5462(8)). 
Currently, the Board is the Supervisory Agency for two FMUs that 
have been designated by the Council--The Clearing House Payments 
Company, L.L.C., on the basis of its role as operator of the 
Clearing House Interbank Payments System, and CLS Bank 
International. These standards also apply to any designated FMU for 
which another Federal banking agency is the appropriate Title VIII 
Supervisory Agency. At this time, there are no designated FMUs in 
this category.
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    In July 2012, the Board adopted Regulation HH, Designated Financial 
Market Utilities, to implement, among other things, the statutory 
provisions under section 805(a)(1)(A) of the Act.\3\ Regulation HH 
established two sets of risk-management standards for certain 
designated FMUs: One set of risk-management standards for designated 
FMUs that operate a payment system (Sec.  234.3(a)) and another set for 
designated FMUs that operate a central securities depository or a 
central counterparty (CCP) (Sec.  234.4(a)).\4\ The Regulation HH risk-
management standards do not apply to designated FMUs for which the U.S. 
Commodity Futures Trading Commission (CFTC) or the U.S. Securities and 
Exchange Commission (SEC) is the Supervisory Agency under Title VIII of 
the Dodd-Frank Act.\5\
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    \3\ 12 CFR part 234.
    \4\ At the time of the rulemaking, the Board acknowledged that 
designated FMUs that operate as central securities depositories or 
CCPs generally would be subject to the risk-management standards 
promulgated by the U.S. Commodity Futures Trading Commission (CFTC) 
or U.S. Securities and Exchange Commission (SEC). The Board, 
however, adopted standards for designated FMUs that operate as 
central securities depositories, CCPs, or both, to address the event 
that a designated FMU operates as one of the two types of FMUs and 
is not required to register as a derivatives clearing organization 
or a clearing agency with the CFTC or SEC, respectively.
    \5\ 12 CFR 234.1.
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    In adopting Regulation HH, the Board considered relevant 
international standards that were in effect at the time the rule was 
proposed in March 2011 as well as the Board's Federal Reserve Policy on 
Payment System Risk (PSR policy).\6\ In April 2012, CPSS and IOSCO 
published the PFMI, which updated, harmonized, strengthened, and 
replaced the previous international risk-management standards for 
payment systems that are systemically important, central securities 
depositories, securities settlement systems, and CCPs.\7\ The PFMI is 
now widely recognized as the most relevant set of international risk-
management standards for payment, clearing, and settlement systems.
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    \6\ The relevant international standards were the 2001 CPSS 
report on the Core Principles for Systemically Important Payment 
Systems, the 2001 CPSS-IOSCO report on the Recommendations for 
Securities Settlement Systems, and the 2004 CPSS-IOSCO report on the 
Recommendations for Central Counterparties. The Board previously 
incorporated these international standards into its PSR policy.
    \7\ The PFMI also establishes minimum requirements for trade 
repositories, which have emerged internationally as an important 
category of financial market infrastructure. The term ``financial 
market utility,'' as defined in Title VIII of the Act, excludes 
trade repositories.
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    In January 2014, the Board published for comment a notice of 
proposed rulemaking (NPRM) to revise the risk-management standards in 
Regulation HH based on the PFMI.\8\ The revisions were proposed to 
replace the risk-management standards in Sec. Sec.  234.3 and 234.4 
with a common set of risk-management standards applicable to all types 
of designated FMUs in proposed Sec.  234.3. The Board also made 
conforming changes to the definitions in proposed Sec.  234.2. The 
public comment period for the proposed revisions closed on March 31, 
2014.
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    \8\ Concurrent with the NPRM, the Board issued in a separate 
Federal Register notice proposed revisions to part I of the PSR 
policy based on the PFMI. These revisions incorporated the headline 
standards from the 24 principles with no modification as the 
relevant risk-management standards for all central securities 
depositories, securities settlement systems, CCPs, and trade 
repositories, as well as certain payment systems. (79 FR 2838, 
January 16, 2014.)

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II. Summary of Public Comments and Analysis

    The Board received four public comment letters that were responsive 
to the NPRM, all from entities that operate designated FMUs. The Board 
considered each of these comments as well as subsequent staff analysis 
in developing its final rule as discussed below. Except as noted 
herein, the Board is adopting the rule text as proposed.\9\
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    \9\ The Board is also making several technical edits, which are 
not specifically addressed in the discussion below.
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A. Overall Approach

    The Board proposed to amend Regulation HH by replacing the existing 
risk-management standards with a set of standards based on the PFMI and 
making conforming changes to the definitions. Commenters were generally 
supportive of the Board's overall approach. One commenter, however, 
raised two general concerns with respect to the Board's overall 
approach. The commenter expressed concern that one uniform set of 
standards that applies to all designated FMUs and all designs of the 
same type of designated FMU does not sufficiently take into account 
material differences that can be found among the same types of system. 
The commenter also expressed concern that differences in language 
between the risk-management standards in Regulation HH and in part I of 
the PSR policy may result in two different sets of risk-management 
standards for FMUs.
    With respect to differences among types of systems, the Board 
believes that a uniform set of standards for all types of designated 
FMU is appropriate because all designated FMUs potentially face and 
must manage many of the same types of risk. Although the design of 
systems may vary, the flexibility in the standards allows individual 
designated FMUs to implement, and supervisors to enforce, the standards 
appropriately based on the design of and risks that arise in a 
particular designated FMU. The Board also believes that a uniform set 
of standards promotes financial stability because it facilitates 
effective and consistent risk management across different types of FMUs 
and markets. Furthermore, the Board has noted in the rule when a 
particular requirement applies only to certain types of designated FMU 
because of its specific design or function (for example, only 
designated FMUs that operate a CCP are required to have a risk-based 
margin system to cover credit risk). For these reasons, the Board 
continues to believe the overall approach is appropriate.
    With respect to the differences in the language between Regulation 
HH and part I of the PSR policy, the Board continues to believe that 
such differences are appropriate. Regulation HH is an enforceable rule 
applicable to designated FMUs other than those supervised by the CFTC 
or SEC, so additional details from the key considerations and 
explanatory notes of the PFMI were incorporated in the rule text to 
provide greater clarity on the Board's expectations. The PSR policy, on 
the other hand, is a policy statement that provides guidance with 
respect to the Board's exercise of its other supervisory or regulatory 
authority over other financial market infrastructures (including those 
operated by the Federal Reserve Banks) or their participants, its 
participation in cooperative oversight arrangements for financial 
market infrastructures, or the provision of intraday credit to eligible 
Federal Reserve account holders. Incorporating the headline standards 
from the PFMI is consistent with the purpose of the document and the 
Board's long-standing principles-based approach to its PSR policy. 
Further, the Board has stated that it will be guided by the key 
considerations and the explanatory text of the PFMI in its application 
of the PSR policy. The Board does not intend for differences in 
language in the two documents to lead to inconsistent policy results.

B. Proposed Sec.  234.2--Definitions

    The Board proposed amendments to the definitions in Sec.  234.2 by 
revising three definitions, adding six definitions, and deleting one 
definition.\10\ The revisions were proposed for clarity and consistency 
with the revised risk-management standards. The Board received one 
comment letter that addressed several of the proposed changes to the 
definitions in Sec.  234.2. The Board has revised the definitions of 
``recovery'' and ``wind-down'' in response to these comments. In 
addition, the Board has decided to make clarifying edits to the 
proposed definition of ``link'' and to add a definition for ``trade 
repository.''
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    \10\ The Board proposed deletion of the term ``payment system'' 
because it was not used in the proposed single set of standards for 
all designated FMUs. If, in the future, the Board revises Regulation 
HH to provide risk-management standards specific to payment systems, 
it anticipates, at that time, reinserting a definition of the term 
``payment system,'' if necessary.
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    Recovery. The Board proposed to add a definition for the term 
``recovery'' as used in proposed Sec.  234.3(a)(3) and Sec.  
234.3(a)(15). The proposal defined ``recovery'' for the purposes of 
Sec.  234.3(a)(3) and Sec.  234.3(a)(15) as ``the actions of a 
designated financial market utility consistent with its rules, 
procedures, and other ex-ante contractual arrangements, to address any 
uncovered credit loss, liquidity shortfall, capital inadequacy, or 
business, operational or other structural weakness, including the 
replenishment of any depleted prefunded financial resources and 
liquidity arrangements, as necessary to maintain the designated 
financial market utility's viability as a going concern.'' The term 
``recover'' was also used, with a different meaning, in proposed Sec.  
234.3(a)(17) on operational risk in the context of business continuity 
management.
    The commenter requested clarification between ``recovery'' as used 
in proposed Sec.  234.3(a)(3) and proposed Sec.  234.3(a)(15) and 
``recover'' as used in proposed Sec.  234.3(a)(17). The commenter 
suggested that the concept of recovery is financial in nature and that 
the reference to operational weakness in the proposed definition 
concerns the financial impact of an operational issue. The Board agrees 
with the commenter's understanding of ``recovery'' as used in proposed 
Sec.  234.3(a)(3) and proposed Sec.  234.3(a)(15). The reference in the 
definition to the designated FMU's ``viability as a going concern'' is 
intended to indicate that the objective of the recovery plan is a 
return to financial health. Therefore, a designated FMU should consider 
in its recovery plan scenarios in which an operational event could 
cause the designated FMU to become insolvent. The use of ``recover'' in 
proposed Sec.  234.3(a)(17), however, refers to a designated FMU's 
ability to recover and resume its critical operations and services in a 
timely manner after an operational disruption. This use of the term is 
operational in nature, not financial. The Board is making technical 
edits to the definition for clarity.
    Wind-down. The Board proposed to add a definition for the term 
``wind-down,'' which is used in proposed Sec.  234.3(a)(3) and proposed 
Sec.  234.3(a)(15). The proposal defined ``wind-down'' as ``the actions 
of a designated financial market utility to effect the permanent 
cessation, sale, or transfer of one or more of its critical operations 
or services.'' The commenter requested additional guidance on whether a 
wind-down plan should consider appropriate notice to participants and 
the market, or whether the plan should focus only on the amount of time 
required to wind down the corporate entity.
    Although the commenter referred to the definition of ``wind-down'' 
in its

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comment, the Board understands that the commenter is referring to the 
requirement in proposed Sec.  234.3(a)(3) to develop and maintain a 
plan for an orderly wind-down. As stated in the proposed rule, the 
Board requires the designated FMU to plan for an orderly wind-down, 
which would include providing appropriate notice to the market to allow 
participants to transition to alternative arrangements in an orderly 
manner. This would likely require the designated FMU to assume a longer 
period for wind-down than if the requirement were only to wind down the 
corporate entity as quickly as possible. Given that the term ``wind-
down'' is only used in the context of an ``orderly wind-down'' in the 
proposed rule, the Board has replaced the definition of ``wind-down'' 
with a definition for ``orderly wind-down.'' The new definition is 
intended to clarify that if a designated FMU were to wind down, it 
would be expected to do so in a manner that would not 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.
    Link. The Board proposed to add a definition for ``link,'' which is 
used in proposed Sec.  234.3(a)(20). The proposal defined ``link'' as 
``for purposes of Sec.  234.3(a)(20), a set of contractual and 
operational arrangements between two or more central counterparties, 
central securities depositories, or securities settlement systems that 
connect them directly or indirectly, such as for the purposes of 
participating in settlement, cross margining, or expanding their 
services to additional instruments and participants.''
    Because of the difference in the definition of financial market 
infrastructure in the PFMI, which includes trade repositories, and 
financial market utility in the Dodd-Frank Act, which does not, this 
definition inadvertently excluded links to trade repositories. Upon 
further consideration, the Board has added these links to the 
definition for consistency with the PFMI, defined trade repository in 
Sec.  234.2 as ``an entity that maintains a centralized electronic 
record of transaction data, such as a swap data repository or a 
security-based swap data repository,'' and made conforming changes to 
Sec.  234.3(a)(20).

C. Governance

    Proposed Sec.  234.3(a)(2) outlined the requirements for a 
designated FMU's governance arrangements. The comments the Board 
received on the proposed rule are discussed below.
    Support for public interest considerations. Proposed Sec.  
234.3(a)(2)(iii) required the designated FMU to have governance 
arrangements that support the stability of the broader financial 
system, other relevant public interest considerations, and the 
legitimate interests of relevant stakeholders. One commenter noted that 
public interest considerations is a vague concept, and that private-
sector systems should not be required to consider public interest 
considerations and should focus exclusively on the needs of 
participants. The Board believes that, in addition to supporting the 
stability of the broader financial system, a designated FMU should 
support public interest considerations that are consistent with the 
other objectives of Title VIII of the Act to promote robust risk 
management, promote the safety and soundness of the designated FMU, and 
reduce systemic risks. For example, in the NPRM, the Board listed 
supporting fair and efficient markets as a possible relevant public 
interest consideration because a designated FMU that creates 
inefficiencies in the market may drive market participants toward less-
safe alternatives that could increase systemic risks. Market 
transparency is another public interest consideration that may be 
relevant. For example, a designated FMU that provides information to 
relevant authorities and the public about payment flows may help to 
identify and reduce sources of systemic risk. For certain designated 
FMUs, however, stability of the broader financial system may be the 
predominant or only relevant public interest consideration.
    Further, in the NPRM, the Board asked whether proposed Sec.  
234.3(a)(2)(iii) should specify ``other relevant public interest 
considerations'' for a specific type of or a particular designated FMU. 
One commenter responded that the examples given in the NPRM--fostering 
fair and efficient markets, market transparency, and investor 
protection--in combination with the Board's guidance through the 
supervisory process would be sufficient to assist a designated FMU in 
identifying relevant public interests. The Board is adopting the text 
of the rule as proposed.
    Representation on the board of directors. Proposed Sec.  
234.3(a)(2)(iv)(D) required that the designated FMU's board of 
directors include a majority of individuals who are not executives, 
officers, or employees of the designated FMU or an affiliate. In the 
NPRM, the Board asked whether it should set a specific minimum 
percentage of these individuals on the board of directors and whether 
it should set any requirements for the participation of outside 
directors (that is, directors who are not participants in or 
executives, officers, or employees of the designated FMU or an 
affiliate). Commenters generally indicated that the final rule should 
retain flexibility on board representation and did not advocate for a 
change to the proposed text. The Board is adopting the text of the rule 
as proposed to provide some flexibility in the composition of the board 
of directors. The Board, however, believes that outside directors 
should exercise predominate influence over the board of directors to 
ensure robust governance and oversight of the designated FMU.
    In the NPRM, the Board also asked whether there should be a 
requirement that the chair of the board of directors be (a) an 
individual who is not an executive, officer, or employee of the 
designated FMU or an affiliate of the designated FMU or (b) a different 
individual than the designated FMU's chief executive officer. One 
commenter responded that the chair of the board of directors should be 
an independent director. Although it believes designating an 
independent director as board chair generally results in more robust 
governance, the Board recognizes that other board structures, such as 
the appointment of a lead independent director, may achieve a similar 
outcome as having an independent director as board chair. Therefore, 
the Board is adopting the text of the rule as proposed to provide 
flexibility in the structure of the board of directors. If the Board 
has governance concerns regarding the FMU, however, it may ask, as part 
of the supervisory process, a designated FMU that has a single person 
serving as the chief executive officer and the board chair to consider 
splitting these roles or adding a lead independent director.
    Performance reviews of the board of directors. Proposed Sec.  
234.3(a)(2)(iv)(E) required the board of directors to establish 
policies and procedures to review its own performance. In the NPRM, the 
Board asked whether there should be a requirement for these regular 
reviews to include periodic independent assessments of the board of 
directors. One commenter responded that an independent party should 
perform such reviews but that the precise frequency, scope, and 
specifics of the review should be determined by the designated FMU. An 
independent review of board performance is a good practice that can 
help strengthen the governance of the designated FMU. A designated FMU 
might consider conducting such reviews on a periodic basis. The Board 
has decided, however,

