[Federal Register Volume 81, Number 198 (Thursday, October 13, 2016)]
[Rules and Regulations]
[Pages 70786-70906]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-23891]
[[Page 70785]]
Vol. 81
Thursday,
No. 198
October 13, 2016
Part III
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Part 240
Standards for Covered Clearing Agencies; Final Rule
Federal Register / Vol. 81 , No. 198 / Thursday, October 13, 2016 /
Rules and Regulations
[[Page 70786]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-78961; File No. S7-03-14]
RIN 3235-AL48
Standards for Covered Clearing Agencies
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting amendments to Rule 17Ad-22 and adding new
Rule 17Ab2-2 pursuant to Section 17A of the Securities Exchange Act of
1934 (``Exchange Act'') and the Payment, Clearing, and Settlement
Supervision Act of 2010 (``Clearing Supervision Act''), enacted in
Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (``Dodd-Frank Act''). Among other things, the rules
establish enhanced standards for the operation and governance of those
clearing agencies registered with the Commission (``registered clearing
agencies'') that meet the definition of ``covered clearing agency.''
DATES: Effective date: December 12, 2016.
Compliance date: April 11, 2017.
The compliance date is discussed in Part II.G below.
FOR FURTHER INFORMATION CONTACT: Jeffrey Mooney, Assistant Director;
Stephanie Park, Senior Special Counsel; Matthew Lee, Branch Chief;
Elizabeth Fitzgerald, Branch Chief; or DeCarlo McLaren, Attorney-
Adviser; Office of Market Infrastructure, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-7010, at (202) 551-5710.
SUPPLEMENTARY INFORMATION: The Commission is amending Rule 17Ad-22 by
adding new Rule 17Ad-22(e) to establish requirements for the operation
and governance of registered clearing agencies that meet the definition
of a ``covered clearing agency.'' A covered clearing agency includes a
registered clearing agency that (i) has been designated as systemically
important by the Financial Stability Oversight Council (``FSOC'') and
for which the Commission is the supervisory agency under the Clearing
Supervision Act (``designated clearing agency''), or (ii) provides
central counterparty (``CCP'') services for security-based swaps or is
involved in activities the Commission determines to have a more complex
risk profile (``complex risk profile clearing agency''), unless the
Commodity Futures Trading Commission (``CFTC'') is the supervisory
agency under the Clearing Supervision Act.
To facilitate the addition of new Rule 17Ad-22(e), the Commission
is amending existing Rule 17Ad-22(d) to limit its application to
clearing agencies other than covered clearing agencies and revising
Rule 17Ad-22(a) to add 14 new definitions. The Commission is also
adopting new Rule 17Ad-22(f) to codify the Commission's statutory
authority under Section 807(c) of the Clearing Supervision Act and new
Rule 17Ab2-2 to establish procedures for making determinations
regarding covered clearing agencies in certain defined circumstances,
described further below.
In developing these rules, Commission staff has consulted with the
FSOC, CFTC, and Board of Governors of the Federal Reserve System
(``FRB''). The Commission has also considered the relevant
international standards as required by Section 805(a)(2)(A) of the
Clearing Supervision Act.\1\ The relevant international standards for
designated clearing agencies and complex risk profile clearing agencies
are the Principles for Financial Market Infrastructures (``PFMI'').\2\
---------------------------------------------------------------------------
\1\ See 12 U.S.C. 5464(a)(2)(A).
\2\ See Committee on Payment and Settlement Systems and
Technical Committee of the International Organization of Securities
Commissions (``CPSS-IOSCO''), Principles for financial market
infrastructures (Apr. 16, 2012), available at http://www.bis.org/publ/cpss101a.pdf. In 2014, the CPSS became the Committee on
Payments and Market Infrastructures (``CPMI'').
---------------------------------------------------------------------------
Table of Contents
I. Introduction
A. Regulatory Framework
1. Exchange Act
2. Dodd-Frank Act
3. Rule 17Ad-22
4. Regulation SCI
5. Relevant International Standards
6. Recognition and Equivalence Within the EU
B. Summary of the Commission's Proposal
C. Comments Received
1. Financial Stability and the Dodd-Frank Act
2. Relationship Between Rules 17Ad-22(d) and (e)
3. Relationship Among Rules 17Ad-22(b), (c), and (e)
4. Risk of Duplicative or Inconsistent Regulation
5. Flexible Versus Prescriptive Approaches to Regulation, and
the Role of Rule Filings under Rule 19b-4
6. Consistency With the PFMI
7. Other Comments
II. Description of the Amendments to Rule 17AD-22 and Rule 17AB2-2
A. Scope of Rule 17Ad-22(e)
1. As Applied to CCPs Generally
2. As Applied to Security-Based Swap Clearing Agencies
3. As Applied to Dually Registered Clearing Agencies
B. Principles-Based Approach to Rule 17Ad-22(e)
C. Requirements for Covered Clearing Agencies Under Rule 17Ad-
22(e)
1. Rule 17Ad-22(e)(1): Legal Risk
2. Rule 17Ad-22(e)(2): Governance
3. Rule 17Ad-22(e)(3): Framework for the Comprehensive
Management of Risks
4. Rule 17Ad-22(e)(4): Credit Risk
5. Rule 17Ad-22(e)(5): Collateral
6. Rule 17Ad-22(e)(6): Margin
7. Rule 17Ad-22(e)(7): Liquidity Risk
8. Rule 17Ad-22(e)(8): Settlement Finality
9. Rule 17Ad-22(e)(9): Money Settlements
10. Rule 17Ad-22(e)(10): Physical Delivery Risks
11. Rule 17Ad-22(e)(11): CSDs
12. Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems
13. Rule 17Ad-22(e)(13): Participant-Default Rules and
Procedures
14. Rule 17Ad-22(e)(14): Segregation and Portability
15. Rule 17Ad-22(e)(15): General Business Risk
16. Rule 17Ad-22(e)(16): Custody and Investment Risks
17. Rule 17Ad-22(e)(17): Operational Risk Management
18. Rule 17Ad-22(e)(18): Access and Participation Requirements
19. Rule 17Ad-22(e)(19): Tiered Participation Arrangements
20. Rule 17Ad-22(e)(20): Links
21. Rule 17Ad-22(e)(21): Efficiency and Effectiveness
22. Rule 17Ad-22(e)(22): Communication Procedures and Standards
23. Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures,
and Market Data
D. Rule 17Ab2-2
1. Proposed Rule
2. Comments Received and Commission Response
3. Final Rule
E. Rule 17Ad-22(f)
F. Amendment to Rule 17Ad-22(d)
G. Effective and Compliance Dates
III. Economic Analysis
A. Economic Baseline
1. Regulatory Framework for Registered Clearing Agencies
2. Current Practices
B. Consideration of Benefits, Costs, and the Effect on
Competition, Efficiency, and Capital Formation
1. General Economic Considerations
2. Effect on Competition, Efficiency, and Capital Formation
3. Effect of Amendments to Rule 17Ad-22 and Rule 17Ab2-2
IV. Paperwork Reduction Act
A. Summary of Collection of Information and Use of Information
1. Rule 17Ad-22(e)(1)
2. Rule 17Ad-22(e)(2)
3. Rule 17Ad-22(e)(3)
4. Rule 17Ad-22(e)(4)
5. Rule 17Ad-22(e)(5)
6. Rule 17Ad-22(e)(6)
7. Rule 17Ad-22(e)(7)
[[Page 70787]]
8. Rule 17Ad-22(e)(8)
9. Rule 17Ad-22(e)(9)
10. Rule 17Ad-22(e)(10)
11. Rule 17Ad-22(e)(11)
12. Rule 17Ad-22(e)(12)
13. Rule 17Ad-22(e)(13)
14. Rule 17Ad-22(e)(14)
15. Rule 17Ad-22(e)(15)
16. Rule 17Ad-22(e)(16)
17. Rule 17Ad-22(e)(17)
18. Rule 17Ad-22(e)(18)
19. Rule 17Ad-22(e)(19)
20. Rule 17Ad-22(e)(20)
21. Rule 17Ad-22(e)(21)
22. Rule 17Ad-22(e)(22)
23. Rule 17Ad-22(e)(23)
24. Rule 17Ab2-2
25. Rule 17Ad-22(c)(1)
B. Respondents
C. Total Annual Reporting and Recordkeeping Burdens
1. Rule 17Ad-22(e)(1)
2. Rule 17Ad-22(e)(2)
3. Rule 17Ad-22(e)(3)
4. Rule 17Ad-22(e)(4)
5. Rule 17Ad-22(e)(5)
6. Rule 17Ad-22(e)(6)
7. Rule 17Ad-22(e)(7)
8. Rule 17Ad-22(e)(8)
9. Rule 17Ad-22(e)(9)
10. Rule 17Ad-22(e)(10)
11. Rule 17Ad-22(e)(11)
12. Rule 17Ad-22(e)(12)
13. Rule 17Ad-22(e)(13)
14. Rule 17Ad-22(e)(14)
15. Rule 17Ad-22(e)(15)
16. Rule 17Ad-22(e)(16)
17. Rule 17Ad-22(e)(17)
18. Rule 17Ad-22(e)(18)
19. Rule 17Ad-22(e)(19)
20. Rule 17Ad-22(e)(20)
21. Rule 17Ad-22(e)(21)
22. Rule 17Ad-22(e)(22)
23. Rule 17Ad-22(e)(23)
24. Total Burden for Rule 17Ad-22(e)
25. Total Burden for Rule 17Ab2-2
26. Total Burden for Rule 17Ad-22(c)(1)
D. Collection of Information Is Mandatory
E. Confidentiality
V. Regulatory Flexibility Act
A. Registered Clearing Agencies
B. Certification
VI. Statutory Authority
I. Introduction
A. Regulatory Framework
Below is an overview of the regulatory requirements for registered
clearing agencies that relate to the amendments to Rule 17Ad-22 and new
Rule 17Ab2-2 as set forth under the Exchange Act, the Dodd-Frank Act,
and Commission rules and regulations thereunder.
1. Exchange Act
Section 17A of the Exchange Act directs the Commission to
facilitate the establishment of (i) a national system for the prompt
and accurate clearance and settlement of securities transactions and
(ii) linked or coordinated facilities for clearance and settlement of
securities transactions.\3\ In facilitating the establishment of the
national clearance and settlement system, the Commission must have due
regard for the public interest, the protection of investors, the
safeguarding of securities and funds, and maintenance of fair
competition among brokers and dealers, clearing agencies, and transfer
agents.\4\
---------------------------------------------------------------------------
\3\ See 15 U.S.C. 78q-1(a)(2); see also Report of the Senate
Committee on Banking, Housing & Urban Affairs, S. Rep. No. 94-75, at
4 (1975) (urging that ``[t]he Committee believes the banking and
security industries must move quickly toward the establishment of a
fully integrated national system for the prompt and accurate
processing and settlement of securities transactions'').
\4\ See 15 U.S.C. 78q-1(a)(2)(A).
---------------------------------------------------------------------------
As discussed in the Standards for Covered Clearing Agencies
proposing release (``CCA Standards proposing release''),\5\ clearing
agencies are broadly defined in the Exchange Act and undertake a
variety of functions.\6\ Under Section 17A and Rule 17Ab2-1,\7\ an
entity that meets the definition of a clearing agency is required to
register with the Commission or obtain from the Commission an exemption
from registration prior to performing the functions of a clearing
agency. To grant registration to a clearing agency, the Exchange Act
requires the Commission to determine that the rules and operations of
the applicant clearing agency meet the standards set forth in Section
17A.\8\ Specifically, Section 17A(b)(3) provides that a clearing agency
shall not be registered unless the Commission determines that the
clearing agency's rules are consistent with the Exchange Act. In so
doing, the Commission must determine that, among other things, (i) the
clearing agency is so organized and has the capacity to be able to
facilitate the prompt and accurate clearance and settlement of
securities transactions and to safeguard securities or funds in its
custody or control, (ii) the rules of the clearing agency assure a fair
representation of its members and participants in the selection of its
directors and administration of its affairs, (iii) the rules of the
clearing agency provide for the equitable allocation of reasonable dues
and fees, and (iv) the rules of the clearing agency are designed to
promote the prompt and accurate clearance and settlement of securities
transactions.\9\
---------------------------------------------------------------------------
\5\ See Exchange Act Release No. 34-71699 (Mar. 12, 2014), 79 FR
16865 (Mar. 26, 2014), corrected at 79 FR 29507, 29510-11 (May 22,
2014); see also Exchange Act Release No. 34-68080 (Oct. 22, 2012),
77 FR 66219, 66221-22 (Nov. 2, 2012) (discussing the same)
(``Clearing Agency Standards adopting release'').
\6\ See 15 U.S.C. 78c(a)(23)(A) (providing the definition of
``clearing agency'').
\7\ See 17 CFR 240.17Ab2-1.
\8\ See 15 U.S.C. 78q-1(b)(3)(A) through(I) (identifying nine
determinations that the Commission must make regarding the rules and
structure of a clearing agency to grant registration). In 1980, the
Commission published a statement of the views and positions of
Commission staff regarding the requirements of Section 17A. See
Exchange Act Release No. 16900 (June 17, 1980), 45 FR 41920 (June
23, 1980).
\9\ See 15 U.S.C. 78q-1(b)(3)(A), (C), (D), (F).
---------------------------------------------------------------------------
Following registration, the Commission supervises registered
clearing agencies using various tools. One of these tools is Rule 17a-1
under the Exchange Act, which requires every registered clearing agency
to keep and preserve at least one copy of all documents, including all
correspondence, memoranda, papers, books, notices, accounts, and other
such records as shall be made or received by it in the course of its
business as such and in the conduct of its self-regulatory activity for
a period not less than five years and, upon request of any
representative of the Commission, to promptly furnish to the possession
of such representative copies of any such documents required to be
kept.\10\ Another of these tools is the rule filing process for self-
regulatory organizations (``SROs''),\11\ set forth in Section 19(b) of
the Exchange Act and rules and regulations thereunder. A registered
clearing agency is required to file with the Commission any proposed
rule or proposed change in, addition to, or deletion from the
registered clearing agency's rules.\12\ The Commission publishes all
proposed rule changes for comment and reviews them. Proposed rule
changes are generally required to be approved by the Commission prior
to going into effect; however, certain types of proposed rule changes
take effect upon filing with the Commission.\13\ When reviewing a
proposed rule change, the Commission considers the submissions of the
clearing agency together with any comments received on the proposed
rule change in making a determination of whether the proposed rule
change is consistent with the requirements of the Exchange Act. In
[[Page 70788]]
addition, Section 17A of the Exchange Act further provides the
Commission with authority to adopt rules as necessary or appropriate in
the public interest, for the protection of investors, or otherwise in
furtherance of the purposes of the Exchange Act and prohibits a
clearing agency from engaging in any activity in contravention of such
rules and regulations.\14\
---------------------------------------------------------------------------
\10\ See 17 CFR 240.17a-1(a) through (c); see also 15 U.S.C.
78q(a)(1), (2).
\11\ Upon registration, registered clearing agencies are SROs
under Section 3(a)(26) of the Exchange Act. See 15 U.S.C.
78c(a)(26).
\12\ An SRO must submit proposed rule changes to the Commission
for review and approval pursuant to Rule 19b-4 under the Exchange
Act. A stated policy, practice, or interpretation of an SRO, such as
its written policies and procedures, would generally be deemed to be
a proposed rule change. See 15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4.
\13\ See 15 U.S.C. 78s(b)(3)(A) (setting forth the types of
proposed rule changes that take effect upon filing with the
Commission). The Commission may temporarily suspend those rule
changes within 60 days of filing and institute proceedings to
determine whether to approve or disapprove the rule changes. See 15
U.S.C. 78s(b)(3)(C).
\14\ See 15 U.S.C. 78q-1(d).
---------------------------------------------------------------------------
In addition, Commission staff conducts examinations of registered
clearing agencies to assess, among other things, existing and emerging
risks, compliance with applicable statutory and regulatory
requirements, and a clearing agency's oversight of compliance by its
participants with its rules. Section 21(a) of the Exchange Act provides
the Commission with authority to initiate and conduct investigations to
determine if there have been violations of the federal securities
laws.\15\ Section 19(h) of the Exchange Act also provides the
Commission with authority to institute civil actions seeking injunctive
and other equitable remedies and/or administrative proceedings arising
out of such investigations.\16\
---------------------------------------------------------------------------
\15\ See 15 U.S.C. 78u(a).
\16\ See 15 U.S.C. 78s(h).
---------------------------------------------------------------------------
2. Dodd-Frank Act
Title VII of the Dodd-Frank Act provides the Commission with
authority to regulate certain over-the-counter (``OTC'') derivatives.
Specifically, Title VII added provisions to the Exchange Act that (i)
require entities performing the functions of a clearing agency with
respect to security-based swaps (``security-based swap clearing
agencies'') to register with the Commission, and (ii) direct the
Commission to adopt rules with respect to security-based swap clearing
agencies.\17\
---------------------------------------------------------------------------
\17\ See 15 U.S.C. 78q-1(i), (j); Dodd-Frank Act, Sec. 763(b),
124 Stat. at 1768-69 (adding paragraphs (i) and (j) to Section 17A
of the Exchange Act).