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to retain flexibility with respect to the manner in which a designated 
FMU reviews performance of its board of directors. The Board is 
adopting the text of the rule as proposed. If the Board has governance 
concerns regarding the FMU, however, it may direct, through the 
supervisory process, a designated FMU to obtain an independent 
performance review of the board of directors.
    Structure and composition of the committees of the board of 
directors. Proposed Sec.  234.3(a)(2)(iv)(H)-(I) required that the 
risk-management and internal audit functions be overseen by a committee 
of the board of directors. In the NPRM, the Board asked whether the 
designated FMU's board of directors should be required to have a 
committee of the board of directors that has only audit 
responsibilities to which the audit function reports and a risk 
committee of the board of directors that has only risk-management 
responsibilities to which the risk-management function reports. The 
Board also asked whether, alternatively, the designated FMU's audit and 
risk-management functions should be required to report directly to the 
entire board of directors. One commenter stated that a designated FMU's 
board of directors should have an audit committee and a risk-management 
committee and that independent directors should chair board committees 
where possible. Another commenter stated that the structure of the 
audit and risk-management committees should be left to the designated 
FMU's discretion and that the audit and risk-management committees can 
be composed of professionals who are not members of the board of 
directors so long as there is reporting to the board of directors.
    After further consideration, the Board agrees that the requirement 
should not be overly prescriptive with respect to the structure of 
board committees. The specific decisions regarding how the board of 
directors will structure its committees to oversee the audit and risk-
management functions should be left to the designated FMU's discretion. 
The Board is adopting the text of the rule as proposed.
    Reporting lines for the internal audit and risk-management 
functions. Proposed Sec.  234.3(a)(2)(iv)(H)-(I) required that the 
risk-management and internal audit functions have sufficient authority, 
resources, and independence and that each have a direct reporting line 
to and be overseen by a committee of the board of directors. A 
commenter stated that a designated FMU's risk-management function 
should have a primary functional reporting line to the executive 
management of the designated FMU, whereas in the case of audit, the 
reporting line should be independent of executive management.
    Although a reporting line from the risk-management function to 
executive management is certainly reasonable and useful, the Board 
believes that the risk-management function should have a reporting line 
to a committee of the board of directors to ensure that the risk-
management function has sufficient independence from executive 
management. The proposed rule required the risk-management function to 
have a direct reporting line to a committee of the board of directors, 
but it does not preclude a reporting line to executive management as 
well. The Board is adopting the text of the rule as proposed.

D. Framework for the Comprehensive Management of Risks

    Proposed Sec.  234.3(a)(3) required a designated FMU to have a 
sound risk-management framework for comprehensively managing legal, 
credit, liquidity, operational, general business, custody, investment, 
and other risks that arise in or are borne by the designated FMU. One 
commenter raised several issues with the requirements in proposed Sec.  
234.3(a)(3), and they are discussed below.
    Frequency of review of the risk-management framework. Proposed 
Sec.  234.3(a)(3) required, among other things, that the framework for 
the comprehensive management of risks be subject to periodic review. In 
the NPRM, the Board asked whether it should establish an annual or 
longer minimum frequency of review for the overall framework. The 
commenter responded that the Board should not be overly prescriptive 
with respect to the review frequency, noting that different standards 
have different review frequencies and that establishing a general 
review frequency for the comprehensive risk-management framework could 
be duplicative or contradict the review frequencies in other proposed 
standards. The Board agrees that a specific frequency for review is not 
necessary, and is adopting the proposed text in Sec.  234.3(a)(3) 
regarding periodic review for the overall framework.
    Requirement to maintain plans for recovery and orderly wind-down. 
Proposed Sec.  234.3(a)(3)(iii) required that a designated FMU's risk-
management framework include plans for the designated FMU's recovery or 
orderly wind-down that contain the elements listed at proposed Sec.  
234.3(a)(3)(iii)(A) to (F). The commenter stated that a designated 
FMU's regulator should have the discretion to determine if the 
designated FMU would be required to produce both a recovery plan and an 
orderly wind-down plan.
    The Board understands that there may have been some ambiguity 
regarding whether proposed Sec.  234.3(a)(3)(iii) required both a 
recovery plan and an orderly wind-down plan or just one of the two. The 
Board expects a designated FMU to prepare plans for both recovery and 
orderly wind-down. Recovery plans should not be based on assumptions of 
government intervention or support. In addition, the Board believes 
that the recovery and orderly wind-down plans should be integrated 
because there may be circumstances in which a designated FMU attempts 
to recover but the recovery effort eventually fails. In such 
circumstances, the designated FMU should have a plan as well as 
sufficient capital to transition to and execute an orderly wind-down. 
The Board is therefore clarifying in Sec.  234.3(a)(3)(iii) that a 
designated FMU must prepare integrated plans for recovery and orderly 
wind-down.\11\ The Board is also making conforming edits in Sec.  
234.3(a)(3)(iii)(C) through (F) and, for greater clarity, has revised 
the requirement in Sec.  234.3(a)(15)(i)(A) with respect to the cost to 
implement the plans to refer back to the requirements in Sec.  
234.3(a)(3)(iii).
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    \11\ As noted above, the compliance date for preparing plans for 
recovery and orderly wind-down is December 31, 2015. Designated FMUs 
are encouraged to share with supervisors drafts of these plans, as 
well as other required plans, procedures, or documents, in advance 
of the compliance date so that final versions are in place by 
December 31, 2015.
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    Scenarios addressed by recovery and orderly wind-down plans. 
Proposed Sec.  234.3(a)(3)(iii)(B) required that a designated FMU's 
plans identify scenarios that may potentially prevent the FMU from 
being able to provide its critical operations and services as a going 
concern, including uncovered credit losses, uncovered liquidity 
shortfalls, and general business losses. The commenter noted that such 
scenarios should contemplate severe and extreme scenarios and that each 
scenario should be distinct so that the analysis of the scenarios would 
not be duplicative. The Board agrees that the scenarios addressed by 
recovery and orderly wind-down plans should include severe and systemic 
stress events beyond those contemplated by business continuity 
planning, normal crisis-management, or failure-management tools. In 
particular, as indicated by the reference to the designated FMU's 
inability to continue

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as a going concern, these scenarios involve shocks that could 
potentially cause the designated FMU to become insolvent and cease 
operations. The Board also agrees that such scenarios should be 
sufficiently distinct so the analysis related to a particular scenario 
is not duplicative. The Board believes, however, that the text of the 
rule is sufficiently clear on these points. The Board is adopting the 
text of the rule as proposed.
    Triggers for implementation of recovery and orderly wind-down 
plans. Proposed Sec.  234.3(a)(3)(iii)(C) required that a designated 
FMU's plans identify criteria that could trigger the implementation of 
the recovery or orderly wind-down plans. The commenter stated that the 
designated FMU should have discretion to decide whether it will 
continue its services that are deemed noncritical, provided that the 
financial consequences are not material to its ability to operate the 
critical services. The commenter also noted that that triggers should 
be flexible and that management, working with its regulators and other 
stakeholders, should make the decision whether to trigger the plan 
based on the relevant facts and circumstances of the given situation. 
Finally, the commenter noted that triggers should not be required to be 
defined solely in quantifiable or monetary terms.
    The Board agrees with the comments provided on the triggers for the 
implementation of the recovery and orderly wind-down plans. The 
designated FMU would have discretion to decide whether it will continue 
its noncritical services, as long as the decision would not impair its 
ability to recover its critical operations and services or to wind them 
down in an orderly manner. Also, the decision to trigger a recovery or 
orderly wind-down plan will depend on the relevant facts and 
circumstances at the time and any such decision will likely include 
discussions between the designated FMU and its supervisor. This is 
consistent with the requirement in proposed Sec.  234.3(a)(3)(iii)(F) 
that the recovery and orderly wind-down plans include procedures for 
informing the Board if the designated FMU is considering initiating one 
of the plans. The Board did not propose inclusion of automatic triggers 
based solely on quantifiable or monetary terms and is not adopting such 
terms in the final rule.
    Requirement for rules, procedures, policies, and tools for recovery 
and orderly wind-down plans. Proposed Sec.  234.3(a)(3)(iii)(D) 
required that the plans include rules, procedures, policies, and any 
other tools the designated FMU would use in a recovery or orderly wind-
down to address the scenarios addressed in proposed Sec.  
234.3(a)(3)(iii)(B). The commenter stated that the application of 
certain tools, such as expense reduction or refinancing, will depend on 
the circumstances at the time of distress and therefore may not fit 
well into the designated FMU's ``rules, policies, and procedures.'' The 
Board believes that if a designated FMU contemplates using a particular 
type of tool in the event of a recovery or orderly wind-down, it should 
develop rules, policies, and procedures to provide a basis for using 
the tool as well as transparency to its participants regarding how the 
tool may be used. The Board expects the designated FMU to provide as 
much detail in the rules, policies, and procedures as possible, but 
recognizes that some components may need to be general, because the 
specific implementation of the tool may depend on the circumstances. 
The Board is not revising the final rule in response to this comment.
    Requirements for informing the Board of initiation of the recovery 
or orderly wind-down plan. Proposed Sec.  234.3(a)(3)(iii)(F) required 
that the designated FMU have procedures to inform the Board, as soon as 
practicable, if it is considering initiating the recovery or orderly 
wind-down plan. The commenter stated that certain tools, such as loss 
allocation, could be triggered automatically pursuant to ex ante 
agreements. In such circumstances, a notification to the Board could be 
contemporaneous with or after use of such tools. The Board believes 
that a designated FMU should notify the Board that it is considering 
initiating the recovery or orderly wind-down plan before initiating the 
relevant plan if at all possible. If there are specific tools or 
elements of a plan that may be activated automatically, the requirement 
proposed in Sec.  234.3(a)(3)(iii)(F) that notification be ``as soon as 
practicable'' permits the designated FMU, in such circumstances, to 
provide notification contemporaneous with or immediately after use of 
such tools. Accordingly, the Board is not revising the final rule in 
response to this comment.
    Frequency of review of recovery and orderly wind-down plans. The 
proposed rule did not specify a frequency of review for the recovery 
and orderly wind-down plans required under proposed Sec.  
234.3(a)(3)(iii), but the Board stated in the NPRM that these plans 
should be reviewed and tested at least annually or following material 
changes to the designated FMU's operations or risk profile. The 
commenter urged that such reviews occur every other year, assuming no 
interim material change in the designated FMU's risk exposure, as this 
frequency would provide sufficient time to amend, draft, negotiate, and 
discuss any such changes with stakeholders. The commenter also noted 
this frequency would be aligned with the requirements for public 
disclosure in proposed Sec.  234.3(a)(23)(v).
    The Board agrees that a designated FMU should review its recovery 
and orderly wind-down plans the earlier of every two years or following 
changes to the designated FMU or the environment in which it operates 
that would significantly affect the viability or execution of the 
plans. After considering the comments, the Board believes a minimum 
requirement for review of the plans of every two years is more 
appropriate than an annual review because an annual review cycle may 
not allow sufficient time to analyze, discuss with stakeholders and 
supervisors, and implement any required changes. The Board is revising 
the rule text to clarify the requirement in Sec.  234.3(a)(3)(iii)(G) 
that the designated FMU review the plans the earlier of every two years 
or following changes to its system or the environment in which it 
operates that would significantly affect the viability or execution of 
the plans.

E. Credit Risk

    Proposed Sec.  234.3(a)(4) required a designated FMU to measure, 
monitor, and manage effectively its credit exposures to its 
participants and the credit exposures arising from its payment, 
clearing, and settlement processes. The Board received two comments on 
this proposed provision that are addressed below.
    Replenishment of financial resources. Proposed Sec.  
234.3(a)(4)(vi)(B) required that a designated FMU establish rules and 
procedures that explicitly describe the designated FMU's process to 
replenish financial resources employed during a stress event. One 
commenter noted that circumstances would dictate how a designated FMU 
manages the replenishment of financial resources employed in a stress 
scenario and that the Board should revise the proposed rule to allow 
greater flexibility. The Board acknowledges that the details of the 
replenishment process may depend on the particular circumstances that 
the designated FMU faces in a stress event and that it may not be 
possible to predict fully the future. The rules and procedures 
regarding replenishment, however, should be explicit and as specific as 
possible in order to provide

[[Page 65548]]

guidance to the designated FMU's staff, participants, and other 
stakeholders during an actual stress event. Moreover, given that a 
designated FMU cannot predict the exact circumstances it may face, its 
rules and procedures for replenishment should address a wide range of 
potential circumstances. The Board is adopting the text of the rule as 
proposed.
    Triggers for a ``cover 2'' requirement. Proposed Sec.  
234.3(a)(4)(ii) provided that the Board may direct a designated FMU 
that operates as a CCP to maintain additional prefunded financial 
resources that are sufficient to cover its credit exposure under a wide 
range of significantly different stress scenarios, including the 
default of the two participants and their affiliates that would 
potentially cause the largest aggregate credit exposure to the CCP in 
extreme but plausible market conditions (a ``cover 2'' requirement). 
The proposal stated further that the Board may direct such a CCP to 
meet a ``cover 2'' requirement if it either is involved in activities 
with a more-complex risk profile, such as clearing financial market 
instruments characterized by discrete jump-to-default price changes or 
that are highly correlated with potential participant defaults, or has 
been determined by another jurisdiction to be systemically important in 
that jurisdiction.
    A commenter stated that, in applying this provision, the Board 
should also consider ``the proportion of the CCP's clearing activities 
involving products with complex risk profiles as well as the manner in 
which the CCP manages those risks.'' The commenter asked the Board to 
confirm that the ``cover 2'' requirement would not be triggered if a 
CCP has a small amount of activity with a complex risk profile relative 
to overall activity or if the CCP addresses the added risk incurred, 
such as through enhanced margin systems. In making its determination 
with respect to a ``cover 2'' requirement, the Board would consider all 
relevant facts and circumstances, including the CCP's product mix and 
risk profile. Except for minor technical edits, the Board is adopting 
the text of the rule as proposed.\12\
---------------------------------------------------------------------------

    \12\ The Board has revised Sec.  234.3(a)(4)(ii) to clarify that 
it is the Board that makes the determination with respect to a 
``cover 2'' requirement.
---------------------------------------------------------------------------

F. Collateral

    Proposed Sec.  234.3(a)(5) required a designated FMU that uses 
collateral to manage its or its participants' credit exposure to accept 
collateral with low credit, liquidity, and market risks and to set and 
enforce appropriately conservative haircuts and concentration limits. 
One commenter supported flexibility in the wording of the requirement 
and urged that it not be interpreted to exclude the use of equity 
securities as collateral for equity options. The Board believes that 
the text in proposed Sec.  234.3(a)(5) retains the necessary 
flexibility to permit, where appropriate, a designated FMU to integrate 
the management of risk from participant positions with the risk from 
fluctuations in the value of collateral provided by participants. One 
example would be for the designated FMU to hold equity securities as 
collateral for options on those same securities. Therefore, the Board 
is adopting the text of the rule as proposed.