---------------------------------------------------------------------------
The Clearing Supervision Act, enacted in Title VIII of the Dodd-
Frank Act, provides for the enhanced regulation of certain financial
market utilities (``FMUs'').\18\ FMUs include clearing agencies that
manage or operate a multilateral system for the purpose of
transferring, clearing, or settling payments, securities, or other
financial transactions among financial institutions or between
financial institutions and the FMU.\19\ FSOC has designated certain
FMUs as systemically important or likely to become systemically
important (``SIFMUs'').\20\ SIFMUs are required to file 60-days advance
notice of changes to rules, procedures, and operations that could
materially affect the nature or level of risk presented by the SIFMU
(``advance notice'').\21\ The Clearing Supervision Act authorizes the
Commission to object to changes proposed in such an advance notice,
which would prevent the clearing agency from implementing the
change.\22\ The Clearing Supervision Act also provides for enhanced
coordination between the Commission and FRB by allowing for regular on-
site examinations and information sharing.\23\ The Clearing Supervision
Act further provides that the Commission and CFTC shall coordinate with
the FRB to jointly develop risk management supervision programs for
SIFMUs.\24\ In addition, the Clearing Supervision Act provides that the
Commission and CFTC may each prescribe risk management standards
governing the operations related to payment, clearing, and settlement
activities (``PCS activities'') of SIFMUs for which each is the
supervisory agency, in consultation with the FSOC and FRB and taking
into consideration relevant international standards and existing
prudential requirements.\25\
---------------------------------------------------------------------------
\18\ The objectives and principles for the risk management
standards prescribed under the Clearing Supervision Act shall be to
(i) promote robust risk management; (ii) promote safety and
soundness; (iii) reduce systemic risks; and (iv) support the
stability of the broader financial system. Further, the Clearing
Supervision Act states that the standards may address areas such as
risk management policies and procedures; margin and collateral
requirements; participant or counterparty default policies and
procedures; the ability to complete timely clearing and settlement
of financial transactions; capital and financial resources
requirements for designated FMUs; and other areas that are necessary
to achieve the objectives and principles described above. See 12
U.S.C. 5464(b), (c).
\19\ See 12 U.S.C. 5462(6). The definition of ``financial market
utility'' in Section 803(6) of the Clearing Supervision Act contains
a number of exclusions that include, but are not limited to, certain
designated contract markets, registered futures associations, swap
data repositories, swap execution facilities, national securities
exchanges, national securities associations, alternative trading
systems, security-based swap data repositories, security-based swap
execution facilities, brokers, dealers, transfer agents, investment
companies, and futures commission merchants. See 12 U.S.C.
5462(6)(B).
\20\ See 12 U.S.C. 5463. An FMU is systemically important if the
failure of or a disruption to the functioning of such FMU could
create or increase the risk of significant liquidity or credit
problems spreading among financial institutions or markets and
thereby threaten the stability of the U.S. financial system. See 12
U.S.C. 5462(9). On July 18, 2012, the FSOC designated as
systemically important the following then-registered clearing
agencies: CME Group (``CME''), The Depository Trust Company
(``DTC''), Fixed Income Clearing Corporation (``FICC''), ICE Clear
Credit (``ICC''), National Securities Clearing Corporation
(``NSCC''), and The Options Clearing Corporation (``OCC'').
The Commission is the supervisory agency for DTC, FICC, NSCC,
and OCC, and the CFTC is the supervisory agency for CME and ICE. The
Commission jointly regulates ICC and OCC with the CFTC. The
Commission also jointly regulates ICE Clear Europe (``ICEEU''),
which has not been designated as systemically important by FSOC,
with the CFTC and Bank of England.
The Commission also jointly regulated CME with the CFTC until
2015, when the Commission published an order approving CME's request
to withdraw from registration as a clearing agency. See Exchange Act
Release No. 34-76678 (Dec. 17, 2015), 80 FR 79983 (Dec. 23, 2015).
\21\ See 12 U.S.C. 5465(e)(1)(A); 17 CFR 240.19b-4(n). The
Commission published a final rule concerning the filing of advance
notices for designated clearing agencies in 2012. See Exchange Act
Release No. 34-67286 (June 28, 2012), 77 FR 41602 (July 13, 2012).
\22\ See 12 U.S.C. 5465(e).
\23\ See 12 U.S.C. 5466.
\24\ See 12 U.S.C. 5472; see also Risk Management Supervision of
Designated Clearing Entities (July 2011), available at https://www.federalreserve.gov/publications/other-reports/files/risk-management-supervision-report-201107.pdf (describing the joint
supervisory framework of the Commission, CFTC, and FRB).
\25\ See 12 U.S.C. 5464(a)(2). The Commission notes that, under
Rule 17Ad-22(a)(6), a SIFMU for which the Commission is the
supervisory agency is a ``designated clearing agency.'' See infra
note 134 and accompanying text.
---------------------------------------------------------------------------
3. Rule 17Ad-22
In 2012, the Commission adopted Rule 17Ad-22 under the Exchange Act
to strengthen the substantive regulation of registered clearing
agencies, promote the safe and reliable operation of registered
clearing agencies, and improve efficiency, transparency, and access to
registered clearing agencies.\26\ At that time, the Commission noted
that the implementation of Rule 17Ad-22 would be an important first
step in developing the regulatory changes contemplated by Titles VII
and VIII of the Dodd-Frank Act.\27\ In this regard, Rule 17Ad-22(b)
established certain requirements for clearing agencies that provide CCP
services, and Rule 17Ad-22(d) established requirements for the
operation and governance of all registered clearing agencies.\28\
---------------------------------------------------------------------------
\26\ See CCA Standards proposing release, supra note 5, at
29513; see also 17 CFR 240.17Ad-22; Clearing Agency Standards
adopting release, supra note 5, at 66225-26.
\27\ See Clearing Agency Standards adopting release, supra note
5, at 66224-25.
\28\ See 17 CFR 240.17Ad-22(b), (d).
---------------------------------------------------------------------------
The requirements in Rule 17Ad-22 help guide Commission
determinations, when considering an application to register as a
clearing agency, that the rules and operations of the applicant
clearing agency satisfy the requirements in Section 17A of the Exchange
Act.\29\ Today's amendments to Rule 17Ad-22 build on the existing
framework for registered clearing agencies by establishing new
requirements for designated clearing agencies, complex risk profile
clearing agencies unless the
[[Page 70789]]
CFTC is the supervisory agency, and, pursuant to Rule 17Ab2-2, any
other clearing agencies determined by the Commission to be covered
clearing agencies.
---------------------------------------------------------------------------
\29\ See supra notes 8-9 and accompanying text.
---------------------------------------------------------------------------
4. Regulation SCI
In 2014, the Commission adopted Regulation Systems Compliance and
Integrity (``Regulation SCI'') to strengthen the technology
infrastructure of the U.S. securities markets.\30\ In particular, the
Commission notes that Regulation SCI is designed to reduce the
occurrence of systems issues, improve resiliency when systems problems
do occur, and enhance the Commission's oversight and enforcement of
securities market technology infrastructure. Since adoption of
Regulation SCI, the Commission has established a monitoring and
examination structure to oversee compliance with Regulation SCI.
---------------------------------------------------------------------------
\30\ See Exchange Act Release No. 34-73639 (Nov. 19, 2014), 79
FR 72252 (Dec. 5, 2014) (``Regulation SCI adopting release'').
---------------------------------------------------------------------------
Regulation SCI applies to ``SCI entities,'' a term which includes
SROs such as registered clearing agencies.\31\ It requires SCI entities
to, among other things, maintain policies and procedures reasonably
designed to ensure that certain systems have levels of capacity,
integrity, resiliency, availability, and security adequate to maintain
their operational capability and promote the maintenance of fair and
orderly markets, and that they operate in a manner that complies with
the Exchange Act as well as their own rules.\32\ Certain SCI systems
that are ``critical SCI systems'' are held to heightened requirements
under Regulation SCI,\33\ including a requirement to establish,
maintain, and enforce written policies and procedures reasonably
designed, among other things, to include a two-hour resumption goal
following a wide-scale disruption,\34\ and broader dissemination
obligations for ``major SCI events.'' \35\ The definition of critical
SCI systems in Regulation SCI was designed to cover ``those SCI systems
whose functions are critical to the operation of the markets, including
those systems that represent potential single points of failure in the
securities markets.'' \36\ Regulation SCI requires SCI entities to take
certain corrective actions when ``SCI events'' occur. Regulation SCI
defines SCI events to include an event in an SCI entity's SCI systems
that disrupts, or significantly degrades, the normal operation of an
SCI system. In the Regulation SCI adopting release, the Commission
explained its view that for clearance and settlement systems a return
to ``normal operations'' following a systems disruption would include
all steps necessary to effectuate timely and accurate end of day
settlement.\37\
---------------------------------------------------------------------------
\31\ See 17 CFR 242.1000 (providing the definition of ``SCI
SROs'').
\32\ See 17 CFR 242.1001.
\33\ See 17 CFR 242.1000 (providing definitions of ``SCI
systems'' and ``critical SCI systems'').
\34\ See 17 CFR 242.1001(a)(2)(v).
\35\ See 17 CFR 242.1002(c)(3).
\36\ See Regulation SCI adopting release, supra note 30, at
72277.
\37\ See id. at 72285 n.395.
---------------------------------------------------------------------------
5. Relevant International Standards
When prescribing regulations that contain risk management standards
for designated clearing agencies, Section 805(a) of the Clearing
Supervision Act requires the Commission to consider the relevant
international standards and existing prudential requirements.\38\ As
previously noted, the PFMI is the relevant international standard for
systemically important financial market infrastructures, such as
covered clearing agencies.\39\ The PFMI sets forth twenty-four
principles, each of which includes a headline standard and a list of
key considerations that further explain the headline standard.
Accompanying explanatory notes further discuss the objectives of and
rationales for the standards, as well as provide guidance on how the
standard can be implemented.\40\
---------------------------------------------------------------------------
\38\ See 12 U.S.C. 5464(a)(2); see also supra note 25 and
accompanying text.
\39\ See supra note 2 and accompanying text. The PFMI defines a
``financial market infrastructure'' (``FMI'') as a multilateral
system among participating institutions, including the operator of
the system, used for the purposes of clearing, settling, or
recording payments, securities, derivatives, or other financial
transactions. See PFMI, supra note 2, at 7. FMIs include CCPs,
central securities depositories (``CSDs''), securities settlement
systems (``SSSs''), and trade repositories (``TRs''). Cf. 12 U.S.C.
5462(6)(B) (defining ``financial market utility'' under the Clearing
Supervision Act). The PFMI presumes that all CSDs, SSSs, CCPs, and
TRs are systemically important in their home jurisdiction. See PFMI,
supra note 2, at 131 & n.177 (noting the ``presumption . . . that
all CSDs, SSSs, CCPs, and TRs are systemically important because of
their critical roles in the markets they serve,'' but also noting
that ultimately ``national law will dictate the criteria to
determine whether an FMI is systemically important'').
The Commission notes that the PFMI's definition of ``financial
market infrastructure'' is consistent with the Commission's prior
use of the term. See Study of Unsafe and Unsound Practices of
Brokers and Dealers, H.R. Doc. No. 231, 92d Cong., 1st Sess. 13
(1971) (defining ``financial market infrastructure'' as a
multilateral system among participating institutions, including the
operator of the system, used for the purposes of clearing, settling,
or recording payments, securities, derivatives, or other financial
transactions).
\40\ See PFMI, supra note 2, at 17.
---------------------------------------------------------------------------
Commission staff co-chaired the working group within CPSS-IOSCO
that drafted both the consultative and final versions of the PFMI,\41\
and the Commission believes that the requirements applicable to
clearing agencies set forth in the Exchange Act and the rules
thereunder, including the rules adopted today, are consistent with the
standards set forth in the PFMI.\42\ Regulatory authorities around the
world are in various stages of updating their regulatory regimes to
adopt measures consistent with the PFMI.\43\ The rules set forth below
are a continuation of the Commission's active effort to foster the
development of the national clearance and settlement system, consistent
with the requirements of the Exchange Act, and enhance the regulation
and supervision of SIFMUs, consistent with the Clearing Supervision
Act.
---------------------------------------------------------------------------
\41\ CPMI-IOSCO has also published subsequent guidance relevant
to implementation of the PFMI. See PFMI: Disclosure framework and
Assessment methodology (Dec. 2012), available at http://www.bis.org/cpmi/publ/d106.pdf (``PFMI disclosure framework''); Recovery of FMIs
(Oct. 2014), available at http://www.bis.org/cpmi/publ/d121.pdf;
Public quantitative disclosure standards for CCPs (Feb. 2015),
available at http://www.bis.org/cpmi/publ/d125.pdf (``PFMI
quantitative disclosures''); Guidance on cyber resilience for FMIs
(Nov. 2015, consultative report), available at http://www.bis.org/cpmi/publ/d138.pdf; Resilience and recovery for CCPs (July 2016,
consultative report), available at http://www.bis.org/cpmi/publ/d149.pdf.
\42\ See 15 U.S.C. 78q-1.
\43\ See, e.g., CPMI-IOSCO, Implementation monitoring of PFMIs:
Third update to the Level 1 assessment report (June 2016), available
at http://www.bis.org/cpmi/publ/d145.pdf (describing efforts by
various jurisdictions to adopt standards for FMIs consistent with
the PFMI). Both the CFTC and FRB have indicated publicly that they
have completed all measures necessary to incorporate fully the PFMI
into their regulatory frameworks. See id. at 35.
---------------------------------------------------------------------------
In addition, the Basel Committee on Banking Supervision (``BCBS'')
has finalized an updated capital framework that sets standards for
capital charges arising from bank exposures to CCPs related to OTC
derivatives, exchange-traded derivatives, and securities financing
transactions.\44\ Among other things, the BCBS capital framework
includes lower capital charges for exposures to a qualifying CCP
(``QCCP'') that is subject to a regulatory framework consistent with
the PFMI. The availability of QCCP status for certain covered clearing
agencies with bank clearing members would have
[[Page 70790]]
implications for the capital charges applicable to those members.\45\
---------------------------------------------------------------------------
\44\ See BCBS, Capital requirements for bank exposures to
central counterparties (Apr. 2014), available at http://www.bis.org/publ/bcbs282.pdf (``BCBS capital framework''). See generally Basel
III: A global regulatory framework for more resilient banks and
banking systems (rev. June 2011), available at http://www.bis.org/publ/bcbs189.pdf (describing the Basel III framework, which preceded
the BCBS capital framework).
\45\ See infra Part III.A.1.b (further discussing the BCBS
capital framework). The FRB and the Office of the Comptroller of the
Currency have adopted rules implementing the material elements of
the BCBS interim framework for capitalization of bank exposures to
CCPs. See Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 76 FR 62017, 62099 (Oct. 11, 2013) (``Regulatory Capital
Rules''). In doing so, the FRB noted the ongoing international
discussions on the topic and stated that it intends to revisit its
rules once the BCBS capital framework is revised. See id. The FRB
and the Office of the Comptroller of the Currency's rules define
``QCCP'' to mean, among other things, a SIFMU under the Clearing
Supervision Act. See 12 CFR 217.2; see also Regulatory Capital
Rules, supra, at 62100.
---------------------------------------------------------------------------
6. Recognition and Equivalence Within the EU
The Commission is aware of recent public attention on the
availability of QCCP status under EU capital requirements for certain
covered clearing agencies that operate in the United States and have
bank clearing members affiliated with a European Union (``EU'')
entity.\46\ Specifically, the Commission understands that availability
of QCCP status in the EU for a U.S. CCP hinges on the European
Securities and Markets Authority (``ESMA'') recognizing the U.S. CCP
pursuant to the requirements of the European Markets Infrastructure
Regulation (``EMIR''). Recognition by ESMA, in turn, is subject to the
European Commission (``EC'') first making certain findings regarding
the Commission's regulatory regime for CCPs.\47\ Recognition by ESMA
would result in QCCP status for those U.S. CCPs for purposes of the
EU's capital requirements, allowing EU-based clearing members of U.S.
CCPs to continue to operate and provide clearing services to market
participants based in the EU. Under the EU's capital requirements
regulation, EU banks and their subsidiaries will incur higher capital
charges if they clear through a U.S. CCP not afforded QCCP status in
the EU, that is, a CCP not recognized or authorized by ESMA.\48\
---------------------------------------------------------------------------
\46\ See, e.g., Fiona Maxwell, EU members of U.S. options CCP
face $30 billion capital hit: OCC fears approval will be held up by
absence of SEC clearing rules, Risk.net, Nov. 30, 2015, available at
http://www.risk.net/risk-magazine/news/2436901/eu-members-of-us-options-ccp-face-usd30bn-capital-hit (``A new wrinkle in the
transatlantic dispute over clearing house regulation could leave 18
European banks facing an estimated $30 billion jump in capital
requirements, and limit access to equity options listed in the
[United States] . . . . The potential capital hit for OCC members is
a consequence of the Capital Requirements Regulation (CRR), which
states that European banks--whether acting through their branch or
subsidiary--will only be given a 2% risk weight for cleared trades
if using a so-called qualifying CCP following expiration of the
current extended grandfathering period. Clearing at a non-QCCP can
translate to risk weights of more than 1250%.'').
\47\ On March 16, 2016, the EC issued an equivalence decision
stating that the CFTC's regulatory framework for CCPs is equivalent
to EU requirements. See Commission Implementing Decision (EU) 2016/
377 of 15 March 2016 on the equivalence of the regulatory framework
of the United States of America for central counterparties that are
authorised and supervised by the CFTC to the requirements of
Regulation (EU) No 648/2012 of the European Parliament and of the
Council, available at http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32016D0377.
\48\ Regulation (EU) No 575/2013 on prudential requirements for
credit institutions and investment firms. As noted earlier, although
the United States affords QCCP status to SIFMUs, QCCP status in the
EU is distinct from the U.S. banking regulators' determination that
any FMU designated as systemically important by FSOC is a U.S. QCCP.
---------------------------------------------------------------------------
As an initial matter, the Commission understands that, for the EC
to make an equivalence decision, Article 25(6) of the European Markets
Infrastructure Regulation (``EMIR'') requires the EC to determine that
the legal and supervisory arrangements of a third country ensure
that CCPs authorised in that third country comply with legally
binding requirements which are equivalent to the requirements laid
down in [EMIR], that those CCPs are subject to effective supervision
and enforcement in that third country on an ongoing basis and that
the legal framework of that third country provides for an effective
equivalent system for the recognition of CCPs authorised under
third-country legal regimes.\49\
\49\ See Article 25(6), Regulation (EU) No. 648/2012 of the
European Parliament and of the Council of 4 July 2012 on OTC
derivatives, central counterparties and trade repositories,
available at http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32012R0648.