G. Liquidity Risk

    Proposed Sec.  234.3(a)(7) required a designated FMU to measure, 
monitor, and manage effectively the liquidity risk that arises in or is 
borne by the designated FMU. The comments received on specific elements 
of the liquidity risk-management requirements are discussed below.
    Participants' affiliates. Under proposed Sec.  234.3(a)(7)(ii), a 
designated FMU was required to maintain sufficient liquid resources in 
all relevant currencies to effect same-day and, as applicable, intraday 
and multiday settlement of payment obligations with a high degree of 
confidence under a wide range of significantly different potential 
stress scenarios, including the default of the participant and its 
affiliates that would generate the largest aggregate liquidity 
obligation for the designated FMU in extreme but plausible market 
conditions.\13\ One commenter stated that the inclusion of the 
liquidity obligations of a defaulting participant's affiliates in 
calculating the largest aggregate liquidity obligation in proposed 
Sec.  234.3(a)(7)(ii) should be clarified or removed because ``a 
designated FMU may not have the authority to demand detailed 
information on participants' affiliates, particularly for affiliates in 
peripheral lines of business.''
---------------------------------------------------------------------------

    \13\ The Board believes that deliveries of currency are payment 
obligations, rather than physical deliveries under Sec.  
234.3(a)(10), and expects a designated FMU subject to Regulation HH 
to manage effectively the liquidity risk related to these payments.
---------------------------------------------------------------------------

    The Board believes this requirement is sufficiently clear as 
written. Participants' affiliates that would generate liquidity 
obligations to the designated FMU would be known to the designated FMU. 
Such affiliates may include affiliates that are also participants in 
the designated FMU, liquidity providers to the designated FMU, and 
custodians of the assets held in accounts for the designated FMU. 
Affiliates in peripheral lines of business would be unlikely to 
generate liquidity obligations to the designated FMU. Therefore, the 
Board is retaining the text of the rule as proposed.
    Qualifying liquid resources. For purposes of meeting the liquid 
resource requirement under proposed Sec.  234.3(a)(7)(ii), proposed 
Sec.  234.3(a)(7)(iii) required the designated FMU to maintain these 
liquid resources in cash in each relevant currency at the central bank 
of issue or at creditworthy commercial banks, or in assets that are 
readily available and convertible into cash through committed 
arrangements without material adverse change conditions. These 
committed arrangements included, but were not limited to, 
collateralized lines of credit, foreign exchange swaps, and repurchase 
agreements. Proposed Sec.  234.3(a)(7)(iii) required these arrangements 
to be committed in order to ensure that the resources are highly 
reliable even in extreme but plausible market conditions.\14\
---------------------------------------------------------------------------

    \14\ The Board recognized that the language on qualifying liquid 
resources under Principle 7 of the PFMI is phrased differently. 
Principle 7 requires qualifying liquid resources to be, among other 
things, highly marketable collateral held in custody and investments 
that are readily available and convertible into cash with 
``prearranged and highly reliable'' funding arrangements. The Board 
has had a longstanding expectation that FMUs under its authority 
maintain cash or committed arrangements for converting noncash 
assets into cash to meet the minimum liquidity resource requirement. 
The Board believes that, in order for arrangements to be ``highly 
reliable,'' they must be ``prearranged and committed.'' The legal 
enforceability of committed arrangements helps to ensure obligations 
will be fulfilled even in extreme but plausible market conditions. 
The Board recognizes, however, that such commitments do not 
guarantee performance. Supplemental resources beyond amounts needed 
to meet the minimum liquid resource requirement in Sec.  234.3(a)(7) 
may be obtained on an uncommitted basis.
---------------------------------------------------------------------------

    A commenter stated that meeting the minimum liquid resource 
requirement in proposed Sec.  234.3(a)(7)(ii) with only cash and 
committed arrangements, as required in proposed Sec.  234.3(a)(7)(iii), 
would be challenging for cash market CCPs and their participants. 
Furthermore, the commenter stated that requiring committed arrangements 
for sovereign debt, such as U.S. Treasury securities, is inconsistent 
with CFTC's final rule for systemically important derivatives clearing 
organizations, the SEC's proposed rules for covered clearing agencies, 
and the rules for financial market infrastructures in foreign 
jurisdictions, and that requiring committed arrangements could

[[Page 65549]]

significantly reduce the total amount of liquidity available to CCPs. 
The commenter also stated that the proposal is inconsistent with the 
Board's treatment of Treasury securities for systemically important 
financial institutions (SIFIs) under the Board's Liquidity Coverage 
Ratio rule. The commenter recommended that uncommitted arrangements for 
converting U.S. Treasury securities into cash, such as customary 
repurchase agreements or pre-established dealer accounts to facilitate 
same-day market sales, be included as qualifying liquid resources.
    After consideration of the comments, the Board has determined not 
to include uncommitted arrangements for U.S. Treasuries as qualifying 
liquid resources. The Board believes that legal enforceability of 
committed arrangements helps to ensure that obligations are fulfilled 
even in extreme but plausible market conditions. For example, the Board 
believes committed arrangements provide an additional level of 
assurance that U.S. Treasury securities would be converted into cash in 
large quantities on a same-day basis, even in stressed market 
conditions. Furthermore, the Board believes a more-robust requirement 
is necessary for designated FMUs than for SIFIs because the timely 
completion of settlement is an essential function of an FMU and an 
explicit expectation of the Board for these entities. The failure of an 
FMU to complete settlement as expected can create broader liquidity 
dislocations and undermine confidence in the FMU's ability to manage 
effectively a default by absorbing rather than transmitting shocks to 
the financial system.
    After consideration of the comments, however, the Board has added a 
new category of liquidity arrangements in Sec.  234.3(a)(7)(iii)(C) of 
the final rule that would allow prearranged uncommitted arrangements 
for converting noncash assets into cash to be considered qualifying 
liquid resources if they are determined by the Board to be highly 
reliable in extreme but plausible market conditions. The Board is 
adding this category in order to allow flexibility for future 
innovation in arrangements for converting noncash assets into cash on a 
same-day basis. The Board believes that including this category 
improves consistency with the text of the CFTC's final rule and the 
SEC's proposed rule. The Board is also adopting conforming edits to 
Sec.  234.3(a)(7)(iv) in the final rule.
    Testing. Proposed Sec.  234.3(a)(7) contained multiple testing 
requirements for the management of liquidity risk. Proposed Sec.  
234.3(a)(7)(iv) required a designated FMU to evaluate and confirm, at 
least annually, whether each provider of its committed liquidity 
arrangements has sufficient information to understand and manage that 
provider's associated liquidity risks and whether the provider has the 
capacity to perform as required under the commitment. Proposed Sec.  
234.3(a)(7)(v) required the designated FMU to maintain and test its 
procedures and operational capacity for accessing each type of its 
liquid resources at least annually. Proposed Sec.  234.3(a)(7)(vi) 
required the designated FMU to determine the amount and regularly 
stress-test the sufficiency of the liquid resources necessary to meet 
the minimum liquid resource requirement (A) daily using standard and 
predetermined stress scenarios, parameters, and assumptions and (B) at 
least monthly through a comprehensive and thorough analysis of the 
existing stress scenarios, models, and underlying parameters and 
assumptions. Proposed Sec.  234.3(a)(7)(viii) required an annual 
validation of the designated FMU's liquidity risk-management model.
    A commenter stated that the testing of the procedures and 
operational capacity for accessing liquid resources required by 
proposed Sec.  234.6(a)(7)(v) should not cause disruption to the 
designated FMU's participants or involve the use of large amounts of 
participant funds. The commenter also suggested generalizing the 
requirement in proposed Sec.  234.6(a)(7)(vi)(B) to perform monthly 
stress testing and avoid being overly prescriptive because the monthly 
review requirement may not be appropriate for all models or all types 
of designated FMUs.
    The Board agrees that none of the testing requirements need to be 
or should be met in a manner that would cause significant disruption to 
the designated FMU's participants or the market or involve the use of 
large amounts of participant funds. In addition, after consideration of 
the comments, the Board continues to believe that the requirement in 
Sec.  234.3(a)(7)(vi) to perform an analysis of the existing stress 
scenarios, models, and underlying parameters and assumptions at least 
monthly is appropriate. The Board believes that all designated FMUs 
should assess the effectiveness of their stress testing at least 
monthly to ensure that the designated FMU will not neglect to consider 
any relevant new information in its stress-testing methodology and that 
the stress tests continue to be appropriate for achieving the 
designated FMU's identified liquidity needs in light of current and 
evolving market conditions. The Board is adopting the text of the rule 
as proposed.

H. Settlement Finality

    Proposed Sec.  234.3(a)(8) required, in part, the designated FMU to 
provide clear and certain final settlement intraday or in real time as 
appropriate, and at a minimum, by the end of the value date. One 
commenter requested confirmation that the proposed provision would not 
require a designated FMU that is a CCP to accelerate its novation of 
certain noncompetitive transactions, such as backloaded over-the-
counter options. The proposed requirement in Sec.  234.3(a)(8) applied 
to a designated FMU's obligations to deliver funds and other financial 
instruments, at a minimum, by the end of the value date in accordance 
with the terms of the underlying contract, and did not address the 
timing of novation. The Board is adopting the text of the rule as 
proposed.

I. Participant-Default Rules and Procedures

    Proposed Sec.  234.3(a)(13) required the designated FMU to have 
effective and clearly defined participant-default rules and procedures 
that are designed to ensure that the designated FMU can take timely 
action to contain losses and liquidity pressures and continue to meet 
its obligations. The proposal also required the designated FMU to test 
and review its default procedures, including any closeout procedures, 
at least annually or following material changes to these rules and 
procedures. One commenter stated that the required testing should not 
be so extensive as to cause disruption to the designated FMU's members, 
participants, or broader financial markets, nor require the use of 
participant funds, nor unnecessarily stress the designated FMU's 
critical services.
    The Board agrees that any testing pursuant to the requirement in 
proposed Sec.  234.3(a)(13) should not cause disruption to the 
designated FMU's members, participants, or broader financial markets. 
To the extent such testing would require use of participant funds, it 
would likely be limited to small or de minimus amounts. The Board is 
adopting the text of the rule as proposed.

J. Segregation and Portability

    Proposed Sec.  234.3(a)(14) required a designated FMU that operates 
as a CCP to have rules and procedures that enable the segregation and 
portability of positions of a participant's customers and the 
collateral provided to the

[[Page 65550]]

designated FMU with respect to those positions. The Board received two 
comment letters on this proposed rule that addressed portability 
requirements and alternative segregation regimes.
    Portability requirement. One commenter noted that while porting 
positions is a highly desirable result when feasible, there may be 
scenarios in which liquidating positions is preferred. The commenter 
suggested that the rule text permit a designated FMU to retain broad 
discretion to liquidate positions promptly where it has determined that 
timely transfer would not be feasible. The proposed rule requires that 
the designated FMU's rules and procedures enable the segregation and 
portability of positions, and does not exclude the possibility that 
liquidation of positions may take place if a timely transfer would not 
be feasible. For these reasons, the Board is adopting the text of the 
rule as proposed.
    Alternative segregation regimes. One commenter encouraged the Board 
to retain the flexibility to permit different segregation regimes as 
appropriate for different markets and different classes of market 
participant. Another commenter requested that the final text of the 
rule acknowledge the different legal frameworks for cash markets. The 
Board acknowledged in the NPRM that effective segregation and 
portability arrangements depend not only on the operational 
capabilities of the designated FMU but also on the applicable legal 
framework. The Board notes that a CCP serving certain cash markets, for 
example, may operate in a legal regime that offers the same degree of 
protection for a participant's customers as the segregation and 
portability approaches under proposed Sec.  234.3(a)(14). Where an 
alternative regime exists, the Board will consider the CCP's assessment 
of whether the applicable legal or regulatory framework achieves the 
same degree of protection and efficiency for customers that would 
otherwise be achieved by segregation and portability arrangements at 
the CCP level described in the proposed requirement. Additionally, the 
Board will review whether the CCP's own rules enable the operation of 
the relevant legal and regulatory framework. The Board believes 
segregation and portability arrangements may differ depending on the 
design of and the products and markets served by the CCP and would work 
with any applicable designated FMU through the supervisory process to 
determine how best to meet the requirements in Sec.  234.3(a)(14).
    Where alternative segregation and portability arrangements offer 
the same degree of protection, proposed Sec.  234.3(a)(14) would not 
prohibit the use of such arrangements. As noted above, the requirement 
is that the designated FMU's rules and procedures enable segregation 
and portability of positions and does not prescribe a single means by 
which this could be achieved. The Board is adopting the text of the 
rule as proposed.

K. General Business Risk

    Proposed Sec.  234.3(a)(15) required a designated FMU to identify, 
monitor, and manage its general business risk. To this end, proposed 
Sec.  234.3(a)(15)(i) required a designated FMU to maintain 
unencumbered liquid financial assets that are sufficient to cover the 
greater of the cost to implement the designated FMU's recovery or 
orderly wind-down plan to address general business losses or six months 
of current operating expenses. This provision also required a 
designated FMU to hold equity that is greater than or equal to the 
amount of unencumbered liquid financial assets held to meet the 
requirement. Proposed Sec.  234.3(a)(15)(ii) required a designated FMU 
to maintain and update annually a plan for raising additional equity 
before the designated FMU's equity falls below the amount required 
under Sec.  234.3(a)(15)(i).
    The Board received four comment letters that addressed this 
provision. The commenters generally supported proposed Sec.  
234.3(a)(15) but raised specific concerns that are discussed below.
    Recovery and orderly wind-down plans. Proposed Sec.  
234.3(a)(15)(i)(A)(1) referred to the cost to implement the recovery or 
orderly wind-down plan to address general business losses as required 
under proposed Sec.  234.3(a)(3)(iii) as one possible determinant of 
the amount of liquid net assets funded by equity the designated FMU 
must hold. One commenter stated that recovery and orderly wind-down 
plans should be calibrated to take into account the existence of 
alternative systems or arrangements that provide similar services to 
those of the designated FMU. The Board expects that the designated FMU 
will take into consideration in its recovery and orderly wind-down 
plans any viable alternatives to its critical operations and services. 
The commenter did not suggest any changes to the proposed rule text on 
this point. For clarity and to streamline the rule text, however, the 
Board is revising Sec.  234.3(a)(15)(i)(A)(1) to require the designated 
FMU to cover the cost to implement the plans to address general 
business losses as required under Sec.  234.3(a)(3)(iii).
    Required amount of unencumbered liquid financial assets. Proposed 
Sec.  234.3(a)(15)(i)(A) required a designated FMU to hold unencumbered 
liquid financial assets equal to the greater of the cost to implement 
its recovery or orderly wind-down plan to address general business 
losses or six months of current operating expenses or as otherwise 
determined by the Board. Two commenters provided comments on the type 
of operating expenses that should be included in the calculation of six 
months of current operating expenses. Both stated that the requirement 
to hold unencumbered liquid financial assets and equity to fund current 
operating expenses would overstate the amount actually needed in a 
recovery or orderly wind-down scenario because an FMU that suffers 
losses will likely eliminate or reduce certain expenses, such as travel 
and marketing expenses. The commenters proposed that the amount be 
calculated instead as the current expenses required to operate the 
FMU's critical operations and services in such a scenario.
    After consideration of the comments, the Board continues to believe 
that the calculation of six months of current operating expenses (or as 
otherwise determined by the Board) should include all business-as-usual 
operating expenses. Although certain expenses may decrease in a 
recovery or orderly wind-down, the Board believes that certain other 
expenses, such as legal and consulting fees, would likely increase in a 
recovery or orderly wind-down scenario and that it is difficult to 
predict the net effect on the designated FMU's expenses in such a 
scenario. Therefore, the requirement to hold six months of business-as-
usual operating expenses (or as otherwise determined by the Board) is 
intended to set a floor for the designated FMU's holdings of 
unencumbered liquid assets and equity that is independent of the 
assumptions about the specifics of the recovery and orderly wind-down 
scenarios as well as easy to calculate and verify because the 
information is included on the designated FMU's income statement. The 
Board, however, does expect that if the designated FMU foresees 
significant and lasting increases or decreases in its business-as-usual 
operating expenses due to structural or other changes to the designated 
FMU's operating environment, the designated FMU will include this 
information in its calculation. For these reasons, the Board is 
adopting Sec.  234.3(a)(15)(i)(A)(2) as proposed.
    Type of liquid assets required. Proposed Sec.  234.3(a)(15)(i)(A) 
would require the designated FMU to hold

[[Page 65551]]

unencumbered liquid financial assets, such as cash or highly liquid 
securities. One commenter stated that a designated FMU should be able 
to include as unencumbered liquid financial assets revenues that are 
projected to be received by the designated FMU over the same six-month 
period, subject to an appropriate haircut, because the designated FMU 
may be able to expect to continue to generate fees in a recovery or 
orderly wind-down scenario.
    The intent of the proposed standard, however, is to ensure that the 
designated FMU has the necessary liquid assets and equity on hand at 
any particular time. Projected revenues would not meet the requirement 
because projected revenues are not assets held on the balance sheet. 
Furthermore, the Board does not consider accounts receivable to qualify 
as unencumbered liquid financial assets under this provision because 
the funds associated with those receivables have not yet been collected 
and therefore are not available for immediate use. In a recovery or 
orderly wind-down scenario, the designated FMU may not be able to 
collect its accounts receivable in the amounts expected because market 
participants may be unable to pay amounts owed to the designated FMU. 
For these reasons, neither projected revenues nor accounts receivable 
should be included in types of unencumbered liquid financial assets 
held to meet the requirement in proposed Sec.  234.3(a)(15)(i)(A).
    It may be appropriate, however, for a designated FMU to consider 
its expected revenues, subject to an appropriate haircut, in its 
calculation of the cost to implement its recovery and orderly wind-down 
plans. Depending on the structure of the market it serves, a designated 
FMU may expect to earn revenues in a recovery or orderly wind-down 
scenario that could partially offset the cost of recovering or winding 
down. The size of the haircut applied to the expected revenues would 
likely need to reflect this market structure. For example, a designated 
FMU that operates in a market with viable alternatives to the services 
of the designated FMU should not assume that it would receive a large 
amount of revenue during an orderly wind-down.
    Type of equity required. Proposed Sec.  234.3(a)(15)(i)(B) lists 
common stock, disclosed reserves, and other retained earnings as 
examples of equity that should be held to meet the requirement. Two 
commenters stated that noncumulative perpetual preferred stock should 
be included in the types of equity allowed to meet the requirements in 
proposed Sec.  234.3(a)(15)(i)(B) because some designated FMUs do not 
have ready access to public capital markets to replenish capital. One 
of these commenters also stated that such stock should be redeemable at 
the discretion of the designated FMU after five years.
    Proposed Sec.  234.3(a)(15)(i)(B) provided a non-exhaustive 
illustrative list of types of equity that would be acceptable. There 
may be other types of equity, in addition to common stock, disclosed 
reserves, and other retained earnings, that could be held to meet the 
requirement in proposed Sec.  234.3(a)(15)(i)(B). The purpose of the 
requirement is to ensure that the designated FMU can absorb general 
business losses on an ongoing basis. Equity that has characteristics 
similar to debt will not be counted toward the requirement. Designated 
FMUs should work with supervision staff to assess whether specific 
equity holdings meet the intent of the requirement. The Board is 
adopting the text of the rule as proposed.
    Application of Sec.  234.3(a)(15)(i) to a DFMU that is part of a 
larger legal entity. In the NPRM, the Board asked whether the proposed 
rule should require a designated FMU that is part of a larger legal 
entity to take into account, when calculating the cost to implement its 
recovery and orderly wind-down plans, recovery or wind-down scenarios 
in which other business lines in the legal entity or the legal entity 
itself may face an adverse business environment. One commenter stated 
that a designated FMU should consider ``any adverse environment that 
may be faced by the other business lines within the legal entity, or by 
the legal entity itself.'' Another stated that the FMU should ``treat 
the service that caused it to be designated as systemically important 
as a separate division of the company and require liquid assets and 
capital to be earmarked for that service, so that the company's other 
services are not taken into account when calculating these 
requirements.''
    In the NPRM, the Board also asked, for a designated FMU that is 
engaged in several business lines, but is designated as systemically 
important for purposes of Title VIII of the Dodd-Frank Act for only one 
of those business lines, whether there are any reasonable methodologies 
for determining which of the liquid net assets and equity held at the 
legal entity level belong to a particular business line. As a single 
legal entity, the firm's equity supports all the business lines, but it 
is a designated FMU for purposes of Title VIII of the Dodd-Frank Act 
with respect to only one of those business lines. One commenter stated 
that ``it is difficult to determine the capital specific to a 
designated FMU when the designated FMU is part of a larger legal 
entity'' and that ``in insolvency it may not be possible to ring-fence 
assets within a legal entity.'' Another commenter suggested, however, 
that separate pro forma balance sheets and income statements could be 
created for a particular business line.
    After consideration of the comments, the Board has determined to 
adopt the rule text as proposed. When developing its recovery and 
orderly wind-down plans and calculating the cost of implementing those 
plans, a designated FMU that also engages in business lines for which 
it has not been designated by the Council under Title VIII should 
consider business shocks to other business lines if those shocks could 
potentially cause the designated FMU to need to recover or wind down 
the critical operations and services of the business line for which it 
has been designated. When calculating six months of current operating 
expenses (or as otherwise determined by the Board), however, the 
designated FMU may include only the current operating expenses of the 
business line for which it was designated rather than the current 
operating expenses of the whole legal entity.\15\ Furthermore, when 
determining whether the designated FMU has sufficient unencumbered 
liquid financial assets and equity on its balance sheet to equal or 
exceed the greater of the cost to implement the recovery and orderly 
wind-down plans to address general business losses or six months of 
current operating expenses, the designated FMU may use the assets and 
equity held at the legal entity level that would be available to meet 
the requirement rather than having to attribute assets and equity to a 
certain business line.
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    \15\ The designated FMU's current operating expenses should 
include the designated FMU's share of overhead and support costs and 
any cost of shared services that are allocated to the designated 
FMU.
---------------------------------------------------------------------------

    Content of the plan for raising additional equity. Proposed Sec.  
234.3(a)(15)(ii) required the designated FMU to maintain a viable plan 
for raising additional equity before the designated FMU's equity falls 
below the amount required in proposed Sec.  234.3(a)(15)(i). Two 
commenters stated that raising equity may take time, especially in 
stressed market conditions. Another commenter suggested that the 
designated FMU have a cushion above the required amount as an 
alternative to a plan to raise capital before equity falls below the 
minimum amount.

[[Page 65552]]

Commenters also suggested methods for raising equity, such as a 
committed contingent funding plan or a refinancing plan involving a 
loan until an orderly equity recapitalization can be executed. A 
commenter also suggested that the designated FMU should consider the 
probability of an event that could cause equity to fall below the 
required amount and the period over which the event is likely to occur.
    The Board agrees that it may not be possible in all cases to have a 
viable plan to raise equity before the designated FMU's equity falls 
below the required amount. Business shocks may cause equity levels to 
fall rapidly and unexpectedly and in circumstances under which it may 
be difficult to raise capital quickly. The Board does not believe, 
however, that the rule should specify the features of the plan or the 
methods for raising capital, because the details of the plan will 
depend on the ownership structure of the designated FMU and the 
environment in which it operates. Therefore, the Board is modifying the 
text of proposed Sec.  234.3(a)(15)(ii) to require a designated FMU to 
maintain a viable plan for raising equity should its equity fall below 
the amount required under proposed Sec.  234.3(a)(15)(i).
    Schedule for updating the plan for raising additional equity. 
Proposed Sec.  234.3(a)(15)(ii) required the designated FMU to update 
its plan for raising additional equity at least annually. One commenter 
stated that the plan should be reviewed every three years instead of 
annually. The commenter also stated that the plan could be reviewed 
more frequently when there are material changes to the designated FMU's 
financial position or to the capital markets.
    After consideration of the comment, the Board agrees that annual 
review of the plan may not be necessary in the absence of material 
changes to the designated FMU's financial position or to the capital 
markets. The Board believes, however, that the plan should be reviewed 
at least every other year, consistent with the required review 
frequency of the recovery and orderly wind-down plans in Sec.  
234.3(a)(3)(iii)(G) and the public disclosure in Sec.  
234.3(a)(23)(vi). For these reasons, the Board is modifying proposed 
Sec.  234.3(a)(15)(ii) to require a designated FMU to update its plan 
the earlier of every two years or following changes to the designated 
FMU or the environment in which it operates that would significantly 
affect the viability or execution of the plan.

L. Operational Risk

    Proposed Sec.  234.3(a)(17) required a designated FMU to manage its 
operational risks by establishing a robust operational risk-management 
framework, which includes a business continuity plan. Proposed Sec.  
234.3(a)(17)(vii)(B) required a designated FMU to have a business 
continuity plan that is designed to ensure that critical information 
technology systems can recover and resume operations no later than two 
hours following disruptive events. One commenter stated that ensuring 
that critical information technology systems can meet the two-hour 
recovery objective in the case of an extreme cyberattack could be very 
costly and require substantial changes to the designated FMU's 
production infrastructure, potentially including creating additional 
replicas of production infrastructure and systems. The commenter 
supported the Board's proposal in the NPRM to address reasonable 
approaches to preparing for potential extreme cyberattacks through the 
supervisory process.
    The Board believes that it is imperative to financial stability 
that a designated FMU be able to recover and resume operations quickly 
after disruptive events and to complete settlement by the end of the 
day of the disruption. For many types of disruptive scenarios, such as 
a wide-scale physical disruption, the technology and methods exist to 
enable a designated FMU to recover and resume operations within two 
hours of the disruption. The Board understands, however, that certain 
threats to the designated FMU's operations as well as the technology to 
mitigate those threats are continually evolving. The Board expects that 
a designated FMU's business continuity planning will be a dynamic 
process in which the designated FMU works on an ongoing basis to update 
its plan to recover and resume operations no later than two hours 
following disruptive events and to complete settlement by the end of 
the day of the disruption, even in extreme circumstances. In areas 
where threats and technology are evolving, such as is the case for 
certain extreme cyberattacks, the Board recognizes that it may not be 
possible at this time for the designated FMU to recover within two 
hours. In such cases, the Board will work with the designated FMU 
through the supervisory process to identify reasonable approaches to 
preparing for and recovering from such attacks. The Board is revising 
proposed Sec.  234.3(a)(17)(vii)(B) to indicate this intent.
    The Board is also making a technical edit to Sec.  234.3(a)(17)(ii) 
to clarify that a designated FMU should identify, monitor, and manage 
the material risks its operations may pose to trade repositories as 
well as to other financial market utilities. As mentioned above, 
because of the differences in the definition for financial market 
infrastructure in the PFMI, which includes trade repositories, and the 
definition of financial market utility in the Dodd-Frank Act, which 
does not, the Board inadvertently excluded consideration of risks posed 
to trade repositories.