The Commission understands that its adoption of new Rule 17Ad-22(e)
could be relevant to the EC's ongoing consideration of the Commission's
regulatory regime for CCPs.\50\ Further, with respect to EMIR's
requirement that the legal and supervisory regime of the United States
include an ``effective equivalent system'' for the recognition of CCPs
authorized under non-U.S. legal regimes, the Commission notes the
following.\51\
---------------------------------------------------------------------------
\50\ See, e.g., Philip Stafford, European banks face U.S.
capital hit unless rules converge, FT.com, Apr. 4, 2016, available
at http://www.ft.com/cms/s/0/bbe6678a-f5c5-11e5-803c-d27c7117d132.html#axzz48oFXlFrR.
\51\ See Article 25(6) of EMIR.
---------------------------------------------------------------------------
First, the Commission observes that, in certain specific contexts,
it is not unfamiliar with the EMIR regime given that one registered
clearing agency, ICEEU, is subject to EMIR and will be a covered
clearing agency pursuant to Rule 17Ad-22(a)(5).\52\ As previously
discussed, each registered clearing agency is an SRO subject to Section
19(b) of the Exchange Act, which requires SROs to submit proposed rule
changes to the Commission for public comment and Commission review and
approval.\53\ In the course of its regulation of ICEEU as a registered
clearing agency, the Commission has published, reviewed, and approved
under the Exchange Act a number of proposed rule changes submitted by
ICEEU under Rule 19b-4 that, based on the information and
representations made by ICEEU at the time, were intended to facilitate
ICEEU's efforts to comply with EMIR. These proposed rule changes
covered such areas as (i) segregation and portability of customer
positions and margin, (ii) risk modeling, (iii) back testing, (iv)
stress testing, (v) default management, and (vi) liquidity risk
management.\54\
---------------------------------------------------------------------------
\52\ As noted above, ICEEU is also regulated by the Bank of
England. See supra note 20.
\53\ See supra Part I.C.5 (further describing the obligations of
a registered clearing agency to file proposed rule changes under
Rule 19b-4).
\54\ See Exchange Act Release No. 34-73075 (Sept. 11, 2014), 79
FR 55848 (Sept. 17, 2014); Exchange Act Release No. 34-72756 (Aug.
4, 2014), 79 FR 46479 (Aug. 8, 2014); Exchange Act Release No. 34-
72755 (Aug. 4, 2014), 79 FR 46481 (Aug. 8, 2014); Exchange Act
Release No. 34-72754 (Aug. 4, 2014), 79 FR 46477 (Aug. 8, 2014).
---------------------------------------------------------------------------
Further, the Commission observes that the Exchange Act and
Commission rules require that CCPs register with the Commission in
certain circumstances, and if registered, must comply with the relevant
U.S. requirements, including the Commission rules applicable to
registered clearing agencies. The Commission also observes that the
registration and supervisory framework for clearing agencies under the
Exchange Act provides the Commission with broad authority to provide
exemptive relief from certain of the Commission's regulatory
requirements under the Exchange Act. Specifically, Section 17A(b)(1) of
the Exchange Act provides the Commission with authority to exempt a
clearing agency or any class of clearing agencies from any provision of
Section 17A or the rules or regulations thereunder. Such an exemption
may be effected by rule or order, upon the Commission's own motion or
upon application, and conditionally or unconditionally.\55\ The
[[Page 70791]]
Commission's exercise of authority to grant exemptive relief must be
consistent with the public interest, the protection of investors, and
the purposes of Section 17A, including the prompt and accurate
clearance and settlement of securities transactions and the
safeguarding of securities and funds.\56\
---------------------------------------------------------------------------
\55\ To apply with the Commission for an exemption under Section
17A(b)(1), the applicant must complete and file a Form CA-1. In this
context, an applicant must attach to its Form CA-1, along with the
other customary exhibits, an Exhibit S. The Exhibit S is a statement
by the applicant demonstrating why the granting of an exemption
would be consistent with the public interest, the protection of
investors and the purposes of Section 17A of the Exchange Act,
including the prompt and accurate clearance and settlement of
securities transactions and the safeguarding of securities and
funds.
\56\ See 15 U.S.C. 78q-1(b)(1).
---------------------------------------------------------------------------
The outcome of any exemptive request by the Commission (including,
potentially, any exemptions from requirements under Rule 17Ad-22(e)) is
dependent on a number of elements. For example, the Commission has used
its authority under Section 17A(b)(1) of the Exchange Act to grant
exemptions to certain non-U.S. clearing agencies. These exemptions have
been tailored in each instance to the exemptive applicants'
contemplated clearing agency activities. In certain instances, non-U.S.
clearing agencies have received exemptive relief from the registration
requirement under Section 17A(b)(1) to perform the functions of a
clearing agency with respect to transactions involving U.S. government
and agency securities for U.S. participants.\57\ Factors the Commission
has considered when determining whether to grant an exemption have
included the anticipated level or volume of activity that the applicant
seeks to effect within the United States. Generally, the particular
system of supervision and oversight in a jurisdiction may also be
factors for the Commission to consider in evaluating any non-U.S.
framework.
---------------------------------------------------------------------------
\57\ See Exchange Act Release No. 34-39643 (Feb. 11, 1998), 63
FR 8232 (Feb. 18, 1998), as modified by Exchange Act Release No. 34-
43775 (Dec. 28, 2000), 66 FR 819 (Jan. 4, 2001); Exchange Act
Release No. 34-38328 (Feb. 24, 1997), 62 FR 9225 (Feb. 28, 1997).
In the case of matching service providers, the Commission first
sought comment on providing exemptive relief before considering any
application for exemptive relief. See Exchange Act Release No. 34-
39829 (Apr. 6, 1998), 63 FR 17943 (Apr. 13, 1998) (``Even though
matching services fall within the definition of clearing agency, the
Commission preliminarily is of the view that an entity that limits
its clearing agency functions to providing matching services need
not be subject to the full panoply of clearing agency
regulation.''). The Commission then engaged a close analysis of the
attendant facts and circumstances of each applicant for an exemption
from registration as a clearing agency on a case-by-case basis. See,
e.g., Exchange Act Release No. 34-44188 (Apr. 17, 2001), 66 FR 20494
(Apr. 23, 2001) (order granting exemption from registration as a
clearing agency to Global Joint Venture Matching Services--US, LLC,
now Omgeo).
---------------------------------------------------------------------------
Other factors the Commission could consider in exercising its
exemptive authority could include: the structure of, scope of, and
requirements under the regulatory regime to which the applicant is
subject in its home jurisdiction; the extent to which the presence of
said regime is relevant to the findings the Commission must make in
considering an exemption under Section 17A(b)(1) of the Exchange Act,
and the nature of the non-U.S. covered clearing agency's activities.
Such factors, depending on the attendant facts and circumstances, could
lead the Commission to determine that the full scope of the
requirements under Rule 17Ad-22(e) need not be applied to a non-U.S.
clearing agency to achieve the Commission's regulatory objectives.
The Commission also notes that where it has exercised its exemptive
authority under Section 17A(b)(1) of the Exchange Act, the Commission
and the relevant national competent authority (``NCA'') of the non-U.S.
clearing agency have entered into cooperative arrangements whereby the
Commission and the NCA have arranged to communicate and cooperate to
fulfill their respective regulatory mandates.\58\ For the purposes of
the discussion immediately above, such cooperation could also be useful
in streamlining the Commission's consideration and analysis of an
application for registration or an exemption from any provision of
Section 17A of the Exchange Act or the rules or regulations thereunder
by a non-U.S. clearing agency. For example, in the case of a non-U.S.
clearing agency that is seeking to register or seeking an exemption
with the Commission and is already subject to EMIR, the Commission
could look to coordinate with the applicant's NCA for the purposes of
analyzing and evaluating any materials the applicant might submit as
part of the Form CA-1, including the documentation generated in the
course of the NCA's EMIR authorization process for the applicant, and
any self-assessment an applicant might produce to evidence its analysis
of potential duplication between EMIR requirements and Commission
requirements for registered clearing agencies. Such cooperative
arrangements could be useful not only for the registration or exemption
process but also ongoing coordinated or joint supervisory matters
between the Commission and the NCA. However, as previously noted,
additional careful analysis would need to be performed by the
Commission on a case-by-case basis before the Commission could be
willing to determine whether such cooperative arrangements would be
appropriate.
---------------------------------------------------------------------------
\58\ See, e.g., Understanding regarding an Application of
Euroclear Bank for an Exemption under U.S. Federal Securities Laws
(Jan. 30, 2001), available at https://www.nbb.be/doc/cp/nl/aboutcbfa/mou/pdf/mou_2001-01-30_euroclearbank.pdf; Exchange Act
Release No. 34-37309 (June 12, 1996) (notice of filing of
application for exemption from registration as a clearing agency by
Cedel Bank); see also Undertaking on Consultation and Cooperation
regarding Belgian Firms that are Members of U.S. Clearing
Organizations (July 6, 2006), available at http://www.sec.gov/about/offices/oia/oia_bilateral/belgium.pdf.
---------------------------------------------------------------------------
B. Summary of the Commission's Proposal
The Commission is adopting Rules 17Ad-22(e) and (f) and amendments
to Rules 17Ad-22(a) and (d) substantially as proposed. The Commission
is adopting Rule 17Ab2-2 with several modifications in light of the
comments received. Modifications to the proposed rules are discussed in
Part II. Below is a brief summary of the Commission's proposal as set
forth in the CCA Standards proposing release.
In proposing amendments to Rule 17Ad-22, the Commission sought to
establish an enhanced regulatory framework for registered clearing
agencies that meet the definition of a ``covered clearing agency.''
Specifically, as proposed, a covered clearing agency would include (i)
a designated clearing agency; (ii) a complex risk profile clearing
agency unless the CFTC is the supervisory agency; \59\ and (iii) any
other registered clearing agency that the Commission determines to be a
covered clearing agency pursuant to the procedures set forth in
proposed Rule 17Ab2-2. A covered clearing agency would be subject to
the requirements in Rule 17Ad-22(e) whereas a registered clearing
agency that is not a covered clearing agency would remain subject to
the requirements in Rule 17Ad-22(d).\60\ As discussed in the CCA
Standards proposing release, the Commission believed that such an
approach would allow the Commission to maintain discretion to apply
Rule 17Ad-22(d) to certain new clearing agencies while also
[[Page 70792]]
applying the requirements under Rule 17Ad-22(e) to those clearing
agencies that raise systemic risk concerns due to, among other things,
their size, systemic importance, global reach, or the risks inherent in
the products they clear.\61\ To facilitate this approach, the
Commission proposed to modify Rule 17Ad-22(d) so that it would only
apply to a registered clearing agency other than a covered clearing
agency.
---------------------------------------------------------------------------
\59\ The Commission notes that, as defined in Rule 17Ad-22(a)(4)
and as used in this release, ``security-based swap clearing
agencies'' are a subset of complex risk profile clearing agencies
that provide CCP services for security-based swaps. For a CCP other
than a security-based swap clearing agency, the Commission may
determine whether the activities of such CCP have a more complex
risk profile and, therefore, whether such CCP is a covered clearing
agency pursuant to Rule 17Ab2-2. See infra Part II.D (further
discussing Commission determinations under Rule 17Ab2-2).
\60\ Rule 17Ad-22(d) sets forth minimum requirements for the
operation and governance of registered clearing agencies. Under the
proposal, all registered clearing agencies and covered clearing
agencies would also remain subject to the requirements in Section
17A of the Exchange Act and the other relevant Commission rules and
regulations thereunder, including Rules 17Ad-22(a), (b), and (c).
\61\ See CCA Standards proposing release, supra note 5, at
29516.
---------------------------------------------------------------------------
Under proposed Rule 17Ad-22(e), a covered clearing agency would be
required to establish, implement, maintain and enforce written policies
and procedures reasonably designed to address the following topics
concerning its operation and governance:
General organization (including legal basis, governance,
and a framework for the comprehensive management of risks);
financial risk management (including credit risk,
collateral, margin, and liquidity risk);
settlement (including settlement finality, money
settlements, and physical deliveries);
CSDs and exchange-of-value settlement systems;
default management (including default rules and procedures
and segregation and portability);
business and operational risk management (including
general business risk, custody and investment risks, and operational
risk);
access (including access and participation requirements,
tiered participation arrangements, and links);
efficiency (including efficiency and effectiveness and
communication procedures and standards); and
transparency.
The Commission is adopting Rule 17Ad-22(e) substantially as
proposed. Each of the requirements under Rule 17Ad-22(e), any
modifications made thereto, and the comments received with respect to
them, are discussed in Part II.C.
In addition, the Commission proposed Rule 17Ab2-2 to provide the
Commission with procedures to make determinations regarding the
following:
Whether a registered clearing agency should be considered
a covered clearing agency;
whether a covered clearing agency meets the definition of
``systemically important in multiple jurisdictions;'' \62\ and
---------------------------------------------------------------------------
\62\ See infra note (discussing the definition of ``systemically
important in multiple jurisdictions'').
---------------------------------------------------------------------------
whether the activities of a clearing agency providing CCP
services have a more complex risk profile.
The proposed rule would allow such determinations to occur either
at the Commission's own initiative or upon request by either a clearing
agency or one of its members. In each case, the Commission would
publish notice of its intention to consider such determinations,
together with a brief statement of the grounds under consideration, and
provide at least a 30-day public comment period prior to any
determination. Under the proposed rule, the Commission may also provide
a clearing agency subject to any proposed determination opportunity for
hearing. The Commission is adopting Rule 17Ab2-2 substantially as
proposed. Modifications to Rule 17Ab2-2 made in response to the
comments received are discussed in Part II.D.
To facilitate the addition of proposed Rule 17Ad-22(e) and proposed
Rule 17Ab2-2, the Commission proposed to add 14 new definitions to Rule
17Ad-22(a). The Commission is adopting those definitions substantially
as proposed, but is combining the definitions of ``sensitivity
analysis'' and ``conforming sensitivity analysis'' into one definition
of ``sensitivity analysis.'' \63\ Each of the definitions, any
modifications made thereto, and the comments received with respect to
them, are discussed in Part II.C.
---------------------------------------------------------------------------
\63\ Each definition is discussed in Part II. For discussion of
the new definition of ``sensitivity analysis,'' see Part II.C.6.c.
---------------------------------------------------------------------------
Finally, the Commission also proposed Rule 17Ad-22(f) to codify the
Commission's statutory authority under Section 807(c) of the Clearing
Supervision Act. The Commission received no comments regarding Rule
17Ad-22(f) and is adopting it as proposed.\64\
---------------------------------------------------------------------------
\64\ See infra Part II.E.
---------------------------------------------------------------------------
C. Comments Received
The Commission received seventeen comment letters in response to
the CCA Standards proposing release.\65\ Commenters included market
participants from across the financial industry, including registered
clearing agencies, non-U.S. clearing agencies, non-profit groups,
various entities participating in or representing professionals who
provide investment or asset management services, participants in the
derivatives markets, an association of banks representing clearing
participants and members of certain CCPs, and members of the general
public.
---------------------------------------------------------------------------
\65\ See letters from Timothy W. Cameron, Asset Management
Group--Head, and Laura Martin, Asset Management Group--Managing
Director and Associate General Counsel, Securities Industry and
Financial Markets Association, and David W. Blass, General Counsel,
and Jennifer S. Choi, Associate General Counsel, Investment Company
Institute (May 12, 2016) (``AMG-ICI''); Chris Barnard (May 26, 2014)
(``Barnard''); Dennis M. Kelleher, President and CEO, Stephen Hall,
Securities Specialist, Katelynn Bradley, Attorney, and Caitlin
Kline, Derivatives Specialist, Better Markets, Inc. (May 27, 2014)
(``Better Markets''); Kurt N. Schact, CFA, Managing Director,
Standards and Financial Market Integrity, and Linda L. Rittenhouse,
Director, Capital Markets, CFA Institute (May 27, 2014) (``CFA
Institute''); Kathleen M. Cronin, Senior Managing Director, General
Counsel, and Corporate Secretary, CME Group, Inc. (May 27, 2014)
(``CME''); Larry E. Thompson, Managing Director and General Counsel,
The Depository Trust and Clearing Corporation (May 27, 2014)
(``DTCC''); Scott C. Goebel, Senior Vice President and General
Counsel, Fidelity Investments (May 27, 2014) (``Fidelity''); Paul
Swann, President and Managing Director, ICE Clear Europe Limited
(May 23, 2014) (``ICEEU''); Dorothy M. Donohue, Acting General
Counsel, Investment Company Institute (May 21, 2014) (``ICI'');
Stephen O'Connor, Chairman, International Swaps and Derivatives
Association, Inc. (May 22, 2014) (``ISDA''); John Joyce, Northern
Illinois University College of Law (Apr. 1, 2014) (``Joyce''); Susan
Milligan, Head of U.S. Public Affairs, LCH.Clearnet (May 27, 2014)
(``LCH''); James E. Brown, Executive Vice President, General
Counsel, and Secretary, The Options Clearing Corporation (May 27,
2014) (``OCC''); Akshat Tewary et al., Occupy the SEC (June 10,
2014) (``OSEC''); Sheila Bair, Chair, The Systemic Risk Council (May
28, 2014) (``SRC''); Jarryd E. Anderson, Vice President, Regulatory
Affairs, The Clearing House Association LLC (May 27, 2014) (``The
Clearing House''); Tim Buckley, Managing Director and Chief
Investment Officer, and John Hollyer, Principal and Head of Risk
Management and Strategy Analysis, Vanguard (May 27, 2014)
(``Vanguard''). Copies of the comment letters are available at
http://www.sec.gov/comments/s7-03-14/s70314.shtml.