M. Tiered Participation Arrangements

    Proposed Sec.  234.3(a)(19) required a designated FMU to identify, 
monitor, and manage the material risks to the designated FMU arising 
from tiered participation arrangements. These arrangements are those in 
which firms that are not members in the designated FMU (indirect 
participants) rely on the services provided by members (direct 
participants) of the designated FMU to access the designated FMU's 
payment, clearing, and settlement facilities.
    Three commenters addressed this provision of the proposed rule. Two 
commenters opposed the adoption of the provision as drafted. The third 
commenter supported the proposal.
    Applicability of the proposed requirements. Two commenters 
addressed the applicability of the proposed requirements to them. One 
commenter opposed the proposed rule because it does not believe that it 
or its participants bear any significant risk from its participants' 
relationships with their customers. Another commenter supported the 
view that a designated FMU needs to understand the risks associated 
with the relationships between direct participants and their customers 
in order to be able to understand and assess what risks, if any, the 
tiered arrangements may present to the designated FMU and its other 
participants. This commenter mentioned that it had developed a document 
that identifies risks that arise from tiered participation arrangements 
and best practices for mitigating these risks. This commenter also 
monitors settlement and funding metrics for indirect participants, and 
encourages indirect participants that exceed certain thresholds to 
become direct participants in order to reduce systemic risk.
    After consideration of the comments and further analysis, the Board 
continues to believe that for certain designated FMUs, based on the 
design of their settlement arrangements, material risks could arise 
from tiered

[[Page 65553]]

participation arrangements that are borne by the FMU or by its 
participants. For example, in an FMU in which a direct participant 
processes large transaction values on behalf of a large customer such 
as a large correspondent bank, the failure of the customer could 
jeopardize the direct participant's ability to meet its obligations to 
the FMU or to the other participants in the FMU. The failure to meet 
these obligations could result in liquidity dislocations that would 
pose significant liquidity risk to the FMU or to the other participants 
in the FMU. The Board acknowledges that certain designated FMUs with 
particular system designs may not face material risks arising from 
tiered participation arrangements, but these designated FMUs should 
present an analysis to that effect.
    Tiered participation arrangements could also pose other risks to 
the designated FMU and its participants, including operational risk. 
For example, a designated FMU may want to understand how its direct 
participants manage any spikes or peaks in volume submitted to the 
designated FMU on behalf of indirect participants. Understanding the 
potential for spikes in volume will allow the designated FMU to prepare 
to have the scalable operational capacity necessary to process those 
volumes effectively, such that it is able to achieve its service-level 
objectives.
    The Board believes that a designated FMU should seek to understand 
the risks associated with the relationships between direct participants 
and their customers in order to assess whether any material risk to the 
designated FMU or its other participants exists. If material risks 
exist, the designated FMU should mitigate or manage this risk. However, 
the Board does not expect a designated FMU to manage all risks that 
arise between a direct participant and its customers, but rather to 
manage only the material risks to the designated FMU itself or to its 
other participants as a result of their participation in the system. 
The Board is revising Sec.  234.3(a)(19) to clarify that the designated 
FMU should assess the material risks arising from tiered participation 
arrangements that are borne by the designated FMU or by its other 
participants as a result of their participation in the system.
    Duplicative monitoring. One commenter stated that a requirement for 
a designated FMU to monitor the risks posed by indirect participants 
would be costly and duplicative of monitoring activities of regulators 
and the direct participants in the designated FMU. After consideration 
of the comment, the Board continues to believe that monitoring by 
direct participants or by their supervisors may not fully and 
effectively address all risks that may arise from tiered participation 
arrangements. Direct participants would likely monitor risks posed to 
them by their customers but may not consider how their actions to 
mitigate or manage those risks could affect the FMU or its other 
participants. In addition, the supervisory focus for certain direct 
participants is typically different from that for designated FMUs, and 
their supervisory monitoring might not take into account the effects of 
tiered participation arrangements on the designated FMU or its other 
participants. Direct participants in a designated FMU may also be 
subject to varying degrees of supervision. Therefore, the onus should 
be on the designated FMU to understand the tiered participation 
arrangements in the system and the impact of these relationships on the 
designated FMU and its participants.
    Requirements for an FMU with respect to tiered participation 
arrangements. One commenter stated that the proposed rule was ambiguous 
about what would actually be required of a designated FMU to comply 
with Sec.  234.3(a)(19). The commenter stated that the Board should 
make clear that an FMU that does not bear any risk from its 
participants or their customers should not need to take any action to 
comply with the proposed rule. Another commenter stated that a 
designated FMU should be required to ensure that its direct 
participants have sufficient information to assess their relationships 
with their customers. The designated FMU should also ensure that its 
direct participants have sufficient information to evaluate and manage 
their risks with respect to participation in the designated FMU.
    After consideration of the comments, the Board continues to believe 
that designated FMUs should manage material risks arising from tiered 
participation arrangements. The Board is adopting provisions in the 
final rule that clarify what would be expected from a designated FMU. 
The Board is including Sec.  234.3(a)(19)(i) to clarify that the 
designated FMU should conduct an analysis to determine whether material 
risks arise from tiered participation arrangements. Depending on the 
nature of their payment, clearing, or settlement activities, designated 
FMUs' methodologies for conducting the analysis may differ. For 
example, some designated FMUs may choose to gather information about 
the volume and value of activity processed by direct participants on 
behalf of indirect participants in the designated FMU or other relevant 
information. Where such information would be useful, a designated FMU 
may want to consider defining reasonable thresholds and other factors 
for gathering the information in order to minimize burden.
    The Board is including Sec.  234.3(a)(19)(ii) to clarify that, 
where material risks from tiered participation arrangements are 
identified, the designated FMU must mitigate or manage such risks. The 
appropriate actions to mitigate or manage the material risks identified 
will depend on the circumstances of the designated FMU and the risks 
identified. For example, one commenter noted that it provides a set of 
best practices with respect to tiered participation arrangements to 
guide participants' understanding and facilitate the assessment of 
risks related to tiered participation. This revision to the rule is 
also intended to clarify that the designated FMU is required to take 
additional action only if material risks are identified pursuant to 
Sec.  234.3(a)(19)(i).
    The Board is including Sec.  234.3(a)(19)(iii) to clarify that a 
designated FMU will be required to review and update its analysis of 
risks arising from tiered participation arrangements at the earlier of 
every two years or following material changes to the system design or 
operations or the environment in which the designated FMU operates if 
those changes could affect the analysis conducted as required in Sec.  
234.3(a)(19)(i). If a designated FMU's review of its analysis indicates 
that the designated FMU faces no material risks from tiered 
participation arrangements, then no further action would be required. 
This provision is intended to clarify, in response to concerns raised 
by one commenter, that a designated FMU will not be required to monitor 
constantly the risks posed by tiered participation arrangements. The 
review requirement is also intended to be responsive to another comment 
that the review frequency for the assessment of risks arising from 
tiered participation arrangements should be consistent with the review 
standards under proposed Sec.  234.3(a)(3). The Board agrees and is 
also adopting a requirement for biennial review of the recovery and 
orderly wind-down plans in Sec.  234.3(a)(3)(iii).
    Definition of `indirect participants'. Proposed Sec.  234.3(a)(19) 
refers to firms that are not members of the designated FMU (indirect 
participants) that rely on the services provided by direct

[[Page 65554]]

participants to access the designated FMU's payment, clearing, or 
settlement facilities. One commenter stated that the Board should limit 
the application of the rule to firms that are known by the designated 
FMU, have an agreement binding them to the FMU's rules, and may have a 
direct connection to the FMU. The Board believes that material risks 
can originate from arrangements with a range of indirect participants 
having a range of relationships or arrangements with the FMU. If such 
arrangements may pose material risks, the designated FMU should seek to 
gather information from its direct participants on those arrangements 
and assess the risks from those arrangements. Therefore, the Board is 
retaining the concept of indirect participant as those firms that 
access the services of the designated FMU through a direct participant, 
whether or not they are bound by some part of the rules or have a 
direct connection to the designated FMU.\16\ The Board wishes to 
clarify, however, that the designated FMU should focus its analysis on 
the direct customers of the direct participants and need not extend its 
analysis to other tiers of customers, such as the customers of the 
customers of the direct participants.
---------------------------------------------------------------------------

    \16\ For example, some firms may submit transactions or 
instructions to an FMU directly under the account of a direct 
participant. In this case, the firm may be bound by the FMU's rules, 
but the direct participant would be accountable for the firm's 
performance on its obligations. In other FMUs, indirect participants 
are not bound by the rules of the FMU and do not have a direct 
connection to the FMU.
---------------------------------------------------------------------------

    Thresholds for identifying indirect participants that could pose 
risk to the designated FMU. In the preamble to the proposed rule, the 
Board asked how, if at all, the Board should define the thresholds for 
identifying indirect participants responsible for a significant 
proportion of transactions processed by the designated FMU and for 
identifying indirect participants whose transaction volumes or values 
are large relative to the capacity of the direct participant through 
which the indirect participants access the designated FMU. One 
commenter stated that the Board should not be too prescriptive in 
defining these thresholds, because they may vary across individual 
designated FMUs. The Board is not defining specific thresholds for 
identifying indirect participants that may pose risk to the designated 
FMU.
    Conflicts of interest and antitrust issues. One commenter stated 
that the proposed rule raises conflict-of-interest and antitrust 
issues. The commenter stated that the collection of data on indirect 
participation that the Board proposed in the NPRM would give the board 
of directors of the designated FMU a complete picture of each 
participant's relationships with its most important customers, which 
could create a conflict of interest if the designated FMU's board of 
directors is made up of representatives of the member banks. The 
commenter also stated that the proposed requirement appeared to require 
designated FMUs to encourage indirect participants that are large 
relative to their direct participants to move to a larger direct 
participant or become direct participants themselves, which could 
create antitrust issues if the designated FMU's actions to comply with 
the requirement appear to third parties as an effort by the designated 
FMU to favor its owner banks.
    The Board believes that any conflicts of interest or antitrust 
issues that may arise from the requirements in proposed Sec.  
234.3(a)(19) can be avoided through the careful design of the 
information-gathering and risk-management processes developed by the 
designated FMU. First, the designated FMU's board of directors does not 
have to see a complete picture of each participant's relationships with 
its customers. The designated FMU can put controls in place that would 
minimize potential conflicts to ensure that information is shared in an 
appropriate manner that would allow the board of directors to carry out 
its responsibility for the comprehensive management of risks. Second, 
the rule does not require the designated FMU to encourage indirect 
participants that are large relative to their direct participants to 
move to a larger direct participant or become direct participants 
themselves. The designated FMU may choose other methods for mitigating 
or managing risks to the designated FMU from tiered participation 
arrangements. For example, if the designated FMU is concerned that a 
direct participant's exposures to its customers could cause it to 
default to the designated FMU, the designated FMU may require the 
direct participant to provide additional collateral to mitigate the 
relevant financial risks posed by its relationships with its customers. 
Therefore, the Board does not believe it is necessary to modify the 
rule to address these concerns.

N. Efficiency and Effectiveness

    Proposed Sec.  234.3(a)(21) required a designated FMU to be 
efficient and effective in meeting the requirements of its participants 
and the markets it serves. In the NPRM, the Board explained that 
efficiency generally encompasses what a designated FMU chooses to do, 
how it does it, and the resources required by the designated FMU to 
perform its functions. Effectiveness refers to whether the designated 
FMU is meeting its goals and objectives, which include the requirements 
of its participants and the markets it serves.
    One commenter stated that the Board has not given sufficient weight 
to market judgments regarding an FMU's effectiveness and that an FMU 
that does not meet the requirements of its participants and the markets 
it serves or that does not meet its objectives efficiently will not 
survive in the market. The commenter suggested that the Board remove 
the requirement or redefine efficiency and effectiveness in terms of 
market judgments.
    The Board continues to believe that a requirement for a designated 
FMU to be efficient and effective should be included in Sec.  234.3(a) 
and that the terms efficiency and effectiveness should not be defined 
solely in terms of market judgments. The Board agrees with the comment 
that market forces may encourage an FMU to be efficient and effective, 
particularly in cases where it has a direct competitor. Many markets 
for payment, clearing and settlement services, however, are monopolies 
or oligopolies. Furthermore, it may be difficult for market 
participants to determine if a particular designated FMU is efficient 
and effective because of imperfect information about the designated 
FMU. Therefore, market judgments alone may be insufficient to encourage 
the designated FMU to operate efficiently and effectively. The Board 
does not believe that changes to the proposed requirement are necessary 
and is adopting the text of the rule as proposed.

O. Disclosure of Rules, Procedures and Market Data

    Proposed Sec.  234.3(a)(23) required the designated FMU to disclose 
relevant information about its operations and risk management to its 
participants and to the public. Proposed Sec.  234.3(a)(23)(ii) 
required a designated FMU to disclose publicly all rules and key 
procedures, including key aspects of its default rules and procedures. 
Proposed Sec.  234.3(a)(23)(iii) required a designated FMU to provide 
sufficient information to enable participants to have an accurate 
understanding of the risks, fees, and other material costs they incur 
by participating in the designated FMU. The Board also asked a question 
in the NPRM about whether a designated FMU should disclose information 
about fees and discount policies to the public.

[[Page 65555]]

    The Board received two comment letters that addressed this 
provision of the proposed rule. In response to the proposed rule, one 
commenter stated that certain procedures should not be publicly 
disclosed because they would help unauthorized persons gain access to 
the system. The Board agrees that certain procedures should not be 
disclosed to the public in detail if such detail would create 
vulnerabilities for the designated FMU or undermine its safety and 
soundness. Although the Board expects disclosures to be robust, it does 
not expect a designated FMU to disclose to the public sensitive 
information, such as its detailed business continuity plan. In such 
cases, it may be sufficient to disclose to the public only the key 
highlights of the plan.
    In response to the Board's question about public disclosure of 
information on fees and discount policies, one commenter stated that 
high-level information about pricing principles and rationale for the 
designated FMU's pricing principles should be disclosed, while another 
commenter opposed such a requirement. After consideration of the 
comments, the Board has determined not to include a requirement for a 
designated FMU to disclose information about fees and discount policies 
to the public. Although the Board believes that public disclosure of, 
at a minimum, high-level information about the designated FMU's pricing 
principles and rationale for those principles is a best practice for 
transparency purposes, the Board believes that a requirement to 
disclose specific details about fees and discounts to the public is not 
relevant to the objectives of Title VIII to promote robust risk 
management, promote safety and soundness, reduce systemic risks, and 
support the stability of the broader financial system. For these 
reasons, the Board is not introducing this requirement in Sec.  
234.3(a)(23).