---------------------------------------------------------------------------
Commenters generally supported the Commission's proposal and the
Commission's ongoing efforts to regulate registered clearing
agencies,\66\ though several also raised concerns regarding certain
aspects of the proposed rules, as discussed throughout this release.
Below is a discussion of the comments that were not directed to the
content of a particular proposed rule and, where appropriate, the
Commission's response.\67\ Comments received that were directed to a
particular proposed rule, or aspects thereof, are discussed in Part II.
---------------------------------------------------------------------------
\66\ See Barnard at 1 (also focusing support on the proposed
financial risk management and liquidity requirements); CFA Institute
at 2 (expressing overall support for the proposed rules); CME at 2
(applauding the Commission's efforts to support dually registered
entities as they continue to focus their resources on the important
work of maintaining effective systems of governance and enhancing
their operational strength); DTCC at 3 (stating that it is broadly
supportive of the proposed rules); ICEEU at 1 (expressing support
for comprehensive regulation of clearing agencies and linking such
comprehensive regulation to the PFMI and the rules of the
Commission); OCC at 3 (expressing support for the Commission's
effort to strengthen the substantive regulation of registered
clearing agencies).
\67\ For comments not directed to the substance of the proposal
itself, see Part I.C.7.
---------------------------------------------------------------------------
[[Page 70793]]
1. Financial Stability and the Dodd-Frank Act
One commenter supported the Commission's stated goal of
contributing to the enhancement of the stability of the U.S. securities
markets.\68\ Another commenter strongly supported the Commission's
efforts to promote financial stability through the application of
enhanced standards for covered clearing agencies, in particular those
that act as CCPs for security-based swaps and other derivatives.\69\ A
third commenter similarly expressed the belief that the proposed
requirements should promote market integrity, improve the robustness of
clearing systems, and protect the financial system against
contagion.\70\ The Commission believes that Rule 17Ad-22(e) achieves
these goals by supporting the objectives of (i) the Exchange Act to
facilitate the establishment of a national system for the prompt and
accurate clearance and settlement of securities transactions and linked
or coordinated facilities for clearance and settlement of securities
transactions, having due regard for the public interest, the protection
of investors, the safeguarding of securities and funds, and maintenance
of fair competition among brokers and dealers, clearing agencies, and
transfer agents,\71\ and (ii) the Clearing Supervision Act to promote
robust risk management, promote safety and soundness, reduce systemic
risks, and support the stability of the broader financial system.\72\
---------------------------------------------------------------------------
\68\ See CME at 1.
\69\ See The Clearing House at 1.
\70\ See Barnard at 1.
\71\ See supra notes 3-4 and accompanying text.
\72\ See supra note 18 and accompanying text.
---------------------------------------------------------------------------
One commenter generally supported the mandate of Title VII of the
Dodd-Frank Act to promote transparency and regulation in the
derivatives markets.\73\ Another commenter noted that the Dodd-Frank
Act has sought to shed light on the opaque markets for swaps and other
exotic OTC derivatives, which numerous other commentators have asserted
contributed to the recent financial crisis, by requiring such
derivatives to be cleared through registered clearing agencies.\74\ The
commenter stated that this shift toward transparency could be useful if
clearing agencies are themselves robust and stable, noting that, in
some ways, the risks associated with OTC derivatives trading have not
gone away but simply shifted to clearing agencies. The commenter stated
that, thus, it is vital for the Commission to not only promulgate
strong regulations for clearing agencies but also to enforce such
regulations in a vigorous manner. As noted above, the Commission
believes that the focus in Rule 17Ad-22(e) on transparency, governance,
financial risk management, and operational risk management are
consistent with the objectives of promoting strong rules that help
ensure covered clearing agencies are robust and stable, and that any
risks particular to OTC derivatives trading and the risks present in
clearing such derivatives are addressed in requirements for the covered
clearing agency's management of financial risks.
---------------------------------------------------------------------------
\73\ See Vanguard at 1.
\74\ See OSEC at 3.
---------------------------------------------------------------------------
2. Relationship Between Rules 17Ad-22(d) and (e)
One commenter generally supported the Commission's approach to the
regulation of registered clearing agencies, which the commenter stated
applies a more general set of standards under Rule 17Ad-22(d) for
registered clearing agencies other than covered clearing agencies.\75\
The commenter stated that this framework would allow new entrants to
more firmly establish themselves as clearing agencies, which is
important for the deconsolidation and diffusion of risk across the
market. The commenter noted that at present the clearance and
settlement industry, like much of the financial sector, can be
described as highly concentrated, and stated that it is paramount that
the Commission set policies that promote the proliferation of viable
new clearing agencies, given that existing clearing agencies typically
serve as intermediaries for trillions of dollars in trading volumes. In
the commenter's view, such concentration in the provision of clearance
and settlement services results in risk concentration and inhibits
price allocation for services, which, in turn, inhibits liquidity.\76\
The Commission is mindful of these concerns and notes, as discussed
above, that the approach under Rules 17Ad-22(d) and (e) take into
account various clearing agency activities and the risks they pose
while promoting robust risk management practices and the general safety
and soundness of registered clearing agencies. In particular, as
discussed in Part III.B.1.d, the Commission has considered the level of
concentration in the provision of clearing agency services.
---------------------------------------------------------------------------
\75\ See OSEC at 1. The commenter, however, also raised concerns
with the proposed dual framework under existing Rule 17Ad-22(d) and
proposed Rule 17Ad-22(e) because the commenter believed the dual
framework could facilitate regulatory arbitrage. See id. at 1-2; see
also infra note 80 and accompanying text.
\76\ See id.
---------------------------------------------------------------------------
One commenter expressed the belief that some of the proposed
requirements under Rule 17Ad-22(e) represent a clarification of
existing requirements under Rule 17Ad-22(d) rather than enhanced
standards related to the particular risks arising from a clearing
agency's systemic importance.\77\ The commenter recommended that the
Commission review and revise Rule 17Ad-22(d) to align it with the
analogous provisions under proposed Rule 17Ad-22(e), particularly if
the different language in the proposed rule is intended to clarify
language in the existing rule or represents a logical outgrowth from
it. The commenter stated that, to the extent any provision of the
proposed rules reflects a best practice, the provision should apply to
all registered clearing agencies.\78\
---------------------------------------------------------------------------
\77\ See DTCC at 4 (citing proposed Rules 17Ad-22(e)(1), (8),
(10), and (12) as examples).
\78\ See id.
---------------------------------------------------------------------------
The Commission does not believe that the requirements under Rule
17Ad-22(e) represent a clarification of existing requirements in Rule
17Ad-22(d) or a codification of best practices. As discussed above, the
Commission proposed to maintain Rule 17Ad-22(d) to ensure that the
Commission could efficiently and effectively regulate registered
clearing agencies depending on the specific activity and risks that
each type of clearing agency poses to the U.S. financial system. Thus,
Rule 17Ad-22(d) applies requirements to registered clearing agencies
other than covered clearing agencies, consistent with the continuing
development of the national system for clearance and settlement. Since
no clearing agency would be subject to both Rule 17Ad-22(d) and Rule
17Ad-22(e), the Commission does not believe that confusion would arise
from similarities or differences between the requirements under the two
separate rules. With respect to best practices, Rule 17Ad-22(e)
includes requirements for covered clearing agencies intended to address
the activity and risks that their size, operation, and importance pose
to the U.S. securities markets, the risks inherent in the products they
clear, and the goals of both the Exchange Act and the Dodd-Frank Act,
and is not an attempt to merely reflect best practices.\79\
---------------------------------------------------------------------------
\79\ See CCA Standards proposing release, supra note 5, at
29516.
---------------------------------------------------------------------------
One commenter stated that the Commission must be vigilant to
prevent companies from engaging in regulatory arbitrage by seeking
application of Rule 17Ad-22(d) when the requirements of
[[Page 70794]]
proposed Rule 17Ad-22(e) would be more appropriate.\80\ The commenter
explained that the Commission can expect, for instance, large entities
to float new subsidiaries or affiliates seeking to operate under Rule
17Ad-22(d), even though the risk profile of the subsidiary may be part
of the greater risk exposure of the entity at-large.\81\ The Commission
is mindful of this concern and notes that, in a separate release, the
Commission has proposed an expanded definition of ``covered clearing
agency'' that, if adopted, may further reduce potential opportunities
for arbitrage.\82\
---------------------------------------------------------------------------
\80\ See OSEC at 1-2.
\81\ See id. at 2.
\82\ In a separate release, the Commission is proposing to
modify the definition of ``covered clearing agency'' to include all
CCPs, CSDs, and SSSs. See Exchange Act Release No. 34-78963 (Sept.
28, 2016) (``CCA Definition proposing release'').
---------------------------------------------------------------------------
The same commenter also recommended that the Commission regularly
evaluate registered clearing agencies subject to Rule 17Ad-22(d) to
ensure that their activities have not risen to a level warranting
oversight and requirements pursuant to Rule 17Ad-22(e).\83\ The
commenter stated that the Commission should require frequent audits of
the policies and procedures of clearing agencies operating under Rule
17Ad-22(d) and proposed Rule 17Ad-22(e) because (i) smaller, profitable
clearing agencies may quickly outgrow Rule 17Ad-22(d) and (ii) covered
clearing agencies may shift their operations materially after crafting
robust policies and procedures under Rule 17Ad-22(e). In addition, the
commenter noted that even if policies and procedures are implemented in
good faith, their efficacy could be questionable because standard
measurements of credit and liquidity risk may only encourage excessive
confidence in the risk profile of financial institutions.\84\ The same
commenter stated that the Commission's vigorous enforcement of clearing
rules will ultimately remain more important in achieving real-world
risk reduction than the mere promulgation of detailed rules.\85\ The
commenter noted that clearing agencies by definition collect various
counterparty risks and, while the agglomeration of such risks by
clearing agencies may have not played a significant role in the most
recent financial crisis, the continued growth of trading operations and
the consolidation of market power in the banking and finance sectors
suggest that clearing agencies could serve as ``ground zero'' in the
next crisis.\86\
---------------------------------------------------------------------------
\83\ See OSEC at 2.
\84\ See id.
\85\ See id.
\86\ See id.
---------------------------------------------------------------------------
As to this commenter, the Commission notes that registered clearing
agencies are subject to inspections and examinations under both the
Exchange Act and the Clearing Supervision Act.\87\ The Commission also
monitors registered clearing agencies to assess and evaluate the risks
posed by each clearing agency. Rule 17Ad-22(e) provides the Commission
with requirements against which a covered clearing agency can be, among
other things, monitored, inspected, and examined with respect to its
establishing, implementing, maintaining, and enforcing policies and
procedures for managing credit and liquidity risk and its compliance
with such policies and procedures. In addition, the Commission is
proposing in a separate release to expand the definition of ``covered
clearing agency'' to include all CCPs, CSDs, and SSSs. If adopted, the
requirements applied to CCPs, CSDs, and SSSs would be uniform under
Rule 17Ad-22(e).\88\
---------------------------------------------------------------------------
\87\ See 12 U.S.C. 5466.
\88\ See supra note 82.
---------------------------------------------------------------------------
3. Relationship Among Rules 17Ad-22(b), (c), and (e)
One commenter raised concerns regarding overlap between existing
Rules 17Ad-22(b)(1) through (4) and several of the provisions of
proposed Rule 17Ad-22(e).\89\ The commenter expressed the belief that
proposed Rules 17Ad-22(e)(4), (6), and (7) fully address all of the
matters covered by existing Rules 17Ad-22(b)(1) through (4) and that
subjecting covered clearing agencies that provide CCP services to both
sets of requirements may create ambiguities and inconsistencies.\90\
The commenter urged the Commission to revise the proposal so that the
provisions of existing Rules 17Ad-22(b)(1) through (4) are not
applicable to covered clearing agencies that provide CCP services.\91\
The Commission notes that the commenter has not identified specific
ambiguities or inconsistencies between Rules 17Ad-22(b) and (e) that
might result from application of both rule sets. With respect to the
potential for inconsistency, the Commission believes that while Rule
17Ad-22(e) may overlap with some requirements in Rule 17Ad-22(b), it is
not inconsistent with Rule 17Ad-22(b) and, as a general matter,
includes requirements intended to supplement the more general
requirements in Rule 17Ad-22(b). With respect to the potential for
ambiguity, the Commission notes that Rule 17Ad-22(b) applies to a
registered clearing agency that provides CCP services and Rule 17Ad-
22(e) applies to a registered clearing agency that is a covered
clearing agency. To the extent that a registered clearing agency is one
that both provides CCP services and is a covered clearing agency, then
it is subject to the requirements in both rule sets, with the more
general requirements in Rule 17Ad-22(b) supplemented by the
requirements of Rule 17Ad-22(e). The Commission therefore is declining
to limit application of Rule 17Ad-22(b) to clearing agencies that
provide CCP services and are not covered clearing agencies.
---------------------------------------------------------------------------
\89\ See DTCC at 4-5.
\90\ See id. at 5.
\91\ See id.; see also 17 CFR 240.17Ad-22(b)(1)-(4).
---------------------------------------------------------------------------
The commenter stated in the alternative that, at a minimum, the
Commission should clarify that the requirement in existing Rule 17Ad-
22(c)(1), which requires a registered clearing agency that provides CCP
services to calculate and maintain a record of its financial resources
available to cover participant defaults in accordance with existing
Rule 17Ad-22(b)(3), should instead be determined and calculated in
accordance with proposed Rule 17Ad-22(e)(4). The Commission believes
that such clarification in the rule text is appropriate. The Commission
further believes that, in light of the closely linked nature between
the management of credit and liquidity risk, and the holistic approach
taken in Rule 17Ad-22(e),\92\ a covered clearing agency generally
should also calculate and maintain a record of its qualifying liquid
resources under Rule 17Ad-22(e)(7). The Commission therefore is
amending Rule 17Ad-22(c)(1) to include a reference to the requirements
for financial resources and qualifying liquid resources in Rules 17Ad-
22(e)(4) and (e)(7) respectively, so that covered clearing agencies
have reporting requirements for their financial and qualifying liquid
resources equivalent to other registered clearing agencies.\93\ The
Commission notes that, to the extent the computations for financial
resources under Rules 17Ad-22(b)(3) and (e)(4) are the same, a covered
clearing agency could indicate so in the supporting documentation
required pursuant to Rule 17Ad-22(c)(1).
---------------------------------------------------------------------------
\92\ See infra Part II.B (discussing the principles based
approach to Rule 17Ad-22(e)).
\93\ See Rule 17Ad-22(c)(1), infra Part VI.
---------------------------------------------------------------------------
[[Page 70795]]
4. Risk of Duplicative or Inconsistent Regulation
One commenter noted that coordination among regulators in
implementing derivatives reform is critical to the efficient
functioning of the derivatives market by alleviating duplicative and
potentially conflicting regulation of cross-border transactions.\94\ In
response, the Commission notes that, as discussed above and previously
in the CCA Standards proposing release, the Commission has consulted
with the CFTC, FRB, and FSOC in developing these rules.\95\
---------------------------------------------------------------------------
\94\ See ICI at 2.
\95\ See CCA Standards proposing release, supra note 5, at 29508
(noting that the Commission has begun, and intends to continue,
consultation with the CFTC, FRB, and FSOC).
---------------------------------------------------------------------------
Another commenter similarly expressed the belief that consistent
international regimes are critical to mitigating regulatory arbitrage
because opportunities for regulatory arbitrage would disadvantage
smaller market participants.\96\ The commenter stated that no basis
exists for different regulatory treatment between U.S. and non-U.S.
markets for security-based swaps, noting that the Commission may
conform its standards for clearing agencies to reflect evolving
international standards, consistent with the Dodd-Frank Act and the
Exchange Act.\97\ As noted above, the Commission has considered the
relevant international standards in developing these rules, consistent
with the Dodd-Frank Act and the Exchange Act, and the Commission
believes that the scope of and requirements in Rule 17Ad-22(e)
appropriately address the risk profile of CCPs that clear security-
based swaps.\98\
---------------------------------------------------------------------------
\96\ See Fidelity at 7.
\97\ See id. at 7-8.
\98\ See supra note 1 and accompanying text; see also CCA
Standards proposing release, supra note 5, at 29508 & n.1 (noting
the same at the proposing stage).
---------------------------------------------------------------------------
A third commenter supported the view that imposing requirements on
dually registered entities would subject them to duplicative
regimes,\99\ and the commenter stated that avoiding unnecessarily
duplicative regulation allows for the most efficient use of both public
and private sector resources towards the shared goal of protecting the
financial system.\100\
---------------------------------------------------------------------------
\99\ See CME at 2 (citing CCA Standards proposing release, supra
note 5, at 29516).
\100\ See CME at 2.
---------------------------------------------------------------------------
A fourth commenter stated that the Commission should be wary of
imposing additional requirements on top of those imposed by other
regulators, particularly where other regulators are attempting to (or
have) imposed the same or substantially similar standards.\101\ The
commenter expressed the concern that, particularly for those clearing
entities that are regulated by multiple governmental authorities in
multiple jurisdictions, the approach taken in the proposed rules may
unnecessarily subject clearing entities to the risk of duplicative or
inconsistent regulation.\102\ The commenter expressed the belief that
avoiding unnecessarily duplicative or, worse, inconsistent regulation
is key to maximizing effective regulation and the use of limited
regulatory activities.\103\ The commenter stated that avoiding
unnecessarily duplicative regulation will also allow the Commission to
focus its resources on the particular activities within its
jurisdiction that present increased risks and should therefore be
subject to increased supervision. The commenter urged the Commission,
in implementing enhanced standards for covered clearing agencies, to
take a more flexible approach that is not ``one-size-fits-all'' and
considers the overall regulatory status of the relevant clearing
agency.\104\
---------------------------------------------------------------------------
\101\ See ICEEU at 7-8.
\102\ See id. at 1-2.
\103\ See id. at 8.
\104\ See id. at 2.
---------------------------------------------------------------------------
With respect to these two commenters, the Commission notes, as
previously discussed, that the Commission has consulted with the CFTC,
FRB, and FSOC in the development of these rules to, in part, avoid
unnecessarily duplicative or inconsistent regulation with respect to
clearing agencies that are dually registered in the United States. With
respect to such clearing agencies--as well as clearing agencies
regulated by authorities in other jurisdictions--the Commission is
nonetheless mindful, pursuant to the comprehensive framework for
regulating swaps and security-based swaps established in Title VII,
that the SEC has been given regulatory authority over security-based
swaps. CCPs that clear security-based swaps present risks to the
securities markets that must be subject to appropriate risk management.
The Commission's intent with respect to Rule 17Ad-22(e) is, in part, to
take another incremental step under Rule 17Ad-22 to ensure that these
risks are appropriately managed consistent with the purposes of the
Exchange Act, the Clearing Supervision Act, and Title VII of the Dodd-
Frank Act.\105\ In this regard, the Commission does not believe that it
has taken a ``one-size-fits-all'' approach; rather, the Commission has,
through Rule 17Ad-22, sought to apply requirements commensurate and
appropriate to the risk posed by the clearing agency functions and
activities specific to covered clearing agencies as they exist in, and
serve, the U.S. securities markets. The Commission acknowledges that
other rules and regulations may apply to a covered clearing agency that
are similar in scope or purpose to Rule 17Ad-22(e). However, the
presence of similar regulations does not negate the Commission's
obligation to ensure that risk in the U.S. securities markets is
appropriately managed consistent with the purposes of the Exchange Act,
the Clearing Supervision Act, and Title VII of the Dodd-Frank Act.
Further, because Rule 17Ad-22(e) and other comparable regulations--
including those of the CFTC--are based on the same international
standards,\106\ the potential for inconsistent regulation is low. The
commenters have provided no examples suggesting that Rule 17Ad-22(e) is
inconsistent with another comparable regulation. Nonetheless, Part
I.A.6 above discusses the process by which the Commission could
consider the attendant facts and circumstances in assessing the
application of Rule 17Ad-22(e) to a non-U.S. covered clearing agency
that is subject to similar regulation in its home jurisdiction, and
Part II.A.2 further discusses comments regarding the risk of
duplicative or inconsistent regulation targeted to security-based swap
clearing agencies subject to similar regulation in the home
jurisdiction.
---------------------------------------------------------------------------
\105\ See supra Part I.A.
\106\ See supra notes 1-2, 43, and accompanying text.
---------------------------------------------------------------------------
Finally, one commenter noted that opportunities for regulatory
arbitrage may exist based on differences between the Commission's
proposed approach and rules adopted by the CFTC.\107\ Opportunities for
regulatory arbitrage only exist, however, when there are gaps or
conflicting regulations for the same matter. Here, as noted above, the
Commission and CFTC have separate and distinct statutory mandates, as
set forth in the Exchange Act and the Commodity Exchange Act,
respectively, for the different markets they regulate. The Commission
has specific authority over the national system for clearance and
settlement of U.S. securities transactions, including transactions
involving security-based swaps.\108\ Under the Clearing Supervision
Act, the Commission also has specific authority over those SIFMUs for
which it is the
[[Page 70796]]
supervisory agency. In this regard, such a regulatory structure does
not on its face create opportunities for regulatory arbitrage based on
any differences between the Commission's proposed approach and rules
adopted by the CFTC.
---------------------------------------------------------------------------
\107\ See OSEC at 2.
\108\ See supra Parts I.A.1 and 2.
---------------------------------------------------------------------------
5. Flexible Versus Prescriptive Approaches to Regulation, and the Role
of Rule Filings Under Rule 19b-4
One commenter supported the proposed approach that covered clearing
agencies be allowed flexibility to use their market experience and
understanding of their institutions to shape the implementation of
proposed Rule 17Ad-22(e).\109\ The commenter emphasized that a flexible
and holistic approach would allow a clearing agency to make decisions
from a perspective of overall risk management, which may be more
productive than a more prescriptive approach.\110\ Another commenter
was broadly supportive of the proposed rules, noting that the rules
provide covered clearing agencies with the necessary flexibility to
design and structure their policies and procedures to take into account
the differences among clearing agencies.\111\ The commenter expressed
the view that the Commission generally achieved the appropriate balance
between taking a principles-based approach (providing clearing agencies
with flexibility) and a more prescriptive, granular approach (limiting
a clearing agency's discretion).\112\ The commenter also expressed the
belief that the precise form of the written policies and procedures
required by proposed Rule 17Ad-22(e) should be a matter for the
clearing agency to determine, and the commenter listed among such
policies and procedures the following: Service guides, operational
agreements, compliance procedures, link agreements, and protocols.\113\
A third commenter, in contrast, was concerned that the proposed rules
rely inordinately on internal risk testing and standards rather than a
clear set of external, regulatory demands.\114\ In the commenter's
view, financial firms often view their policies and procedures as mere
inconveniences.
---------------------------------------------------------------------------
\109\ See OCC at 3.
\110\ See id. at 4.
\111\ See DTCC at 3.
\112\ See id.
\113\ See DTCC at 12-13.
\114\ See OSEC at 2.
---------------------------------------------------------------------------
The Commission does not believe that policies and procedures
established by covered clearing agencies and required pursuant to Rule
17Ad-22(e) can or would be viewed as ``mere inconveniences.'' In
proposing Rule 17Ad-22(e) the Commission stated--and continues to
believe--that it is important for covered clearing agencies to use
their experience and understanding of the markets they serve to shape
the rules, policies, and procedures implementing proposed Rule 17Ad-
22(e).\115\ Nonetheless, as discussed above, Rule 17Ad-22(e) provides
the Commission with a uniform set of requirements against which a
covered clearing agency can be monitored, inspected, and examined.
Additionally, the Commission notes that, in using its experience to
shape the policies and procedures that implement Rule 17Ad-22(e), a
covered clearing agency must at all times comply with the requirements
of both Section 19 of the Exchange Act and the rules and regulations
thereunder for SROs, as well as, for designated clearing agencies, the
advance notice requirements of the Clearing Supervision Act and the
rules and regulations thereunder.\116\ Under Section 19(g) of the
Exchange Act, a registered clearing agency (as an SRO) must comply with
its own rules and, absent reasonable justification or excuse, enforce
compliance with its own rules by its participants.\117\
---------------------------------------------------------------------------
\115\ See CCA Standards proposing release, supra note 5, at
29517.
\116\ See supra Parts I.A.1 and 2.
\117\ See 15 U.S.C. 78s(g).
---------------------------------------------------------------------------
One of the above commenters further stated that there should be no
change in the requirement for filing proposed rule changes under Rule
19b-4 under the Exchange Act, and noted that not all written policies
and procedures that would be adopted by a clearing agency in compliance
with the proposed rule would be the subject of rule filings under Rule
19b-4.\118\ The Commission notes that the amendments to Rule 17Ad-22 do
not alter the definition of a rule or a proposed rule change under the
Exchange Act, nor do the amendments change a registered clearing
agency's obligation to file proposed rule changes under Rule 19b-
4.\119\
---------------------------------------------------------------------------
\118\ See DTCC at 13; see also supra notes 11-13 and
accompanying text (providing an overview of the requirement to
submit proposed rule changes to the Commission for review).
\119\ See supra note 12 and accompanying text.
---------------------------------------------------------------------------
6. Consistency With the PFMI
Five commenters generally supported the Commission's proposed
approach at least in part because they believed it would reflect
consistency with the PFMI, as described further below.
One commenter supported the Commission's efforts to update its
rules for clearing agencies to take into account the PFMI and to
provide support for determinations by non-U.S. banking regulators that
covered clearing agencies satisfy the requirements for QCCP status
under the BCBS capital framework.\120\ The commenter expressed the
belief that it would be beneficial for the Commission's rules to recite
the Commission's intent to establish standards for covered clearing
agencies that are consistent with the PFMI and to interpret them in
that context so long as it does not result in inconsistency with the
Exchange Act or other Commission regulations, noting that the CFTC
included such provision in its regulations for systemically important
derivatives clearing organizations (``SIDCOs'').\121\ In this regard,
the commenter noted that one of the elements of the QCCP definition
under the BCBS capital framework is that the relevant regulator has
``publicly indicated'' that it applies to a CCP, on an ongoing basis,
domestic rules and regulations that are consistent with the PFMI.\122\
As previously discussed, the Commission has publicly indicated that, in
developing Rule 17Ad-22(e), the Commission has, among other things,
considered the relevant international standards, including the
PFMI.\123\ The Commission also believes, as previously discussed in
Part I.A.5, that the requirements applicable to clearing agencies set
forth in the Exchange Act and the rules thereunder, including the rules
adopted today, are consistent with the PFMI, and that the rules set
forth below are a continuation of the Commission's active effort to
foster the development of the national clearance and settlement system
consistent with the requirements of the Exchange Act.
---------------------------------------------------------------------------
\120\ See ISDA at 1.
\121\ See ISDA at 1-2 & n.4 (citing CFTC requirements at 17 CFR
39.40).
\122\ See id. at 1.
\123\ See supra notes 1-2 and accompanying text; see also CCA
Standards proposing release, supra note 5, at 29508 & n.1.
---------------------------------------------------------------------------
A second commenter similarly supported the Commission's proposal to
adopt enhanced regulatory standards that are consistent with the PFMI
and that would facilitate the ability of covered clearing agencies to
be considered QCCPs.\124\ A third commenter welcomed the efforts of the
Commission to implement standards for clearing agencies that are
consistent with the PFMI.\125\ A fourth commenter noted that enhanced
standards are necessary to ensure that the Commission's regulation of
CCPs is consistent with international standards, including the PFMI--
which serves as a
[[Page 70797]]
prerequisite to obtaining QCCP status under the BCBS capital
framework--and CPSS-IOSCO's consultative report Recovery of Financial
Market Infrastructures (``Consultative Recovery Report'').\126\
---------------------------------------------------------------------------
\124\ See LCH at 2.
\125\ See ICEEU at 1.
\126\ See The Clearing House at 1-2. The Commission notes that,
since the comment letter was submitted, CPMI-IOSCO has published a
final report on this topic. See supra note 41 (citing to the final
report).
---------------------------------------------------------------------------
A fifth commenter noted that the Commission's approach differs from
the PFMI in some areas (e.g., segregation and portability and liquidity
risk), reflecting the nature of the securities markets and the
particular requirements of the Exchange Act.\127\ The commenter
supported this approach because covered clearing agencies need to have
appropriate flexibility to implement timely modifications to relevant
parameters, assumptions, and approaches. The commenter also expressed
the belief that the Commission has generally struck the appropriate
balance with respect to incorporating the PFMI principles and the level
of granular requirements thereunder.\128\
---------------------------------------------------------------------------
\127\ See DTCC at 3.
\128\ See id.
---------------------------------------------------------------------------
A sixth commenter, in contrast to the above commenters, urged the
Commission to adopt the key considerations of each principle identified
in the PFMI and to strengthen the proposed rules to affirmatively
require robust standards and procedures that ensure accountability,
independence, and financial stability.\129\ To the extent that the
commenter identified a particular key consideration that the Commission
should include as a requirement in Rule 17Ad-22(e), it is discussed and
addressed in Part II.C. As a general matter, the Commission believes
that the requirements applicable to clearing agencies set forth in the
Exchange Act and the rules thereunder, including the rules adopted
today, are consistent with the PFMI. The Commission also believes Rule
17Ad-22(e) achieves the appropriate balance between imposing new
requirements on covered clearing agencies and allowing each covered
clearing agency, subject to its obligations and responsibilities as an
SRO under the Exchange Act, to design its policies and procedures
pursuant to Rule 17Ad-22(e). This approach is consistent with the
Commission's existing approach under Rules 17Ad-22(b) and (d) and
recognizes that each registered clearing agency has different
organizational and operating structures and clears distinct products
that warrant a tailored approach to governance and risk management
respectively. The Commission notes that such a policies and procedures
approach is also consistent with the Commission's existing regulation
of SROs generally.\130\ In addition, in the discussion of each final
rule under Rule 17Ad-22(e) in Part II.C, the Commission has provided
guidance based on the key considerations in the PFMI.
---------------------------------------------------------------------------
\129\ See Better Markets at 4-5.
\130\ In the Commission's experience, proposed rule changes of
the type necessary to implement the rules would generally entail
changes to the SRO's written policies and procedures that must be
submitted for Commission review and approval pursuant to Rule 19b-4
under the Exchange Act. See supra note 12.
---------------------------------------------------------------------------
7. Other Comments
The Commission also received several comments that were not
directed to the substance of the CCA Standards proposal itself. These
comments recommended study and rulemaking beyond the scope of the
proposed amendments to Rule 17Ad-22 and Rule 17Ab2-2.\131\
---------------------------------------------------------------------------
\131\ See ISDA at 4, 6 (recommending that the Commission (i)
develop, in a subsequent rulemaking, more detailed rules that
require customer-by-customer accounting of the collateral value held
by the covered clearing agency with respect to security-based swap
positions and impose corresponding limitations on the value of
collateral that the covered clearing agency may apply towards losses
on other customers' positions carried by the participant and (ii)
commit to a study of insolvency of security-based swap clearing
agencies with the goal of identifying uncertainties, proposing
solutions, and fostering public discussion); CFA Institute at 2
(expressing general concern regarding the central clearing of OTC
swaps and derivatives, urging the Commission to take caution in
regulating OTC swaps and derivatives, and asking the Commission to
consider whether to require all OTC contracts, whether standardized
or not, to be cleared); SRC at 2 (stating that the SEC and CFTC
continue to lack the resources available to other self-funded
financial regulators, creating structural weakness). The Commission
also received one comment letter that recommended modifications to
Rule 17Ad-22(e)(14) and other rulemaking outside the scope of Rule
17Ad-22. See AMG-ICI at 8-12.
---------------------------------------------------------------------------
II. Description of the Amendments to Rule 17Ad-22 and Rule 17Ab2-2
Below is a discussion of the amendments to Rule 17Ad-22 and Rule
17Ab2-2. Part II.A discusses the scope of new Rule 17Ad-22(e). Part
II.B discusses the Commission's principles-based approach to developing
the requirements in Rule 17Ad-22(e). Part II.C discusses the
requirements for covered clearing agencies under new Rule 17Ad-22(e)
and the definitions that the Commission is adopting in Rule 17Ad-22(a).
Part II.D discusses new Rule 17Ab2-2, Part II.E discusses new Rule
17Ad-22(f), and Part II.F discusses the amendment to Rule 17Ad-22(d).
Part II.G discusses the effective and compliance dates.\132\
---------------------------------------------------------------------------
\132\ If any of the provisions of these rules, or the
application thereof to any person or circumstance, is held to be
invalid, such invalidity shall not affect other provisions or
application of such provisions to other persons or circumstances
that can be given effect without the invalid provision or
application.
---------------------------------------------------------------------------
A. Scope of Rule 17Ad-22(e)
To facilitate the approach to clearing agency regulation described
in Part I.B, the Commission proposed to add five definitions to Rule
17Ad-22(a) to identify those clearing agencies that would be subject to
the requirements in Rule 17Ad-22(e). First, the Commission proposed to
define ``financial market utility'' as defined in Section 803(6) of the
Clearing Supervision Act.\133\ Second, the Commission proposed to
define ``designated clearing agency'' as a clearing agency registered
with the Commission under Section 17A of the Exchange Act that is
designated as systemically important by the FSOC and for which the
Commission is the supervisory agency as defined in Section 803(8) of
the Clearing Supervision Act.\134\ Third, the Commission proposed to
define ``clearing agency involved in activities with a more complex
risk profile'' to mean a clearing agency registered with the Commission
under Section 17A of the Exchange Act and that either (i) provides CCP
services for security-based swaps or (ii) has been determined by the
Commission to be involved in activities with a more complex risk
profile (``complex risk profile clearing agency''), either at the time
of its initial registration or upon a subsequent determination by the
Commission pursuant to proposed Rule 17Ab2-2. Fourth, the Commission
also proposed to define ``security-based swap'' to mean security-based
swap as defined in Section 3(a)(68) of the Exchange Act.\135\ The
Commission received no comments regarding these four definitions. The
Commission is modifying the definition of ``clearing agency involved in
activities with a more complex risk profile'' to strike ``and'' because
it is unnecessary. The Commission is adopting the remaining three
definitions as proposed.\136\
---------------------------------------------------------------------------
\133\ See 12 U.S.C. 5462(6) (defining ``financial market
utility'' pursuant to the Clearing Supervision Act); supra note 20
(further discussing FMUs under the Clearing Supervision Act).
\134\ Rule 17Ad-22 does not currently apply to entities
operating pursuant to an exemption from clearing agency
registration.
\135\ See 15 U.S.C. 78c(a)(68).
\136\ The Commission notes that, because of modifications to
Rule 17Ad-22(a), the definition of ``financial market utility'' is
being moved to Rule 17Ad-22(a)(7), the definition of ``designated
clearing agency'' is being moved to Rule 17Ad-22(a)(6), the
definition of ``security-based swap'' is being moved to Rule 17Ad-
22(a)(15). The definition of ``clearing agency involved in
activities with a more complex risk profile'' remains in Rule 17Ad-
22(a)(4). See infra Part VI.