P. Compliance Dates

    In the NPRM, the Board proposed that the revisions to Sec.  
234.3(a) become effective 30 days from the date final rules are 
published in the Federal Register. The Board proposed that designated 
FMUs be expected to comply with the requirements in the final rule 30 
days from the date final rules are published in the Federal Register, 
with the exception of establishing plans for recovery and orderly wind-
down, set forth in proposed Sec.  234.3(a)(3)(iii); addressing 
uncovered credit losses, set forth in proposed Sec.  234.3(a)(4)(vi); 
addressing liquidity shortfalls, set forth in proposed Sec.  
234.3(a)(7)(viii); maintaining sufficient liquid net assets funded by 
equity and a viable capital plan, set forth in proposed Sec.  
234.3(a)(15)(i) and (ii); managing risks arising in tiered 
participation arrangements, set forth in proposed Sec.  234.3(a)(19); 
and providing comprehensive public disclosure, set forth in proposed 
Sec.  234.3(a)(23)(iv). The Board proposed that compliance with these 
requirements be required within six months of publication of the final 
rules.
    The Board received three comment letters that addressed the 
extension to the compliance date for certain requirements. Two 
commenters agreed with the six-month extension for these requirements. 
The third commenter stated that a minimum of 18 months would be 
required to comply with requirements in the proposed rule, especially 
if the requirements set forth in proposed Sec.  234.3(a)(19) were 
adopted as proposed. One of the commenters also stated that the 
compliance date for proposed Sec.  234.3(a)(20) on links to other FMUs 
should also be extended for at least six months because implementation 
of that rule will require extensive cooperation and coordination 
between FMUs.
    The Board has adopted the effective date of December 31, 2014 for 
the final rule. Designated FMUs are also expected to comply with the 
requirements in the final rule on December 31, 2014, with the exception 
of establishing plans for recovery and orderly wind-down, set forth in 
Sec.  234.3(a)(3)(iii); addressing uncovered credit losses, set forth 
in Sec.  234.3(a)(4)(vi); addressing liquidity shortfalls, set forth in 
Sec.  234.3(a)(7)(viii); maintaining sufficient liquid net assets 
funded by equity and a viable capital plan, set forth in Sec.  
234.3(a)(15)(i) and (ii); managing risks arising in tiered 
participation arrangements, set forth in Sec.  234.3(a)(19); and 
providing comprehensive public disclosure, set forth in Sec.  
234.3(a)(23)(iv). Compliance with these provisions will be required on 
or before December 31, 2015. Designated FMUs, however, are encouraged 
to comply with the provisions as soon as possible.
    The Board is making these changes to the effective date and the 
compliance dates after consideration of the public comments as well as 
internal analysis. The Board decided to extend the compliance date for 
the new and heightened requirements in order to allow sufficient time 
to the designated FMUs to complete their processes and procedures for 
changes to their rulebooks and to minimize burden on the designated 
FMUs and the markets they serve. Also, the Board has decided not to 
include Sec.  234.3(a)(20) in the list of provisions for which there is 
an extension to the compliance period because this provision does not 
apply to the designated FMUs that will be subject to the revisions to 
Sec.  234.3(a) on the effective date of the final rule.

III. Administrative Law Matters

A. Regulatory Flexibility Act Analysis

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (``RFA'') 
generally requires an agency to perform an initial and a final 
regulatory flexibility analysis on the impact a rule is expected to 
have on small entities. However, under section 605(b) of the RFA, the 
regulatory flexibility analysis otherwise required under section 604 of 
the FRA is not required if an agency certifies, along with a statement 
providing the factual basis for such certification, that the rule will 
not have a significant economic impact on a substantial number of small 
entities. Based on current information, the Board believes that the 
payment systems that have been designated by the Council are not 
``small entities'' for purposes of the RFA, and so, the final rule 
likely would not have a significant economic impact on a substantial 
number of small entities. However, the Board has prepared the following 
final regulatory flexibility analysis pursuant to section 604 of the 
RFA.
    1. Statement of the need for, and objectives of, the final rule. In 
accordance with Sections 805(a) of the Dodd-Frank Act, the Board is 
adopting the final rule. The final rule amends the risk-management 
standards for systemically important FMUs in consideration of the new 
international standards. The reasons and justification for the final 
rule are described above in the Supplementary Information.
    2. Summary of the significant issues raised by public comment on 
the Board's initial analysis, the Board's assessment of such issues, 
and a statement of any changes made as a result of such comments. The 
Board did not receive any public comments regarding its initial 
regulatory flexibility analysis. In addition, the Board did not receive 
any comments filed by the Chief Counsel for Advocacy of the Small 
Business Administration in response to the proposed rule.
    3. Small entities affected by the final rule. The final rule would 
affect FMUs that the Council designates as systemically important to 
the U.S. financial system for which the Board is the Supervisory 
Agency. Pursuant to regulations issued by the Small Business 
Administration (the ``SBA'') (13 CFR 121.201), a ``small entity''

[[Page 65556]]

includes an establishment engaged in (i) providing financial 
transaction processing, reserve and liquidity services, or 
clearinghouse services with an average annual revenue of $38.5 million 
or less (NAICS code 522320); (ii) securities and/or commodity exchange 
activities with an average annual revenue of $38.5 million or less 
(NAICS code 523210); and (iii) trust, fiduciary, and/or custody 
activities with an average annual revenue of $38.5 million or less 
(NAICS code 523991). As noted in the NPRM, based on current 
information, the Board does not believe that any of the FMUs that have 
been designated by the Council, and in particular the two designated 
FMUs for which the Board is the Supervisory Agency under Title VIII of 
the Dodd-Frank Act, would be ``small entities'' pursuant to the SBA 
regulation. In addition, the Board is not, and is not likely to become, 
the Supervisory Agency pursuant to section 803(8) of the Dodd-Frank Act 
for any designated FMU that operates as a central securities depository 
or central counterparty.
    4. Recordkeeping, reporting, and compliance requirements. The final 
rule imposes certain reporting and recordkeeping requirements for a 
designated FMU. (See, for example, Sec.  234.3(a)(3) (requiring 
policies, procedures, and systems that enable the designated FMU to 
identify, measure, monitor, and manage the risks that arise in or are 
borne by the designated FMU), Sec.  234.3(a)(13) (requiring effective 
and clearly defined rules and procedures to manage a participant 
default), and Sec.  234.3(a)(23) (requiring a comprehensive public 
disclosure of its legal, governance, risk management, and operating 
framework).) The final rule also contains a number of compliance 
requirements, including the standards that the designated FMU must 
meet, such as (i) having a well-founded, clear, transparent and 
enforceable legal basis for each material aspect of its activities in 
all relevant jurisdictions (Sec.  234.3(a)(1)), (ii) effectively 
measuring, monitoring, and managing its credit exposures under a wide 
range of significantly different stress scenarios (Sec.  234.3(a)(4)), 
(iii) effectively measuring, monitoring, and managing the liquidity 
risk that arises or is borne by the designated FMU (Sec.  234.3(a)(7)), 
and (iv) managing its operational risks by establishing a robust 
operational risk-management framework (Sec.  234.3(a)(17)). Designated 
FMUs for which the Board is the Supervisory Agency are generally 
already expected to meet most of these standards, or are at least 
familiar with these or similar standards, so these requirements would 
not likely impose material additional costs on those designated FMUs.
    The final rule, however, also includes a number of new or 
heightened standards that may impose new or additional compliance costs 
on the designated FMUs for which the Board is the Supervisory Agency. 
For example, as explained above in the Supplementary Information, the 
final rule includes requirements for integrated plans for the 
designated FMU's recovery and orderly wind-down (Sec.  
234.3(a)(3)(iii)); policies and procedures that explicitly address 
uncovered credit losses (Sec.  234.3(a)(4)(vi)); policies and 
procedures that explicitly address liquidity shortfalls (Sec.  
234.3(a)(7)(viii)); maintaining sufficient liquid net assets funded by 
equity sufficient to ensure a recovery or orderly wind-down of critical 
operations and services and a viable plan for raising additional equity 
should the designated FMU's equity fall below the amount required for a 
recovery or orderly wind-down (Sec.  234.3(a)(15)(i) and (ii)); 
managing risks arising in tiered participation arrangements (Sec.  
234.3(a)(19)); and providing comprehensive public disclosure (Sec.  
234.3(a)(23)(iv)).
    All of these requirements would likely require professional skills 
in the legal, risk management, finance, payments operations, and 
accounting areas.
    5. Significant alternatives to the revisions. Section 805(a) of the 
Dodd-Frank Act requires the Board to prescribe risk-management 
standards governing the operations related to payment, clearing, and 
settlement activities of designated FMUs, so other administrative 
methods for accomplishing the goals of the Act were not considered. In 
prescribing the risk-management standards, Section 805(a) of the Act 
also requires the Board to take into consideration relevant 
international standards, among other things. The PFMI is now widely 
recognized as the most relevant set of international risk-management 
standards for payment, clearing, and settlement systems. Consistent 
with the PFMI, the proposed rule generally employed a flexible, 
principles-based approach to permit a designated FMU to employ a cost-
effective method for compliance. In consultation with the Council and 
the other Supervisory Agencies, the Board has included additional 
detail in developing the final rule where necessary or appropriate, 
such as specific testing frequencies or other requirements to provide 
the designated FMUs with sufficient guidance for compliance with the 
standard. As noted above, the Board has revised the level of detail 
provided in the risk-management standards in the final rule, as 
appropriate, in response to the public comments. In addition, after 
consideration of the public comments as well as additional Board 
analysis, the Board has delayed the compliance date for several of the 
new or heightened requirements in order to allow designated FMUs for 
which the Board is the Supervisory Agency sufficient time to revise 
their rules and associated processes and procedures and to minimize 
burden on the designated FMUs and the markets they serve. As noted 
above, the Board does not believe that the alternative adopted in the 
final rule will have a significant economic impact on small entities.

B. Competitive Impact Analysis

    As a matter of policy, the Board subjects all operational and legal 
changes that could have a substantial effect on payment system 
participants to a competitive impact analysis, even if competitive 
effects are not apparent on the face of the proposal.\17\ Pursuant to 
this policy, the Board assesses whether proposed changes ``would have a 
direct and material adverse effect on the ability of other service 
providers to compete effectively with the Federal Reserve in providing 
similar services'' and whether any such adverse effect ``was due to 
legal differences or due to a dominant market position deriving from 
such legal differences.'' If, as a result of this analysis, the Board 
identifies an adverse effect on the ability to compete, the Board then 
assesses whether the associated benefits--such as improvements to 
payment system efficiency or integrity--can be achieved while 
minimizing the adverse effect on competition.
---------------------------------------------------------------------------

    \17\ See ``The Federal Reserve in the Payments System,'' Fed. 
Res. Reg. Svc. Sec. Sec.  9-1550, 9-1558 (Apr. 2009).
---------------------------------------------------------------------------

    This final rule promulgates revised Regulation HH risk-management 
standards, which are based on the PFMI, for certain designated FMUs as 
required by Title VIII of the Dodd-Frank Act. In a separate, related 
Federal Register notice, the Board finalized concurrently revisions to 
part I of its PSR policy, which applies to the Federal Reserve Bank-
operated Fedwire Services, based on the PFMI. At least one currently 
designated FMU that is subject to Regulation HH (The Clearing House 
Payments Company, L.L.C., with respect to its operation of the Clearing 
House Interbank Payments System (CHIPS)) competes with the Fedwire 
Funds

[[Page 65557]]

Service. One commenter expressed concern that differences in language 
between the risk-management standards in Regulation HH and in part I of 
the PSR policy may result in two different sets of risk-management 
standards for FMUs. The commenter also stated that the Board should 
ensure that the requirements in Sec.  234.3(a)(15) with respect to 
general business risk for designated FMUs should also be imposed on the 
equivalent Reserve Bank service.
    The final revisions to the risk-management and transparency 
expectations in part I of the PSR policy are consistent with those in 
final Regulation HH. As discussed above, a different level of detail is 
required for Regulation HH as compared to part I of the PSR policy. 
Regulation HH is an enforceable rule applicable to designated FMUs 
other than those supervised by the CFTC or SEC, so additional details 
from the key considerations and explanatory notes of the PFMI were 
incorporated in the rule text to provide greater clarity on the Board's 
expectations. The PSR policy, on the other hand, is a policy statement 
that provides guidance with respect to the Board's exercise of its 
other supervisory or regulatory authority over other financial market 
infrastructures (including those operated by the Federal Reserve Banks) 
or their participants, its participation in cooperative oversight 
arrangements for financial market infrastructures, or the provision of 
intraday credit to eligible Federal Reserve account holders. 
Incorporating the headline standards from the PFMI is consistent with 
the purpose of the document and the Board's long-standing principles-
based approach to its PSR policy. The Board has stated that it will be 
guided by the key considerations and the explanatory text of the PFMI 
in its application of the PSR policy. The Board does not intend for 
differences in language in the two documents to lead to inconsistent 
requirements for Reserve Bank-operated FMUs and their private sector 
competitors.
    The Board recognizes the critical role that the Fedwire Services 
play in the financial system and is committed to applying risk-
management standards to the Reserve Banks' Fedwire Funds Service that 
are at least as stringent as the applicable Regulation HH standards 
applied to designated FMUs that provide similar services. The final 
revisions to part I of the PSR policy provide that the treatment of 
Reserve Bank systems will be consistent with that of private-sector 
systems in order to avoid any material adverse effect on the ability of 
other service providers to compete effectively with the Reserve Banks.
    There are, however, several risk-management standards for which 
flexibility in implementation will be necessary for the Fedwire 
Services given the Federal Reserve's legal framework and structure and 
its roles as monetary authority and liquidity provider.\18\ The Board 
does not expect that the difference in approach to implementing these 
standards for the Fedwire Funds Service as compared to the requirements 
for its private-sector competitor would create a significant difference 
in operating costs for the two entities, with the possible exception of 
the expectation to hold unencumbered liquid financial assets and equity 
under Sec.  234.3(a)(15)(i). In order to foster competition with 
private-sector systems, the Board will incorporate the cost of this 
requirement into the pricing of the Fedwire Funds Service. Although the 
Fedwire Funds Service does not face the risk that a business shock 
would cause the service to wind down in a disorderly manner and disrupt 
the stability of the financial system, in order to foster competition 
with private-sector systems, the Board will require the Fedwire Funds 
Service to impute the cost of maintaining liquid assets and equity to 
cover general business losses, similar to the requirement for 
designated FMUs in Sec.  234.3(a)(15)(i). The Board will also monitor 
the implementation of the final regulation and policy for issues of 
consistency and competitive equity between private-sector systems and 
the Fedwire Funds Service. Therefore, the Board does not believe the 
final rule promulgating risk-management standards for designated FMUs 
under Title VIII will have any direct and material adverse effect on 
the ability of other service providers to compete with the Reserve 
Banks.
---------------------------------------------------------------------------

    \18\ These standards include principle 2 on governance, 
principle 3 on the framework for the comprehensive management of 
risks, principle 4 on credit risk, principle 5 on collateral, 
principle 7 on liquidity risk, principle 13 on participant-default 
rules and procedures, principle 15 on general business risk, and 
principle 18 on access and participation requirements.
---------------------------------------------------------------------------

C. Paperwork Reduction Act Analysis

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CFR part 1320, Appendix A.1), the Board reviewed the final rule 
under the authority delegated to the Board by the Office of Management 
and Budget. As noted in the proposal, for purposes of calculating 
burden under the Paperwork Reduction Act, a ``collection of 
information'' involves 10 or more respondents. Any collection of 
information addressed to all or a substantial majority of an industry 
is presumed to involve 10 or more respondents (5 CFR 1320.3(c) 
introductory text and (c)(4)(ii)). The Board estimates there are fewer 
than 10 respondents, and these respondents do not represent all or a 
substantial majority of the participants in payment, clearing, and 
settlement systems. Therefore, no collections of information pursuant 
to the Paperwork Reduction Act are contained in the final rule. The 
Board did not receive any comments on this analysis.