---------------------------------------------------------------------------
[[Page 70798]]
Fifth, the Commission proposed to define ``covered clearing
agency'' to mean a designated clearing agency, a complex risk profile
clearing agency for which the CFTC is not the supervisory agency, or
any clearing agency determined to be a covered clearing agency by the
Commission pursuant to proposed Rule 17Ab2-2. Commenters expressed
several views on the entities and activities that should be included
within the ``covered clearing agency'' definition. In Part I.C.4 above,
the Commission considered comments focused generally on the potential
for duplicative or inconsistent regulation as a result of the proposed
scope of Rule 17Ad-22(e). Below is a discussion of comments directed to
aspects of the definition of ``covered clearing agency.'' \137\
Comments directed to the scope of proposed Rule 17Ab2-2(a), which would
have provided procedures for the Commission to determine whether a
registered clearing agency is a covered clearing agency, are discussed
separately in Part II.D. In light of those comments, the Commission has
determined not to adopt proposed Rule 17Ab2-2(a), and therefore, in
adopting the definition of ``covered clearing agency,'' the Commission
has also determined to not adopt the proposed prong regarding
determinations pursuant to Rule 17Ab2-2.\138\ Accordingly, the
Commission is adopting the definition of ``covered clearing agency'' to
mean a designated clearing agency or a complex risk profile clearing
agency for which the CFTC is not the supervisory agency as defined in
the Clearing Supervision Act.\139\
---------------------------------------------------------------------------
\137\ The Commission notes that, because of modifications to
Rule 17Ad-22(a), the definition of ``covered clearing agency'' is
being moved to Rule 17Ad-22(a)(5). See infra Part VI.
\138\ See infra Part II.D.2.a.
\139\ In addition, as first noted in Part 0, in a separate
release the Commission is proposing to modify the definition of
`covered clearing agency' to include all CCPs, CSDs, and SSSs. See
CCA Definition proposing release, supra note 82, at 25-26.
---------------------------------------------------------------------------
1. As Applied to CCPs Generally
Four commenters supported applying enhanced standards to CCPs
generally.\140\ One commenter noted that the mandatory clearing of OTC
derivatives introduced following the 2008 financial crisis has
heightened the need for enhanced standards for CCPs.\141\ A second
commenter suggested that the Commission apply Rule 17Ad-22(e) to all
clearing agencies to reduce the risk of failure and the problems such a
failure would cause for investors.\142\ In so suggesting, the commenter
cited to the size of the derivatives markets and the potential for
disruption and systemic risk that those markets may have on covered
clearing agencies.\143\ A third commenter similarly cited to the risks
associated with derivatives trading that has shifted into clearing
agencies.\144\ With respect to these three commenters, the Commission
notes that, according to the ``covered clearing agency'' definition, a
CCP is a covered clearing agency in either of the following
circumstances: (i) If the CCP is a designated clearing agency; or (ii)
if the CCP is a complex risk profile clearing agency,\145\ unless the
CFTC is the supervisory authority under the Clearing Supervision Act.
Accordingly, under the ``covered clearing agency'' definition, five of
the six active CCPs registered with the Commission will be a covered
clearing agency subject to Rule 17Ad-22(e). The Commission believes
that it is important to take an initial step to establish coverage of
Rule 17Ad-22(e) over this group of clearing agencies and is adopting
the ``covered clearing agency'' definition with only the modification
described above regarding Rule 17Ab2-2. However, in consideration of
these comments, the Commission is proposing in a separate release to
amend the definition of ``covered clearing agency'' so that it would
apply to any registered clearing agency that, among other things,
provides CCP services.\146\ Under this proposed definition, any CCP
registered with the Commission would be a covered clearing agency.
---------------------------------------------------------------------------
\140\ See CFA Institute at 2; OSEC at 3; The Clearing House at
1; DTCC at 4 (recommending that any provision of the proposed rules
that reflects best practices should be applied to all registered
clearing agencies).
\141\ See The Clearing House at 1.
\142\ See CFA Institute at 2.
\143\ See id. The commenter also suggests that, to account for
these risks, the Commission reconsider whether all OTC contracts,
whether standardized or not, ought to clear through covered clearing
agencies. The Commission notes that whether OTC contracts ought to
be subject to mandatory clearing requirements was not a subject of
this rulemaking during the proposing stage, and the Commission
therefore believes this comment is outside the scope of this
rulemaking.
\144\ See OSEC at 3.
\145\ As previously discussed, security-based swap clearing
agencies are a subset of complex risk profile clearing agencies
under Rule17Ad-22(a)(5). See supra note 59.
\146\ See CCA Definition proposing release, supra note 82, at
25-43.
---------------------------------------------------------------------------
The fourth commenter recommended that any provision of the proposed
rules that reflects best practices should be applied to all registered
clearing agencies, CCPs or otherwise.\147\ This comment has been
previously addressed in Part I.C.2.\148\
---------------------------------------------------------------------------
\147\ See DTCC at 4.
\148\ See supra notes 77-78 and accompanying text.
---------------------------------------------------------------------------
2. As Applied to Security-Based Swap Clearing Agencies
In contrast, three commenters sought to limit the scope of Rule
17Ad-22(e) further than was proposed.\149\ The Commission believes
these arguments are unpersuasive, for the reasons described below.
---------------------------------------------------------------------------
\149\ See CME, ICEEU, and LCH.
---------------------------------------------------------------------------
One of these commenters expressed the view that Rule 17Ad-22(e)
should not apply to complex risk profile clearing agencies but only to
designated clearing agencies, and that applying the enhanced regime of
Rule 17Ad-22(e) to non-designated clearing agencies undermines the
significance of being designated, which the commenter stated is
inconsistent with the distinction Congress sought to create between
systemically important clearing agencies and other non-designated
clearing agencies.\150\ The commenter stated that the Commission should
take an approach similar to the CFTC, whereby non-designated clearing
agencies could choose to ``opt-in'' to the enhanced requirements of
Rule 17Ad-22(e) if desired. The commenter further stated that security-
based swap clearing agencies should not automatically fall within the
definition of a covered clearing agency, stating that it is not clear
security-based swap clearing inherently raises issues that require
enhanced standards as compared to other clearing activities.\151\
---------------------------------------------------------------------------
\150\ See ICEEU at 3.
\151\ See id. at 3-4.
---------------------------------------------------------------------------
The Commission believes, however, that it is important to establish
coverage of the enhanced standards of Rule 17Ad-22(e) for CCPs that
clear security-based swaps. In the Commission's view, in addition to
designations of systemic importance under the Clearing Supervision Act,
Title VII of the Dodd-Frank Act sets out separate and equally important
objectives. As described above, Title VII provides the Commission with
enhanced authority to regulate security-based swaps, and, among other
things, requires the Commission to adopt rules with respect to
security-based swap clearing agencies.\152\ The Commission previously
has noted that Title VII's mandate for the central clearing of security
based swaps, wherever possible and appropriate, reinforces the need for
proper risk management by security-
[[Page 70799]]
based swap clearing agencies to ensure the stability of the U.S.
securities markets.\153\ The requirements in Rule 17Ad-22(e), among
other things, help to mitigate the risks inherent in the functions of a
CCP, including a CCP for security-based swaps, and therefore the
Commission believes that requiring registered clearing agencies
performing such CCP functions to comply with Rule 17Ad-22(e), in
addition to those registered clearing agencies that are designated
clearing agencies, is consistent with the framework of both Title VII
and the Clearing Supervision Act. In light of these considerations, the
Commission does not believe that an opt-in regime is appropriate for
security-based swap clearing agencies.
---------------------------------------------------------------------------
\152\ See supra note 17 and accompanying text.
\153\ See CCA Standards proposing release, supra note 5, at
29576.
---------------------------------------------------------------------------
In the alternative, the commenter stated that application of Rule
17Ad-22(e) should be limited to the particular business or product
lines of a covered clearing agency that warrant application of the
higher standards.\154\ The commenter noted that many clearing agencies
clear a range of products, some of which are within and others outside
of the Commission's jurisdiction. According to the commenter, for those
clearing agencies only some activities, such as the clearing of
security-based swaps, should trigger application of Rule 17Ad-22(e),
and therefore the requirements in Rule 17Ad-22(e) should be limited to
those business or product lines. The commenter noted that this would be
applicable where the activity is substantially separate from other
business lines, such as through the use of a separate guaranty fund.
The commenter recognized that certain standards may not be easily
applied to a particular business line,\155\ but noted that a
categorical rule that does not take into account the scope of a
particular clearing agency's security-based swap activities or the
risks presented by them raises concerns.\156\
---------------------------------------------------------------------------
\154\ See ICEEU at 7.
\155\ See id. The commenter further states that this approach
will help reduce the likelihood of clearing agencies being subject
to inconsistent regulation. The Commission addressed this aspect of
the comment above in Part I.C.4.
\156\ See ICEEU at 7.
---------------------------------------------------------------------------
Rule 17Ad-22(e) applies to a covered clearing agency and does not
make distinctions among the various product or business lines that the
covered clearing agency manages. In the Commission's experience, many
aspects of a clearing agency's operations are managed at the entity
level (i.e., as a clearing agency) irrespective of product or business
line. For example, the clearing agency's legal framework, governance,
risk management framework, financial risk management, and operational
risk management are determined as part of the policies and procedures
of the entity (i.e., the clearing agency), and therefore these areas
are not separated out to apply exclusively to a particular business or
product line.\157\ Thus, requirements in Rule 17Ad-22(e) directed to
these aspects of a clearing agency's operations generally could not be
easily applied only to a particular business or product line when the
clearing agency's operations and risk management are organized at the
entity level. The Commission believes that this approach avoids
unnecessary complexity and fragmentation in the policies and procedures
of a clearing agency. The operations and risk management of a covered
clearing agency are closely interrelated across various activities in
which the clearing agency engages, and within Rule 17Ad-22(e), the
requirements have significant interactions among each other, with some
building upon others or complementing others. The Commission believes
that this generally also supports a holistic application of the
requirements in Rule 17Ad-22(e).
---------------------------------------------------------------------------
\157\ See infra Parts II.C.1-7, 17 (discussing each,
respectively).
---------------------------------------------------------------------------
However, the Commission understands that some covered clearing
agencies may manage certain activities and risk at an entity level
while others manage the same activities and risk at a business or
product level. Covered clearing agencies retain the ability to
distinguish among their products in crafting their policies and
procedures. Because a covered clearing agency's practices are diverse
and difficult to generalize, the Commission has sought to address such
concerns in other ways, such as by streamlining the process for rule
filings under Rule 19b-4 filed by dually registered clearing
agencies.\158\ Specifically, for rule filings that primarily concern
the clearing operations of a registered clearing agency that are not
linked to securities clearing operations but only to clearing of
products under the authority of the CFTC, the Commission provides a
streamlined process for such rule filings to become effective upon
filing with the Commission.\159\
---------------------------------------------------------------------------
\158\ See Exchange Act Release No. 34-69284 (Apr. 3, 2013), 78
FR 21046 (Apr. 9, 2013) (``Dually Registered CA release'').
\159\ See id. at 21047.
---------------------------------------------------------------------------
Additionally, two commenters urged the Commission to exclude non-
U.S. security-based swap clearing agencies registered with the
Commission from the definition of ``covered clearing agency'' when they
are regulated in their home jurisdictions under a regime that is
consistent with the PFMI.\160\ The commenters stated that this approach
would be consistent with the Commission's treatment under Rule 17Ad-
22(e) of dually registered SIDCOs for which the CFTC is the supervisory
agency under the Clearing Supervision Act and believe a similar
exclusion would be appropriate for clearing agencies subject to other
regulatory frameworks.\161\ The commenters further stated that any
decision to apply the enhanced standards for covered clearing agencies
should take into account whether, and the extent to which, the clearing
agency is already subject to similar or comparable standards under
other regulation,\162\ noting that recognizing existing foreign
regulation is consistent with the Commission's proposals on regulation
of cross-border activities generally.\163\ In the commenters' view, the
approach set out in the Commission's Cross-Border proposing release
sensibly balanced the interests of the Commission with those of foreign
regulators and appropriately considered the costs and benefits of
adding additional regulatory requirements where the home country
regulation is comparable.
---------------------------------------------------------------------------
\160\ See ICEEU at 5-6; LCH at 3. The Commission has previously
addressed more general comments regarding the risk of duplicative or
inconsistent regulation above in Part I.C.4.
\161\ See ICEEU at 5-6; LCH at 3.
\162\ See id.
\163\ See ICEEU at 6; LCH at 3 (citing Exchange Act Release No.
34-69490 (May 1, 2013), 78 FR 30968, 31039 (May 23, 2013) (``Cross-
Border proposing release'')).
---------------------------------------------------------------------------
In this regard, one commenter expressed the belief that deference
to home country regulation is appropriate because both Rule 17Ad-22(e)
and applicable U.K. regulations are consistent with the PFMI, noting
that U.S. and U.K. regulators thus have generally aligned
interests.\164\ In particular, the commenter cited, as comparable
regulation to Rule 17Ad-22(e), regulation by the Bank of England under
existing U.K. legislation and, for those clearing agencies that have
been granted authorization as a CCP under EMIR, the regulations under
EMIR.\165\ A second commenter echoed this viewpoint, noting that EMIR
is consistent with the PFMI.\166\ Finally, one of the commenters stated
that, in areas where the Commission determines that the home country
regulation is not comparable and determines that additional regulation
may be appropriate, any incremental regulation
[[Page 70800]]
under Rule 17Ad-22 should be targeted to those areas of
difference.\167\
---------------------------------------------------------------------------
\164\ See ICEEU at 6.
\165\ See id.
\166\ See LCH at 3.
\167\ See ICEEU at 6.
---------------------------------------------------------------------------
One commenter further stated that, at a minimum, a clearing agency
subject to Rule 17Ad-22(e) in addition to comparable home regulation is
subject to duplicative regulation, which is costly for both the
clearing agency and its regulators and serves no meaningful regulatory
purpose.\168\ The commenter also stated that it is critical that a
clearing agency not be subject to inconsistent regulations in different
jurisdictions, noting that such inconsistencies can arise not only when
relevant regulations are different but also when regulators interpret
substantially similar regulations in different ways. As a result, the
commenter stated that a clearing agency can still be significantly
burdened by being subject to two substantially similar sets of
regulations, and in its view, the commenter expressed the view that it
would be preferable to allow clearing agencies, where possible, to be
subject to a single set of standards.\169\ The other commenter also
supported an approach that would minimize duplicative requirements on
those registered clearing agencies subject to both Rule 17Ad-22(e) and
home regulation, while ensuring that all registered clearing agencies
that clear security-based swaps are regulated in a manner that is
consistent with the PFMI.\170\
---------------------------------------------------------------------------
\168\ See ICEEU at 5.
\169\ See id.
\170\ See LCH at 3.
---------------------------------------------------------------------------
In response to the above comments, the Commission does not believe
that a non-U.S. security-based swap clearing agency regulated in its
home jurisdiction, under a regime consistent with the PFMI, should be
excluded, as a threshold matter, from designation as a covered clearing
agency. As previously discussed in Part I.C.4, the Commission's intent
with respect to Rule 17Ad-22(e) is, in part, to take another
incremental step under Rule 17Ad-22 to ensure that risks inherent in
certain CCP activity, including the central clearing of security-based
swaps, are appropriately managed consistent with the purposes of the
Exchange Act, the Clearing Supervision Act, and Title VII of the Dodd-
Frank Act. The Commission has, through Rule 17Ad-22, sought to apply
requirements commensurate and appropriate to the risk posed by the
clearing agency functions and activities specific to covered clearing
agencies as they exist in, and serve, the U.S. securities markets. The
Commission acknowledges that other rules and regulations may apply to a
covered clearing agency that are similar in scope or purpose to Rule
17Ad-22(e). However, the presence of similar regulations does not
negate the Commission's obligation to ensure that risk in the U.S.
securities markets is appropriately managed consistent with the
purposes of the Exchange Act, the Clearing Supervision Act, and Title
VII of the Dodd-Frank Act.
Further, because Rule 17Ad-22(e) and other comparable regulations
are based on the same international standards,\171\ the Commission
believes the potential for any inconsistent regulation is low. Indeed,
applying Rule 17Ad-22(e) to a covered clearing agency that is also
subject to comparable regulation consistent with the PFMI in its home
jurisdiction should improve harmonization between the Commission's
regulatory regime and that of the home jurisdiction, which would reduce
the burdens associated with the presence of similar regulation under
multiple regulatory regimes. In addition, because clearing agency
practices are diverse and difficult to generalize, the Commission has
sought to address concerns about duplicative regulation in other ways,
such as through streamlining the process for rule filings under Rule
19b-4 filed by clearing agencies dually registered with the Commission
and the CFTC so that rule filings that do not pertain to securities
clearing operations become effective upon filing with the Commission,
without pre-effective notice and opportunity for comment.\172\ In
addition, Part I.A.6 above discusses the process by which the
Commission could consider the attendant facts and circumstances in
assessing the application of Rule 17Ad-22(e) to a non-U.S. covered
clearing agency that is subject to similar regulation in its home
jurisdiction.
---------------------------------------------------------------------------
\171\ See supra notes 1-2, 43, and accompanying text.
\172\ See Dually Registered CA release, supra note 158, at
21047.
---------------------------------------------------------------------------
3. As Applied to Dually Registered Clearing Agencies
One commenter noted that the proposed definition is sufficiently
broad to enable the Commission to include SIDCOs. The commenter stated
that the potential for a SIDCO to be determined to be a covered
clearing agency is inconsistent with the Commission's acknowledgment of
the purposes of the Clearing Supervision Act and there being
duplicative requirements for some dually registered entities.\173\ The
commenter recommended that the Commission expressly exclude from the
definition of ``covered clearing agency'' those clearing agencies for
which the CFTC is the supervisory agency pursuant to the Clearing
Supervision Act. The Commission notes that the definition of ``covered
clearing agency'' does expressly exclude those clearing agencies for
which the CFTC is the supervisory agency. As previously discussed, in a
separate release, the Commission is proposing to amend the definition
of a covered clearing agency, and addresses the potential effects of
the proposed amendment on clearing agencies dually registered with the
CFTC.\174\
---------------------------------------------------------------------------
\173\ See CME at 3.
\174\ See CCA Definition proposing release, supra note 82, at
39-42.
---------------------------------------------------------------------------
B. Principles-Based Approach to Rule 17Ad-22(e)
Rule 17Ad-22(e) requires a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures that
address a variety of issues, as described in detail below. The
Commission's approach sets forth requirements that a covered clearing
agency must achieve when developing its written policies and
procedures. With a number of exceptions, Rule 17Ad-22(e) does not
prescribe a specific tool or arrangement to achieve its requirements.
The Commission believes that when determining the content of its
policies and procedures, each covered clearing agency must have the
ability to consider its unique characteristics and circumstances,
including ownership and governance structures, effect on direct and
indirect participants, membership base, markets served, and the risks
inherent in products cleared. This ability, however, is subject to the
requirements of the SRO rule filing and advance notice processes, which
provide some opportunities for the public and participants to comment
on the covered clearing agency's rules, policies, and procedures.
The Commission does not believe that a granular or prescriptive
approach to its regulation of covered clearing agencies would be
appropriate, nor would such an approach ensure that a covered clearing
agency does not become a transmission mechanism for systemic risk.
Moreover, the Commission believes that the primarily principles-based
approach reflected in Rule 17Ad-22(e) will help a covered clearing
agency continue to develop policies and procedures that can effectively
meet the evolving risks and challenges in the markets that the covered
clearing agency serves. It has
[[Page 70801]]
been the Commission's experience that particular securities markets
(e.g., equities, fixed income, and options) have their unique
conventions, characteristics, and structure that are best addressed on
a market-by-market basis. The Commission recognizes that a less
prescriptive approach can help promote efficient and effective
practices and encourage regulated entities to consider how to manage
their regulatory obligations and risk management practices in a way
that complies with Commission rules, while considering the particular
characteristics of their business, and believes the approach reflected
in across Rule 17Ad-22, including new paragraph (e), is consistent with
this approach. Such a principles-based approach also is consistent with
the approach taken in Rule 17Ad-22(d).\175\
---------------------------------------------------------------------------
\175\ See, e.g., Clearing Agency Standards adopting release,
supra note 5, at 66231-32 (noting, with respect to credit exposures
and margin requirements under Rule 17Ad-22(d), that a less
prescriptive and more flexible rule sets a more appropriate baseline
standard and stressing the importance of considering different
markets characterized by different trading patterns, volumes,
liquidity, transparency and other unique market characteristics when
determining the appropriate risk management mechanisms for a
particular clearing agency).
---------------------------------------------------------------------------
As a general matter, the Commission believes that using broadly
prescriptive requirements that, on an absolute and ex ante basis,
prohibit a covered clearing agency's use of particular tools makes it
more difficult for a covered clearing agency to maintain flexibility,
subject to its obligations and responsibilities as an SRO under the
Exchange Act, to address the ever-evolving challenges and risks
inherent in the securities markets. Accordingly, the Commission
believes that the approach adopted here appropriately preserves such
flexibility for a covered clearing agency, and the broader market, to
respond to particular risks or issues arising in its operations in an
effective manner.
Finally, in certain instances, commenters have suggested that the
Commission either prohibit or endorse a covered clearing agency's use
of particular tools or rules, policies, or procedures. As discussed in
more detail below, the Commission generally declines to take such an
approach because it is inconsistent with the principles-based approach
reflected in Rule 17Ad-22(e). Instead, the Commission's approach to
Rule 17Ad-22(e) is designed to allow the Commission to consider
particular tools in the context of the specific facts and circumstances
facing a clearing agency in light of its governance structure, the
products it clears, and the markets it serves. In addition, in
consideration of the issues raised by commenters, the Commission has
provided guidance consistent as to what a covered clearing agency
generally should consider when developing and maintaining its policies
and procedures consistent with Rule 17Ad-22(e).
C. Requirements for Covered Clearing Agencies Under Rule 17Ad-22(e)
Below is a discussion of each of the requirements in new Rule 17Ad-
22(e), the related new definitions in Rule 17Ad-22(a), and the comments
received by the Commission that were targeted to specific elements of
those requirements and definitions.\176\ As previously noted, the
Commission is adopting Rule 17Ad-22(e) and the related definitions in
Rule 17Ad-22(a) substantially as proposed.\177\ To the extent the
Commission is adopting any modifications either to the requirements in
Rule 17Ad-22(e) or the definitions in Rule 17Ad-22(a), such
modifications are discussed in detail below. Moreover, the below
sections are organized by the particular rules under Rule 17Ad-22(e),
with discussion of the definitions incorporated into the overall
substantive discussion of each particular rule. Further, in the
discussion of each final rule below, the Commission has included
guidance that a covered clearing agency generally should consider as it
develops and maintains its rules, policies, and procedures in
compliance with Rule 17Ad-22(e). As previously noted, this guidance is
based, in part, on the key considerations in the PFMI.\178\ The
Commission intends for this guidance to be read in conjunction with the
relevant requirements set forth in Rule 17Ad-22(e), so as to provide
further explanation of the types of issues a covered clearing agency
generally should consider when implementing those requirements. The
Commission does not intend for this guidance to expand, diminish, or
otherwise modify the requirements under Rule 17Ad-22(e).
---------------------------------------------------------------------------
\176\ Comments that were of a general nature have been discussed
in Part I.C.
\177\ See supra Part I.B.
\178\ See supra Part I.C.6.
---------------------------------------------------------------------------
1. Rule 17Ad-22(e)(1): Legal Risk
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(1) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to provide for a well-founded,
clear, transparent, and enforceable legal basis for each aspect of its
activities in all relevant jurisdictions.\179\ The Commission proposed
Rule 17Ad-22(a)(20) to define ``transparent'' to mean that relevant
documentation is disclosed, as appropriate, to the Commission and other
relevant authorities, to clearing members and customers of clearing
members, to the owners of the covered clearing agency, and to the
public, to the extent consistent with other statutory and Commission
requirements.\180\
---------------------------------------------------------------------------
\179\ See CCA Standards proposing release, supra note 5, at
29519-20.
\180\ See id. In addition, the Commission notes that the
definition of ``transparent'' is also used in Rules 17Ad-22(e)(2)
and (10). See infra Parts II.C.2 and 10.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
i. Use of Legal Opinions
One commenter supported the Commission's proposal that each covered
clearing agency have policies and procedures that provide for a well-
founded, clear, transparent, and enforceable legal basis for each of
its activities in all relevant jurisdictions, and noted that legal
uncertainty can increase risk.\181\ A second commenter stated that the
Commission explicitly should require a covered clearing agency to
obtain, on at least an annual basis, legal opinions on the
enforceability of structures used to contain losses within a clearing
service upon the insolvency of the clearing service or the covered
clearing agency, including closeout netting, right of set-off,
classification as a repurchase-style transaction, and collateral
protection opinions, and then disclose these opinions to its
participants.\182\
---------------------------------------------------------------------------
\181\ See CFA Institute at 5.
\182\ See The Clearing House at 18.
---------------------------------------------------------------------------
In satisfying the requirements in Rule 17Ad-22(e)(1), a covered
clearing agency could include within its policies and procedures a
requirement regarding legal opinions as to certain matters, such as the
enforceability of structures used to contain losses within a clearing
service upon the insolvency of the clearing service or the covered
clearing agency. The use of legal opinions may be one consideration but
compliance with Rule 17Ad-22(e)(1) ultimately requires that the covered
clearing agency's policies and procedures, taken as a whole, to be
reasonably designed to provide for a well-founded, clear, transparent,
and enforceable legal basis for each aspect of its activities in all
relevant jurisdictions. Whether legal opinions are useful to a covered
clearing agency and, if so, what form they ought to take or subject
matter they ought to address, may vary on a case-by-case
[[Page 70802]]
basis depending on the particular facts and circumstances. Because the
appropriate use of legal opinions will vary on a case-by-case basis,
the Commission does not believe it is appropriate to modify Rule 17Ad-
22(e)(1) to include a specific requirement for legal opinions
addressing particular matters.\183\
---------------------------------------------------------------------------
\183\ The Commission notes that every registered clearing agency
must keep and preserve at least one copy of all documents as shall
be made or received by it in the course of its business as such and
in the conduct of its self-regulatory activity. 17 CFR 240.17a-1.
---------------------------------------------------------------------------
ii. Definition of ``Transparent''
One commenter, although supportive of the Commission's proposal to
require covered clearing agencies to develop policies and procedures to
fulfill the requirements of Rule 17Ad-22(e), noted that, because some
policies and procedures may include commercially sensitive information,
it would be inappropriate to require a covered clearing agency to
disclose all of its policies and procedures. The commenter stated that
it would be helpful for the language of the rules to explicitly reflect
this reality, which was acknowledged by the Commission in the preamble
to the proposed rules.\184\
---------------------------------------------------------------------------
\184\ See id.
---------------------------------------------------------------------------
The Commission acknowledges that disclosure of certain information,
for example, proprietary or commercially sensitive information, may not
be appropriate to be disclosed publicly or to all parties. Because the
definition of ``transparent'' is limited to relevant documentation, as
appropriate, and does not conflict with other statutory and Commission
requirements on confidentiality and disclosure, it does not lead to the
concerns noted by the commenter. The Commission already noted in
proposing the rule that certain types of information, such as
confidential information, may not be appropriate for disclosure in some
circumstances and to some parties. In addition, the level of disclosure
required will necessarily depend on the particular facts and
circumstances. The definition of ``transparent'' provides a covered
clearing agency with some discretion to develop written policies and
procedures addressing disclosures and the use of confidential or
proprietary information, consistent with statutory and Commission
requirements. To improve clarity, the Commission is modifying the
definition of ``transparent'' to mean for the purposes of paragraphs
(e)(1), (2), and (10) of this section, to the extent consistent with
other statutory and Commission requirements on confidentiality and
disclosure, that documentation required under paragraphs (e)(1), (2),
and (10) is disclosed to the Commission and, as appropriate, to other
relevant authorities, to clearing members and to customers of clearing
members, to the owners of the covered clearing agency, and to the
public. Below, the Commission provides additional guidance regarding
the definition of ``transparent.''
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(1) as proposed and
adopting the definition of ``transparent'' as described above but
moving it to Rule 17Ad-22(a)(19) because of other modifications to Rule
17Ad-22(a).\185\ Because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(1), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures to address legal risk:
---------------------------------------------------------------------------
\185\ See infra Part VI.
---------------------------------------------------------------------------
Whether its policies and procedures for legal risk provide
a high degree of certainty for each material aspect of its activities
in all relevant jurisdictions;
whether its rules, policies and procedures, and contracts
are clear, understandable, and consistent with relevant laws and
regulations;
whether it can articulate the legal basis for its
activities to the relevant authorities, participants, and, where
relevant, participants' customers, in a clear and understandable way;
whether it has rules, policies and procedures, and
contracts that are enforceable in all relevant jurisdictions, and
whether it has a high degree of certainty that actions taken by it
under such rules, policies and procedures, and contracts will not be
voided, reversed, or subject to stays; and
whether, if it conducts business in multiple
jurisdictions, it can identify and mitigate the risks arising from any
potential conflict of laws across jurisdictions.
The Commission notes that a covered clearing agency operating in
multiple jurisdictions under Rule 17Ad-22(e)(1) generally should
address any conflicts of law issues that it may encounter.\186\
---------------------------------------------------------------------------
\186\ In addition, for covered clearing agencies, the ``relevant
jurisdiction'' includes the United States and any other jurisdiction
where the covered clearing agency operates.
---------------------------------------------------------------------------
With respect to the definition of ``transparent,'' the Commission
notes that certain types of information, such as confidential
information, may not be appropriate for public disclosure or disclosure
to certain third parties and that confidential information could be
reflected in policies and procedures with respect to the security of
information technology or other critical systems, such as, for example,
as part of business continuity planning. The Commission also notes that
generally a covered clearing agency could meet the definition of
``transparent'' by posting relevant documentation to its Web site.
2. Rule 17Ad-22(e)(2): Governance
a. Proposed Rule
As proposed, Rules 17Ad-22(e)(2) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to provide for governance
arrangements that are: clear and transparent; clearly prioritize the
safety and efficiency of the covered clearing agency; support the
public interest requirements in Section 17A of the Exchange Act and the
objectives of owners and participants; and establish that the board of
directors and senior management have appropriate experience and skills
to discharge their duties and responsibilities.\187\
---------------------------------------------------------------------------
\187\ See CCA Standards proposing release, supra note 5, at
29520-22.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
i. Scope of Interests To Consider
The scope of interests required to be considered as part of Rule
17Ad-22(e)(2)(iii) attracted a range of comments. One commenter
conveyed strong support for the Commission's requirement that covered
clearing agencies adopt policies and procedures for clear and
transparent governance arrangements that prioritize safety and
efficiency, noting that decisions made by covered clearing agencies
could have an impact on multiple financial markets and
jurisdictions.\188\ The commenter urged that governance measures should
support the objectives of owners and participants and, with respect to
certain matters, the public interest. The commenter also noted that a
clearing agency's reactions to competition could undermine the safety
and soundness of the clearing agency as well as the industry as a
whole.\189\
---------------------------------------------------------------------------
\188\ See CFA Institute at 6.
\189\ See id.
---------------------------------------------------------------------------
A second commenter sought to clarify that proposed Rule 17Ad-
22(e)(2)(iii) would not encompass the interests of participants'
customers and other stakeholders.\190\ This commenter expressed the
belief that the Commission's proposed approach, in
[[Page 70803]]
which the objectives of participants' customers and other stakeholders
are not explicitly stated in Rule 17ad-22(e)(2)(iii), is consistent
with the PFMI.\191\ The commenter acknowledged that the Commission and
other regulators must consider the interests of indirect participants,
but the commenter noted that their interests are adequately addressed
through participation of a sufficient number of independent directors
or through other means.\192\ A third commenter expressed support for
the proposed standards, believing that a principles based-formulation
is generally appropriate, but the commenter also expressed the belief
that proposed Rule 17Ad-22(e)(2) should provide clear processes for
consideration of participants' views and involvement of participants in
the covered clearing agency's decision-making process.\193\
---------------------------------------------------------------------------
\190\ See OCC at 4-5.
\191\ See id. (discussing CFTC Rule 39.32(a)(1)(iv) and, as
proposed, FRB Rule 234.3(a)(2)(iii)).
\192\ See id. at 5.
\193\ See ISDA at 2; see also infra notes 212, 215 and
accompanying text (discussing other concerns raised by the
commenter).
---------------------------------------------------------------------------
The Commission believes that the first commenter's concern is
addressed by the fact that policies and procedures under Rule 17Ad-
22(e)(2) reasonably designed to support the public interest
requirements in Section 17A of the Exchange Act generally should
consider whether they support the stability of the broader financial
system of the United States.\194\ For example, as noted by the first
commenter, a covered clearing agency could consider the public interest
in its response to large scale price moves or position changes.\195\
---------------------------------------------------------------------------
\194\ As previously discussed, the Commission has stated that
the public interest is a broad concept that includes contributing to
the ongoing development of the U.S. financial system, in particular
the national clearance and settlement system contemplated by Section
17A of the Exchange Act, protecting investors, and fostering fair
and efficient markets. See supra Part II.C.2.a.
\195\ See CFA Institute at 6.
---------------------------------------------------------------------------
With respect to the second and third commenters,\196\ the
Commission is modifying proposed Rule 17Ad-22(e)(2) to include new
paragraph (vi), which requires policies and procedures for governance
arrangements that consider the interests of participants' customers,
securities issuers and holders, and other relevant stakeholders of the
covered clearing agency.\197\ Under new paragraph (vi), other relevant
stakeholders are persons that access the national system for clearance
and settlement indirectly (e.g., institutional and retail investors),
entities that rely on the national system for clearance and settlement
to effectively provide services to investors and market participants,
and other market infrastructures. Other relevant stakeholders currently
include, for example, transfer agents, liquidity providers, and other
linked market infrastructures, including exchanges, matching service
providers, and payment systems. This new paragraph complements Section
17A(b)(3)(C), which requires the rules of a clearing agency to assure
fair representation of its shareholders and participants in the
selection of its directors and the administration of its affairs.\198\
This requirement for fair representation necessarily applies to
policies and procedures adopted and maintained by a covered clearing
agency pursuant to Rule 17Ad-22(e)(2). Consistent with this
requirement, the Commission believes that a covered clearing agency
generally should, in selecting its directors and administering its
affairs, consider the interests of owners, participants, participants'
customers, securities issuers and holders, and other relevant
stakeholders to, consistent with the public interest requirements in
Section 17A, strike an appropriate balance among the potentially
competing views of such other stakeholders represented within a covered
clearing agency. As noted by one commenter below, the inclusion of
independent directors on the board may be one mechanism for helping to
ensure that the relevant views are presented and considered,\199\
provided the covered clearing agency's overall corporate governance
structure is consistent with the fair representation and public
interest requirements in Section 17A of the Exchange Act. The
Commission notes, further, that the approach a covered clearing agency
may take in considering such views could vary depending on the
ownership structure or organizational form of the covered clearing
agency. A covered clearing agency operating under a mutualized utility
model where losses are fully mutualized among its participant-owners
may take a different approach to consider the interests of all the
relevant stakeholders compared to a covered clearing agency operating
under a different model, such as one where it is owned by another
organization, is operated as a for-profit entity, and/or is publicly
listed and traded.
---------------------------------------------------------------------------
\196\ See supra notes 190-193 and accompanying text.