Text of Final Rule

List of Subjects in 12 CFR 234

    Banks, Banking, Credit, Electronic funds transfers, Financial 
market utilities, Securities.

Authority and Issuance

    For the reasons set forth in the preamble, the Board amends 12 CFR 
part 234 as set forth below.

PART 234--DESIGNATED FINANCIAL MARKET UTILITIES (REGULATION HH)

0
1-2. The authority citation for part 234 continues to read as follows:

    Authority:  12 U.S.C. 5461 et seq.

0
3. Revise Sec.  234.2 to read as follows:


Sec.  234.2  Definitions.

    (a) Backtest means the ex post comparison of realized outcomes with 
margin model forecasts to analyze and monitor model performance and 
overall margin coverage.
    (b) Central counterparty means an entity that interposes itself 
between counterparties to contracts traded in one or more financial 
markets, becoming the buyer to every seller and the seller to every 
buyer.
    (c) Central securities depository means an entity that provides 
securities accounts and central safekeeping services.
    (d) Designated financial market utility means a financial market 
utility that is currently designated by the Financial Stability 
Oversight Council under section 804 of the Dodd-Frank Act (12 U.S.C. 
5463).
    (e) Financial market utility has the same meaning as the term is 
defined in section 803(6) of the Dodd-Frank Act (12 U.S.C. 5462(6)).
    (f) Link means, for purposes of Sec.  234.3(a)(20), a set of 
contractual and operational arrangements between two or more central 
counterparties, central securities depositories, or securities 
settlement systems, or between one or more of these financial market 
utilities

[[Page 65558]]

and one or more trade repositories, that connect them directly or 
indirectly, such as for the purposes of participating in settlement, 
cross margining, or expanding their services to additional instruments 
and participants.
    (g) Orderly wind-down means the actions of a designated financial 
market utility to effect the permanent cessation, sale, or transfer of 
one or more of its critical operations or services in a manner that 
would not 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.
    (h) Recovery means, for purposes of Sec.  234.3(a)(3) and (15), the 
actions of a designated financial market utility, consistent with its 
rules, procedures, and other ex ante contractual arrangements, to 
address any uncovered loss, liquidity shortfall, or capital inadequacy, 
whether arising from participant default or other causes (such as 
business, operational, or other structural weaknesses), including 
actions to replenish any depleted prefunded financial resources and 
liquidity arrangements, as necessary to maintain the designated 
financial market utility's viability as a going concern and to continue 
its provision of critical services.
    (i) Securities settlement system means an entity that enables 
securities to be transferred and settled by book entry and allows 
transfers of securities free of or against payment.
    (j) Stress test means the estimation of credit or liquidity 
exposures that would result from the realization of potential stress 
scenarios, such as extreme price changes, multiple defaults, and 
changes in other valuation inputs and assumptions.
    (k) Supervisory Agency has the same meaning as the term is defined 
in section 803(8) of the Dodd-Frank Act (12 U.S.C. 5462(8)).
    (l) Trade repository means an entity that maintains a centralized 
electronic record of transaction data, such as a swap data repository 
or a security-based swap data repository.

0
4. In Sec.  234.3, revise paragraph (a) to read as follows:


Sec.  234.3  Standards for designated financial market utilities.

    (a) A designated financial market utility must implement rules, 
procedures, or operations designed to ensure that it meets or exceeds 
the following risk-management standards with respect to its payment, 
clearing, and settlement activities.
    (1) Legal basis. The designated financial market utility has a 
well-founded, clear, transparent, and enforceable legal basis for each 
material aspect of its activities in all relevant jurisdictions.
    (2) Governance. The designated financial market utility has 
governance arrangements that--
    (i) Are clear, transparent, and documented;
    (ii) Promote the safety and efficiency of the designated financial 
market utility;
    (iii) Support the stability of the broader financial system, other 
relevant public interest considerations such as fostering fair and 
efficient markets, and the legitimate interests of relevant 
stakeholders, including the designated financial market utility's 
owners, participants, and participants' customers; and
    (iv) Are designed to ensure--
    (A) Lines of responsibility and accountability are clear and 
direct;
    (B) The roles and responsibilities of the board of directors and 
senior management are clearly specified;
    (C) The board of directors consists of suitable individuals having 
appropriate skills to fulfill its multiple roles;
    (D) The board of directors includes a majority of individuals who 
are not executives, officers, or employees of the designated financial 
market utility or an affiliate of the designated financial market 
utility;
    (E) The board of directors establishes policies and procedures to 
identify, address, and manage potential conflicts of interest of board 
members and to review its performance and the performance of individual 
board members on a regular basis;
    (F) The board of directors establishes a clear, documented risk-
management framework that includes the designated financial market 
utility's risk-tolerance policy, assigns responsibilities and 
accountability for risk decisions, and addresses decisionmaking in 
crises and emergencies;
    (G) Senior management has the appropriate experience, skills, and 
integrity necessary to discharge operational and risk-management 
responsibilities;
    (H) The risk-management function has sufficient authority, 
resources, and independence from other operations of the designated 
financial market utility, and has a direct reporting line to and is 
overseen by a committee of the board of directors;
    (I) The internal audit function has sufficient authority, 
resources, and independence from management, and has a direct reporting 
line to and is overseen by a committee of the board of directors; and
    (J) Major decisions of the board of directors are clearly disclosed 
to relevant stakeholders, including the designated financial market 
utility's owners, participants, and participants' customers, and, where 
there is a broad market impact, the public.
    (3) Framework for the comprehensive management of risks. The 
designated financial market utility has a sound risk-management 
framework for comprehensively managing legal, credit, liquidity, 
operational, general business, custody, investment, and other risks 
that arise in or are borne by the designated financial market utility. 
This framework is subject to periodic review and includes--
    (i) Risk-management policies, procedures, and systems that enable 
the designated financial market utility to identify, measure, monitor, 
and manage the risks that arise in or are borne by the designated 
financial market utility, including those posed by other entities as a 
result of interdependencies;
    (ii) Risk-management policies, procedures, and systems that enable 
the designated financial market utility 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; and
    (iii) Integrated plans for the designated financial market 
utility's recovery and orderly wind-down that--
    (A) Identify the designated financial market utility's critical 
operations and services related to payment, clearing, and settlement;
    (B) Identify scenarios that may potentially prevent it from being 
able to provide its critical operations and services as a going 
concern, including uncovered credit losses (as described in paragraph 
(a)(4)(vi)(A) of this section), uncovered liquidity shortfalls (as 
described in paragraph (a)(7)(viii)(A) of this section), and general 
business losses (as described in paragraph (a)(15) of this section);
    (C) Identify criteria that could trigger the implementation of the 
recovery or orderly wind-down plan;
    (D) Include rules, procedures, policies, and any other tools the 
designated financial market utility would use in a recovery or orderly 
wind-down to address the scenarios identified under paragraph 
(a)(3)(iii)(B) of this section;
    (E) Include procedures to ensure timely implementation of the 
recovery and orderly wind-down plans in the

[[Page 65559]]

scenarios identified under paragraph (a)(3)(iii)(B) of this section;
    (F) Include procedures for informing the Board, as soon as 
practicable, if the designated financial market utility is considering 
initiating recovery or orderly wind-down; and
    (G) Are reviewed the earlier of every two years or following 
changes to the system or the environment in which the designated 
financial market utility operates that would significantly affect the 
viability or execution of the plans.
    (4) Credit risk. The designated financial market utility 
effectively measures, monitors, and manages its credit exposures to 
participants and those arising from its payment, clearing, and 
settlement processes. In this regard, the designated financial market 
utility maintains sufficient financial resources to cover its credit 
exposure to each participant fully with a high degree of confidence. In 
addition, the designated financial market utility--
    (i) If it operates as a central counterparty, maintains additional 
prefunded financial resources that are sufficient to cover its credit 
exposure under a wide range of significantly different stress scenarios 
that includes the default of the participant and its affiliates that 
would potentially cause the largest aggregate credit exposure to the 
designated financial market utility in extreme but plausible market 
conditions;
    (ii) If it operates as a central counterparty, may be directed by 
the Board to maintain additional prefunded financial resources that are 
sufficient to cover its credit exposure under a wide range of 
significantly different stress scenarios that includes the default of 
the two participants and their affiliates that would potentially cause 
the largest aggregate credit exposure to the designated financial 
market utility in extreme but plausible market conditions. The Board 
may consider such a direction if the central counterparty--
    (A) Is involved in activities with a more-complex risk profile, 
such as clearing financial instruments characterized by discrete jump-
to-default price changes or that are highly correlated with potential 
participant defaults, or
    (B) Has been determined by another jurisdiction to be systemically 
important in that jurisdiction;
    (iii) If it operates as a central counterparty, determines the 
amount and regularly tests the sufficiency of the total financial 
resources available to meet the requirements of this paragraph by--
    (A) On a daily basis, conducting a stress test of its total 
financial resources using standard and predetermined stress scenarios, 
parameters, and assumptions;
    (B) On at least a monthly basis, and more frequently when the 
products cleared or markets served experience high volatility or become 
less liquid, or when the size or concentration of positions held by the 
central counterparty's participants increases significantly, conducting 
a comprehensive and thorough analysis of the existing stress scenarios, 
models, and underlying parameters and assumptions such that the 
designated financial market utility meets its required level of default 
protection in light of current and evolving market conditions; and
    (C) Having clear procedures to report the results of its stress 
tests to decisionmakers at the central counterparty and using these 
results to evaluate the adequacy of and adjust its total financial 
resources;
    (iv) If it operates as a central counterparty, excludes assessments 
for additional default or guaranty fund contributions (that is, default 
or guaranty fund contributions that are not prefunded) in its 
calculation of financial resources available to meet the total 
financial resource requirement under this paragraph;
    (v) At least annually, provides for a validation of the designated 
financial market utility's risk-management models used to determine the 
sufficiency of its total financial resources that--
    (A) Includes the designated financial market utility's models used 
to comply with the collateral provisions under paragraph (a)(5) of this 
section and models used to determine initial margin under paragraph 
(a)(6) of this section; and
    (B) Is performed by a qualified person who does not perform 
functions associated with the model (except as part of the annual model 
validation), does not report to such a person, and does not have a 
financial interest in whether the model is determined to be valid; and
    (vi) Establishes rules and procedures that explicitly--
    (A) Address allocation of credit losses the designated financial 
market utility may face if its collateral and other financial resources 
are insufficient to cover fully its credit exposures, including the 
repayment of any funds a designated financial market utility may borrow 
from liquidity providers; and
    (B) Describe the designated financial market utility's process to 
replenish any financial resources that the designated financial market 
utility may employ during a stress event, including a participant 
default.
    (5) Collateral. If it requires collateral to manage its or its 
participants' credit exposure, the designated financial market utility 
accepts collateral with low credit, liquidity, and market risks and 
sets and enforces conservative haircuts and concentration limits, in 
order to ensure the value of the collateral in the event of liquidation 
and that the collateral can be used in a timely manner. In this regard, 
the designated financial market utility--
    (i) Establishes prudent valuation practices and develops haircuts 
that are tested regularly and take into account stressed market 
conditions;
    (ii) Establishes haircuts that are calibrated to include relevant 
periods of stressed market conditions to reduce the need for 
procyclical adjustments;
    (iii) Provides for annual validation of its haircut procedures, as 
part of its risk-management model validation under paragraph (a)(4)(v) 
of this section;
    (iv) Avoids concentrated holdings of any particular type of asset 
where the concentration could significantly impair the ability to 
liquidate such assets quickly without significant adverse price 
effects;
    (v) Uses a collateral management system that is well-designed and 
operationally flexible such that it, among other things,--
    (A) Accommodates changes in the ongoing monitoring and management 
of collateral; and
    (B) Allows for the timely valuation of collateral and execution of 
any collateral or margin calls.
    (6) Margin. If it operates as a central counterparty, the 
designated financial market utility covers its credit exposures to its 
participants for all products by establishing a risk-based margin 
system that--
    (i) Is conceptually and methodologically sound for the risks and 
particular attributes of each product, portfolio, and markets it 
serves, as demonstrated by documented and empirical evidence supporting 
design choices, methods used, variables selected, theoretical bases, 
key assumptions, and limitations;
    (ii) Establishes margin levels commensurate with the risks and 
particular attributes of each product, portfolio, and market it serves;
    (iii) Has a reliable source of timely price data;
    (iv) Has procedures and sound valuation models for addressing 
circumstances in which pricing data are not readily available or 
reliable;

[[Page 65560]]

    (v) Marks participant positions to market and collects variation 
margin at least daily and has the operational capacity to make intraday 
margin calls and payments, both scheduled and unscheduled, to 
participants;
    (vi) Generates initial margin requirements sufficient to cover 
potential changes in the value of each participant's position during 
the interval between the last margin collection and the closeout of 
positions following a participant default by--
    (A) Ensuring that initial margin meets an established single-tailed 
confidence level of at least 99 percent with respect to the estimated 
distribution of future exposure; and
    (B) Using a conservative estimate of the time horizons for the 
effective hedging or closeout of the particular types of products 
cleared, including in stressed market conditions; and
    (vii) Is monitored on an ongoing basis and regularly reviewed, 
tested, and verified through--
    (A) Daily backtests;
    (B) Monthly sensitivity analyses, performed more frequently during 
stressed market conditions or significant fluctuations in participant 
positions, with this analysis taking into account a wide range of 
parameters and assumptions that reflect possible market conditions that 
captures a variety of historical and hypothetical conditions, including 
the most volatile periods that have been experienced by the markets the 
designated financial market utility serves; and
    (C) Annual model validations of the designated financial market 
utility's margin models and related parameters and assumptions, as part 
of its risk-management model validation under paragraph (a)(4)(v) of 
this section.
    (7) Liquidity risk. The designated financial market utility 
effectively measures, monitors, and manages the liquidity risk that 
arises in or is borne by the designated financial market utility. In 
this regard, the designated financial market utility--
    (i) Has effective operational and analytical tools to identify, 
measure, and monitor its settlement and funding flows on an ongoing and 
timely basis, including its use of intraday liquidity;
    (ii) Maintains sufficient liquid resources in all relevant 
currencies to effect same-day and, where applicable, intraday and 
multiday settlement of payment obligations with a high degree of 
confidence under a wide range of significantly different potential 
stress scenarios that includes the default of the participant and its 
affiliates that would generate the largest aggregate liquidity 
obligation for the designated financial market utility in extreme but 
plausible market conditions;
    (iii) Holds, for purposes of meeting the minimum liquid resource 
requirement under paragraph (a)(7)(ii) of this section,--
    (A) cash in each relevant currency at the central bank of issue or 
creditworthy commercial banks;
    (B) assets that are readily available and convertible into cash, 
through committed arrangements without material adverse change 
conditions, such as collateralized lines of credit, foreign exchange 
swaps, and repurchase agreements; or
    (C) subject to the determination of the Board, highly marketable 
collateral and investments that are readily available and convertible 
into cash with prearranged and highly reliable funding arrangements, 
even in extreme but plausible market conditions;
    (iv) Evaluates and confirms, at least annually, whether each 
provider of the arrangements as described in paragraphs (a)(7)(iii)(B) 
and (C) of this section has sufficient information to understand and 
manage that provider's associated liquidity risks, and whether the 
provider has the capacity to perform;
    (v) Maintains and tests its procedures and operational capacity for 
accessing each type of liquid resource required under this paragraph at 
least annually;
    (vi) Determines the amount and regularly tests the sufficiency of 
the liquid resources necessary to meet the minimum liquid resource 
requirement under this paragraph by--
    (A) On a daily basis, conducting a stress test of its liquid 
resources using standard and predetermined stress scenarios, 
parameters, and assumptions;
    (B) On at least a monthly basis, and more frequently when products 
cleared or markets served experience high volatility or become less 
liquid, or when the size or concentration of positions held by the 
designated financial market utility's participants increases 
significantly, conducting a comprehensive and thorough analysis of the 
existing stress scenarios, models, and underlying parameters and 
assumptions such that the designated financial market utility meets its 
identified liquidity needs and resources in light of current and 
evolving market conditions; and
    (C) Having clear procedures to report the results of its stress 
tests to decisionmakers at the designated financial market utility and 
using these results to evaluate the adequacy of and make adjustments to 
its liquidity risk-management framework;
    (vii) At least annually, provides for a validation of its liquidity 
risk-management model by a qualified person who does not perform 
functions associated with the model (except as part of the annual model 
validation), does not report to such a person, and does not have a 
financial interest in whether the model is determined to be valid; and
    (viii) Establishes rules and procedures that explicitly--
    (A) Address potential liquidity shortfalls that would not be 
covered by the designated financial market utility's liquid resources 
and avoid unwinding, revoking, or delaying the same-day settlement of 
payment obligations; and
    (B) Describe the designated financial market utility's process to 
replenish any liquid resources that it may employ during a stress 
event, including a participant default.
    (8) Settlement finality. The designated financial market utility 
provides clear and certain final settlement intraday or in real time as 
appropriate, and at a minimum, by the end of the value date. The 
designated financial market utility clearly defines the point at which 
settlement is final and the point after which unsettled payments, 
transfer instructions, or other settlement instructions may not be 
revoked by a participant.
    (9) Money settlements. The designated financial market utility 
conducts its money settlements in central bank money where practical 
and available. If central bank money is not used, the designated 
financial market utility minimizes and strictly controls the credit and 
liquidity risks arising from conducting its money settlements in 
commercial bank money, including settlement on its own books. If it 
conducts its money settlements at a commercial bank, the designated 
financial market utility--
    (i) Establishes and monitors adherence to criteria based on high 
standards for its settlement banks that take account of, among other 
things, their applicable regulatory and supervisory frameworks, 
creditworthiness, capitalization, access to liquidity, and operational 
reliability;
    (ii) Monitors and manages the concentration of credit and liquidity 
exposures to its commercial settlement banks; and
    (iii) Ensures that its legal agreements with its settlement banks 
state clearly--
    (A) When transfers on the books of individual settlement banks are 
expected to occur;
    (B) That transfers are final when funds are credited to the 
recipient's account; and

[[Page 65561]]

    (C) That the funds credited to the recipient are available 
immediately for retransfer or withdrawal.
    (10) Physical deliveries. A designated financial market utility 
that operates as a central counterparty, securities settlement system, 
or central securities depository clearly states its obligations with 
respect to the delivery of physical instruments or commodities and 
identifies, monitors, and manages the risks associated with such 
physical deliveries.
    (11) Central securities depositories. A designated financial market 
utility that operates as a central securities depository has 
appropriate rules and procedures to help ensure the integrity of 
securities issues and minimizes and manages the risks associated with 
the safekeeping and transfer of securities. In this regard, the 
designated financial market utility maintains securities in an 
immobilized or dematerialized form for their transfer by book entry.
    (12) Exchange-of-value settlement systems. If it settles 
transactions that involve the settlement of two linked obligations, 
such as a transfer of securities against payment or the exchange of one 
currency for another, the designated financial market utility 
eliminates principal risk by conditioning the final settlement of one 
obligation upon the final settlement of the other.
    (13) Participant-default rules and procedures. The designated 
financial market utility has effective and clearly defined rules and 
procedures to manage a participant default that are designed to ensure 
that the designated financial market utility can take timely action to 
contain losses and liquidity pressures so that it can continue to meet 
its obligations. In this regard, the designated financial market 
utility tests and reviews its default procedures, including any 
closeout procedures, at least annually or following material changes to 
these rules and procedures.
    (14) Segregation and portability. A designated financial market 
utility that operates as a central counterparty has rules and 
procedures that enable the segregation and portability of positions of 
a participant's customers and the collateral provided to the designated 
financial market utility with respect to those positions.
    (15) General business risk. The designated financial market utility 
identifies, monitors, and manages its general business risk, which is 
the risk of losses that may arise from its administration and operation 
as a business enterprise (including losses from execution of business 
strategy, negative cash flows, or unexpected and excessively large 
operating expenses) that are neither related to participant default nor 
separately covered by financial resources maintained for credit or 
liquidity risk. In this regard, in addition to holding financial 
resources required to manage credit risk (paragraph (a)(4) of this 
section) and liquidity risk (paragraph (a)(7) of this section), the 
designated financial market utility--
    (i) Maintains liquid net assets funded by equity that are at all 
times sufficient to ensure a recovery or orderly wind-down of critical 
operations and services such that it--
    (A) Holds unencumbered liquid financial assets, such as cash or 
highly liquid securities, that are sufficient to cover the greater of--
    (1) The cost to implement the plans to address general business 
losses as required under paragraph (a)(3)(iii) of this section and
    (2) Six months of current operating expenses or as otherwise 
determined by the Board; and
    (B) Holds equity, such as common stock, disclosed reserves, and 
other retained earnings, that is at all times greater than or equal to 
the amount of unencumbered liquid financial assets that are required to 
be held under paragraph (a)(15)(i)(A) of this section; and
    (ii) Maintains a viable plan, approved by the board of directors, 
for raising additional equity should the designated financial market 
utility's equity fall below the amount required under paragraph 
(a)(15)(i) of this section, and updates the plan the earlier of every 
two years or following changes to the designated financial market 
utility or the environment in which it operates that would 
significantly affect the viability or execution of the plan.
    (16) Custody and investment risks. The designated financial market 
utility--
    (i) Safeguards its own and its participants' assets and minimizes 
the risk of loss on and delay in access to these assets by--
    (A) Holding its own and its participants' assets at supervised and 
regulated entities that have accounting practices, safekeeping 
procedures, and internal controls that fully protect these assets; and
    (B) Evaluating its exposures to its custodian banks, taking into 
account the full scope of its relationships with each; and
    (ii) Invests its own and its participants' assets--
    (A) In instruments with minimal credit, market, and liquidity 
risks, 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; and
    (B) Using an investment strategy that is consistent with its 
overall risk-management strategy and fully disclosed to its 
participants.
    (17) Operational risk. The designated financial market utility 
manages its operational risks by establishing a robust operational 
risk-management framework that is approved by the board of directors. 
In this regard, the designated financial market utility--
    (i) Identifies the plausible sources of operational risk, both 
internal and external, and mitigates their impact through the use of 
appropriate systems, policies, procedures, and controls that are 
reviewed, audited, and tested periodically and after major changes;
    (ii) Identifies, monitors, and manages the risks its operations 
might pose to other financial market utilities and trade repositories, 
if any;
    (iii) Has policies and systems that are designed to achieve clearly 
defined objectives to ensure a high degree of security and operational 
reliability;
    (iv) Has systems that have adequate, scalable capacity to handle 
increasing stress volumes and achieve the designated financial market 
utility's service-level objectives;
    (v) Has comprehensive physical, information, and cyber security 
policies, procedures, and controls that address potential and evolving 
vulnerabilities and threats;
    (vi) Has business continuity management that provides for rapid 
recovery and timely resumption of critical operations and fulfillment 
of its obligations, including in the event of a wide-scale disruption 
or a major disruption; and
    (vii) Has a business continuity plan that--
    (A) Incorporates the use of a secondary site that is located at a 
sufficient geographical distance from the primary site to have a 
distinct risk profile;
    (B) Is designed to enable critical systems, including information 
technology systems, to recover and resume operations no later than two 
hours following disruptive events;
    (C) Is designed to enable it to complete settlement by the end of 
the day of the disruption, even in case of extreme circumstances; and
    (D) Is tested at least annually.
    (18) Access and participation requirements. The designated 
financial market utility has objective, risk-based, and publicly 
disclosed criteria for participation, which permit fair and

[[Page 65562]]

open access. The designated financial market utility--
    (i) Monitors compliance with its participation requirements on an 
ongoing basis and has the authority to impose more-stringent 
restrictions or other risk controls on a participant in situations 
where the designated financial market utility determines the 
participant poses heightened risk to the designated financial market 
utility; and
    (ii) Has clearly defined and publicly disclosed procedures for 
facilitating the suspension and orderly exit of a participant that 
fails to meet the participation requirements.
    (19) Tiered participation arrangements. The designated financial 
market utility identifies, monitors, and manages the material risks 
arising from arrangements in which firms that are not direct 
participants in the designated financial market utility rely on the 
services provided by direct participants to access the designated 
financial market utility's payment, clearing, or settlement facilities, 
whether the risks are borne by the designated financial market utility 
or by its participants as a result of their participation. The 
designated financial market utility--
    (i) Conducts an analysis to determine whether material risks arise 
from tiered participation arrangements;
    (ii) Where material risks are identified, mitigates or manages such 
risks; and
    (iii) Reviews and updates the analysis conducted under paragraph 
(a)(19)(i) of this section the earlier of every two years or following 
material changes to the system design or operations or the environment 
in which the designated financial market utility operates if those 
changes could affect the analysis conducted under paragraph (a)(19)(i) 
of this section.
    (20) Links. If it operates as a central counterparty, securities 
settlement system, or central securities depository and establishes a 
link with one or more of these types of financial market utilities or 
trade repositories, the designated financial market utility identifies, 
monitors, and manages risks related to this link. In this regard, each 
central counterparty in a link arrangement with another central 
counterparty covers, at least on a daily basis, its current and 
potential future exposures to the linked central counterparty and its 
participants, if any, fully with a high degree of confidence without 
reducing the central counterparty's ability to fulfill its obligations 
to its own participants.
    (21) Efficiency and effectiveness. The designated financial market 
utility--
    (i) Is efficient and effective in meeting the requirements of its 
participants and the markets it serves, in particular, with regard to 
its--
    (A) Clearing and settlement arrangement;
    (B) Risk-management policies, procedures, and systems;
    (C) Scope of products cleared and settled; and
    (D) Use of technology and communication procedures;
    (ii) Has clearly defined goals and objectives that are measurable 
and achievable, such as minimum service levels, risk-management 
expectations, and business priorities; and
    (iii) Has policies and procedures for the regular review of its 
efficiency and effectiveness.
    (22) Communication procedures and standards. The designated 
financial market utility uses, or at a minimum accommodates, relevant 
internationally accepted communication procedures and standards in 
order to facilitate efficient payment, clearing, and settlement.
    (23) Disclosure of rules, key procedures, and market data. The 
designated financial market utility--
    (i) Has clear and comprehensive rules and procedures;
    (ii) Publicly discloses all rules and key procedures, including key 
aspects of its default rules and procedures;
    (iii) Provides sufficient information to enable participants to 
have an accurate understanding of the risks, fees, and other material 
costs they incur by participating in the designated financial market 
utility;
    (iv) Provides a comprehensive public disclosure of its legal, 
governance, risk management, and operating framework, that includes--
    (A) Executive summary. An executive summary of the key points from 
paragraphs (a)(23)(iv)(B) through (D) of this section;
    (B) Summary of major changes since the last update of the 
disclosure. A summary of the major changes since the last update of 
paragraph (a)(23)(iv)(C), (D), or (E) of this section;
    (C) General background on the designated financial market utility. 
A description of--
    (1) The designated financial market utility's function and the 
markets it serves,
    (2) 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 designated financial market utility's operational 
reliability, and
    (3) The designated financial market utility's general organization, 
legal and regulatory framework, and system design and operations;
    (D) Standard-by-standard summary narrative. A comprehensive 
narrative disclosure for each applicable standard set forth in this 
paragraph (a) with sufficient detail and context to enable a reader to 
understand the designated financial market utility's approach to 
controlling the risks and addressing the requirements in each standard; 
and
    (E) List of publicly available resources. A list of publicly 
available resources, including those referenced in the disclosure, that 
may help a reader understand how the designated financial market 
utility controls its risks and addresses the requirements set forth in 
this paragraph (a); and
    (v) Updates the public disclosure under paragraph (a)(23)(iv) of 
this section the earlier of every two years or following changes to its 
system or the environment in which it operates that would significantly 
change the accuracy of the statements provided under paragraph 
(a)(23)(iv) of this section.
* * * * *


Sec.  234.4  [Removed]

0
5. Remove Sec.  234.4


Sec. Sec.  234.5 through 234.7  [Redesignated as Sec. Sec.  234.4 
through 234.6]

0
6. Redesignate Sec. Sec.  234.5 through 234.7 as Sec. Sec.  234.4 
through 6, respectively.


Sec.  234.5  [Amended]

0
7. In newly redesignated Sec.  234.5, redesignate paragraph (b)(3)(iv) 
as paragraph (b)(3)(iii).

    By order of the Board of Governors of the Federal Reserve 
System, October 28, 2014.
Robert deV. Frierson,
Secretary of the Board.
[FR Doc. 2014-26090 Filed 11-4-14; 8:45 am]
BILLING CODE 6210-01-P