\197\ See Rule 17Ad-22(e)(2)(vi), infra Part VI; see also infra
Part II.C.2.c.
\198\ See 15 U.S.C. 78q-1(b)(3)(C).
\199\ See ICI at 14-15; see also infra Part II.C.2.b.ii below
(discussing comments regarding public or independent representation
on the board of directors).
---------------------------------------------------------------------------
ii. Representation on the Board of Directors
Commenters generally supported the requirement in proposed Rule
17Ad-22(e)(2)(iv) that requires members of the board of directors and
senior management to have the skills and experience to perform their
duties and responsibilities.\200\ Multiple commenters, however,
advocated for the inclusion of additional requirement related to the
board of directors. One commenter urged the Commission to require that
covered clearing agencies have public or independent representation on
their boards.\201\ The commenter also urged the Commission to define
independent directors to exclude parties with significant business
relationships with the covered clearing agency, cross-directorships, or
controlling shareholdings, as well as executives, officers, or
employees of the covered clearing agency or its affiliate.\202\ Another
commenter recommended that the Commission require a covered clearing
agency to include representatives of both buy-side and sell-side market
participants on the board.\203\ The commenter stated that some equities
clearing agencies and stock exchanges already include investor
representatives on their boards to benefit from a diverse group of
market participants.\204\ The commenter expressed the view that
stakeholder involvement at the board level would minimize conflicts of
interest by balancing commercial interests of covered clearing agencies
with those of other stakeholders.\205\ The commenter also expressed the
view that the risk committee of a covered clearing agency should
include a wide range of indirect participants, as the customers of
clearing members also have an interest in ensuring adequate and diverse
stakeholder representation in the covered clearing agency, in addition
to transparency in the decision making process.\206\
---------------------------------------------------------------------------
\200\ See, e.g., CFA Institute at 6 (noting that those
responsible for the operations of a covered clearing agency should
be capable of performing the required decision-making in light of
the systemic importance of covered clearing agencies); OCC at 5
(believing that covered clearing agencies are well positioned to
determine which individuals have the appropriate experience, skills,
incentives, and integrity to discharge their duties and
responsibilities in a way that reflects the particular needs of each
covered clearing agency).
\201\ See Better Markets at 7; Fidelity at 3-4; ICI at 14.
\202\ See Better Markets at 7.
\203\ See ICI at 14.
\204\ See id.
\205\ See id. at 14-15.
\206\ See id. at 15.
---------------------------------------------------------------------------
[[Page 70804]]
After careful consideration of the comments, the Commission has
determined not to modify Rule 17Ad-22(e)(2) to include specific
requirements related to public or independent representation on the
covered clearing agency's board or risk committee. The Commission
believes that new paragraph (vi), previously discussed above,
sufficiently addresses the concerns raised by the commenters because it
requires specific policies and procedures for governance arrangements
that consider the interests of a wide range of market participants. In
addition, public representation, combined with clear requirements for
the qualifications of the board of directors, could improve the
functioning of the board and could be one way to ensure that the
covered clearing agency has governance arrangements consistent with the
fair representation requirements of Section 17A(b)(3)(C) of the
Exchange Act, provided that the covered clearing agency's governance
structure, as a whole, is consistent with the fair representation and
public interest requirements in Section 17A of the Exchange Act. The
Commission is declining to modify Rule 17Ad-22(e)(2) to further specify
that a particular director represent the interests of buy-side or sell-
side market participants. The Commission notes that public or
independent representation are one possible approach to governance that
can help ensure consistency with the fair representation and public
interest requirements in Section 17A of the Exchange Act. In addition,
and for the same reasons, the Commission is declining to modify Rule
17Ad-22(e)(2) to provide further specification regarding business
relationships and affiliates because these topics, like the above, are
already addressed by the fair representation requirement in Section
17A(b)(3)(C) and the public interest requirements of Section 17A of the
Exchange Act.
Separate from the above, one commenter also encouraged the
Commission to specify that independent directors must support the
objectives of customers and the public, rather than simply the clearing
members.\207\ The Commission notes that Rule 17Ad-22(e)(2)(iii)
requires policies and procedures that support not only the public
interest considerations of Section 17A of the Exchange Act but also the
objectives of both owners and participants. In addition, the Commission
generally believes that the governance arrangements of a covered
clearing agency should include consideration of the interests of
participants' customers and other stakeholders, and this is why the
Commission is modifying proposed Rule 17Ad-22(e)(2), as previously
discussed, to include new paragraph (vi), which requires policies and
procedures for governance arrangements that consider the interests of
participants' customers and other stakeholders. Further, the Commission
notes that the requirements of Section 17A(b)(3)(F) of the Exchange
Act, which require that the rules of a clearing agency be designed to,
in general, protect investors and the public interest, also address the
commenter's concern.
---------------------------------------------------------------------------
\207\ See Better Markets at 7.
---------------------------------------------------------------------------
iii. Accountability of the Board of Directors and Senior Management
One commenter expressed concern that the proposed rules fail to
foster accountability by the board and management, and the commenter
requested that the Commission require covered clearing agencies to
clearly document the roles and responsibilities of the board of
directors and management and implement governance arrangements that
specify clear and direct lines of responsibility.\208\ To address this
concern, the Commission is modifying proposed Rule 17Ad-22(e)(2) to
include new paragraph (v) to require each covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for governance arrangements
that specify clear and direct lines of responsibility.\209\ The
Commission believes that such policies and procedures should generally
entail documenting the responsibilities of the board of directors and
senior management, which could help foster accountability and
complement the requirements described above that address the
qualifications of the board and management. The Commission believes
that this additional requirement will assist a covered clearing agency
in formulating its policies and procedures for assessing the
qualifications of board members and management by requiring the covered
clearing agency to further specify the roles that each individual would
fulfill and the lines of responsibility that would exist within the
board and within management. The Commission believes that such
accountability can help ensure that a covered clearing agency is well-
positioned to fulfill its risk management obligations. For example, the
Commission believes that a covered clearing agency should clearly
define roles and responsibilities for addressing governance over
financial risk (including credit risk, margin, and liquidity risk),
operational risk, and other risks reflected in the covered clearing
agency's risk management framework.
---------------------------------------------------------------------------
\208\ See id. at 3.
\209\ See Rule 17Ad-22(e)(2)(v), infra Part VI; ; see also infra
Part II.C.2.c.
---------------------------------------------------------------------------
iv. Conflicts of Interest
One commenter stated that proposed Rule 17Ad-22(e)(2) does not
require covered clearing agencies to resolve conflicts of interests
among board members and management and urged the Commission explicitly
to require covered clearing agencies to document and maintain policies
and procedures governing the resolution of conflicts of interests that
may impact certain decisions by the board of directors.\210\ The
Commission notes, as discussed above, that the commenter's concern is
addressed by Section 17A(b)(3)(F) of the Exchange Act, which requires
that the rules of a clearing agency be designed, in general, to protect
investors and the public interest.\211\
---------------------------------------------------------------------------
\210\ See Better Markets at 6.
\211\ In addition, the Commission has solicited comments on
proposed rules designed to further address conflicts of interest.
See CCA Standards proposing release, supra note 5, at 29589 & n.664;
see also Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR
14472 (Mar. 16, 2011) (proposing Rule 17Ad-25 to address conflicts
of interest and Rule 17Ad-26 to require standards for board members
or board committee directors at registered clearing agencies);
Exchange Act Release No. 34-63107 (Oct. 14, 2010), 75 FR 65881 (Oct.
26, 2010) (proposing Regulation MC to mitigate conflicts of interest
at security-based swap clearing agencies).
---------------------------------------------------------------------------
v. Crisis or Emergency Decision-Making
One commenter stated that governance arrangements should explicitly
address decision-making during a crisis or emergency and require the
covered clearing agency to obtain the views and approval of member
representatives (such as through its risk committee or otherwise)
before taking any material action in response to an emergency.\212\
After careful consideration, the Commission declines to modify Rule
17Ad-22(e)(2) to specifically address decision-making in a crisis or
emergency, and the Commission believes that Rule 17Ad-22(e) addresses
such circumstances as proposed. For instance, Rule 17Ad-22(e)(2)
requires policies and procedures for governance that are clear and
transparent, clearly prioritize the safety and efficiency of the
covered clearing agency, and support the public interest requirements
in Section 17A and the objectives of owners and participants. A covered
clearing agency
[[Page 70805]]
should generally consider whether its governance arrangements for
decision-making in the ordinary course are appropriate for a crisis or
emergency circumstance in light of the requirements in Rule 17Ad-
22(e)(2).
---------------------------------------------------------------------------
\212\ See ISDA at 2.
---------------------------------------------------------------------------
In addition, Rule 17Ad-22(e)(3) requires policies and procedures
that maintain a sound risk management framework for comprehensively
managing risks that arise in or are borne by the covered clearing
agency. Such policies and procedures must be designed to identify,
measure, monitor, and manage those risks and include plans for the
recovery and orderly wind-down of the covered clearing agency.\213\ The
Commission believes that such a framework for comprehensively managing
risk generally should consider the need for decision-making in crisis
or emergency circumstances.
---------------------------------------------------------------------------
\213\ See Rule 17Ad-22(e)(3)(i), (ii), infra Part VI.
---------------------------------------------------------------------------
vi. Disclosure of Major Board Decisions
Three commenters responded to a question asking whether the
Commission should require covered clearing agencies to have policies
and procedures that provide for governance arrangements that ensure
major decisions are disclosed to the public.\214\ One commenter
recommended that the proposed rule expressly require that major board
decisions having a broad market impact be disclosed to all relevant
stakeholders and the public, except to the extent that such disclosure
is inconsistent with statutory and regulatory confidentiality
restrictions. The commenter noted that the CFTC has included this
provision in its requirements for SIDCOs.\215\ Another commenter,
however, expressed the belief that such a requirement is unnecessary
and that the interests of public stakeholders in having visibility into
major decisions are adequately served through the participation of
independent directors, through the rule filing process, and the
existing voluntary disclosure practices.\216\ A third commenter
expressed the view that publication of board resolutions prior to a
determinative decision would be confusing, potentially misleading or
market moving, and could deter open discussions amongst members of the
board of directors.\217\
---------------------------------------------------------------------------
\214\ See CCA Standards proposing release, supra note 5, at
29522.
\215\ See ISDA at 2 n.5 (citing 17 CFR 39.32).
\216\ See OCC at 5.
\217\ See LCH at 4.
---------------------------------------------------------------------------
After careful consideration, the Commission declines to modify Rule
17Ad-22(e)(2). The Commission notes that existing requirements for
registered clearing agencies under Exchange Act Rule 19b-4 provide a
mechanism for publishing notice of proposed rule changes, which in
general must be approved by board action or under authority delegated
by the board, to clearing members, the relevant stakeholders, the
Commission, and the public.\218\ Designated clearing agencies are
further required to submit advance notices under the Clearing
Supervision Act, which provides another mechanism for disclosure.\219\
In addition, the requirements in Rule 17Ad-22(e)(23) regarding
disclosure will also provide stakeholders and the public with
information regarding certain operations and decisions of covered
clearing agencies.\220\
---------------------------------------------------------------------------
\218\ See supra Part I.C.5 (further describing the obligations
of a clearing agency with respect to proposed rule changes).
\219\ See supra Part I.A.2.
\220\ See infra Part II.C.23.
---------------------------------------------------------------------------
vii. Incentives and Skin in the Game
One commenter stated that the Commission should enhance or clarify
Rule 17Ad-22(e)(2) to ensure that covered clearing agencies have
appropriate incentives to oversee and manage risk in a manner
consistent with the public interest and objectives of participants.
According to the commenter, safeguards should exist to ensure that a
covered clearing agency with authority to adopt rules, policies, or
procedures governing or affecting risk to participants does not face
undue incentives to take on excessive risk in pursuit of increased
earnings.\221\ The Commission believes that Rule 17Ad-22(e)(2)
sufficiently addresses the commenter's concern by requiring policies
and procedures that are clear and transparent, clearly prioritize the
safety and efficiency of the covered clearing agency, and support the
public interest requirements in Section 17A of the Exchange Act and the
objectives of owners and participants.\222\ Rule 17Ad-22(e)(3),
discussed below, also requires policies and procedures for the
comprehensive management of risk, and other requirements in Rule 17Ad-
22(e) are specifically designed to establish a risk management
framework that sufficiently accounts for a wide spectrum of risks that
a covered clearing agency may identify, assess, manage, and mitigate.
Further, the Commission believes that, taken as a whole, Rule 17Ad-
22(e) requires each covered clearing agency to undertake careful and
ongoing consideration of the risks faced and posed by its
operations.\223\
---------------------------------------------------------------------------
\221\ See The Clearing House at 7-8.
\222\ See supra Part II.C.2.a. and note 194 (describing the
scope of the public interest requirements under Section 17A of the
Exchange Act).
\223\ See supra Parts II.A.2 and II.C.2.b.i (further discussing
the risks posed by a covered clearing agency's ownership structure,
organizational form, markets served, and products cleared).
---------------------------------------------------------------------------
The same commenter also stated that safeguards should exist to
ensure that any default management decision-making body has appropriate
incentives.\224\ The commenter stated that the Commission should
require that any decision-making body responsible for administering a
covered clearing agency's default management policies and procedures be
composed of constituencies with significant exposure to potential loss
as a consequence of the default management process.\225\
---------------------------------------------------------------------------
\224\ See The Clearing House at 8.
\225\ See The Clearing House at 2, 9. The commenter further
elaborated that the assumption of risk by a CCP must be governed by
a risk management committee comprised of persons whose interests are
aligned by exposure to the losses associated with such risks
(including members and, where a CCP has capital at risk in the
waterfall, representatives of the CCP), with those members with the
greatest risk exposure within the CCP constituting the majority of
such committee. The commenter added that such a structure would
ensure that the CCP's risk management function is appropriately
aligned with risk mitigation incentives. See id., annex at 15.
---------------------------------------------------------------------------
With respect to these comments, the Commission believes, as
discussed above, that Rule 17Ad-22(e)(2) includes requirements designed
to ensure governance arrangements that clearly prioritize the safety
and efficiency of the covered clearing agency, support the public
interest requirements in Section 17A of the Exchange Act applicable to
clearing agencies, and support the objectives of owners and
participants. In addition, the Commission believes that the requirement
in Section 17A(b)(3)(F) of the Exchange Act to have rules designed, in
general, to protect investors help ensure that a covered clearing
agency's risk management functions are appropriately aligned with the
goal of risk mitigation and responsive to the legitimate concerns of
the relevant constituents. The Commission does not believe that an
approach in which a CCP's default management process must be governed
by a decision-making body composed of constituencies with significant
exposure to potential loss as a consequence of the default management
process is appropriate. Instead, the Commission believes that covered
clearing agencies should be afforded discretion to structure their
default management committees and manage incentives in light of the
needs of their unique ownership or governance structures, provided that
their governance arrangements are consistent with the requirements of
the
[[Page 70806]]
Exchange Act and rules and regulations thereunder, including Section
17A(b)(3)(C), concerning the fair representation of shareholders or
members and participants in the administration of the covered clearing
agency's affairs. The Commission believes that decisions regarding
default management should reside with those who have extensive
expertise and expert knowledge of the tools available at the covered
clearing agency to manage a default. Further, even if the risk
exposures of clearing members are generally stable, they can change,
perhaps rapidly, during periods of market stress.
Lastly, the commenter stated that, to ensure that a covered
clearing agency's governance arrangements align with the public
interest and the interest of constituencies subject to the risk of a
clearing agency default, the Commission should require a covered
clearing agency to commit its own capital on a pre-funded basis to
satisfy its losses arising from the default of one or more participants
in an amount that equals or exceeds 10% of the aggregate participant
contribution to the clearing or guaranty fund of the covered clearing
agency. Further, the commenter stated that the Commission should
require that a covered clearing agency provide, in its relevant rules,
policies, or procedures, that upon the occurrence of a default or
series of defaults and application of all available assets of the
defaulting participant(s) to satisfy resulting losses, the covered
clearing agency shall apply its own capital contribution to the
relevant clearing or guaranty fund in full to satisfy any remaining
losses prior to the application of any (a) contributions by non-
defaulting participants to the clearing or guaranty fund or (b)
assessments that the covered clearing agency require non-defaulting
participants to contribute following the exhaustion of such
participant's funded contributions to the relevant clearing or guaranty
fund.\226\ The commenter expressed concern that, absent such a
requirement, a CCP's own exposure to its clearing or guaranty fund(s)--
often described as ``skin in the game''--is generally quite limited and
capped at the amount of the CCP's funded or dedicated
contribution.\227\ The commenter stated that the absence of ``skin-in-
the-game'' insulates a CCP's owners from losses at the CCP even though
they benefit from the fee income associated with increased activity at
the CCP, regardless of the incremental risk presented by such
activity.\228\ The commenter stated that, particularly in the case of
for-profit CCPs (or CCPs whose owners or risk decision-makers are not
subject to default risk assumed by the CCP), this misalignment of risk
and reward creates moral hazard and is inconsistent with supporting the
public interest and the objectives of participants.\229\
---------------------------------------------------------------------------
\226\ See The Clearing House at 2.
\227\ See id. at 8.
\228\ See id.
\229\ See id.
---------------------------------------------------------------------------
After careful consideration, the Commission declines to modify Rule
17Ad-22(e) to specifically include a ``skin-in-the-game'' requirement.
The Commission believes that, taken as a whole, Rule 17Ad-22(e)(2)
facilitates robust governance arrangements and the management of
competing incentives. The Commission believes it is appropriate to
provide covered clearing agencies with flexibility, subject to their
obligations and responsibilities as SROs under the Exchange Act, to
structure their default management processes to take into account the
particulars of their financial resources, ownership structures, and
risk management frameworks. The Commission believes that the proper
alignment of incentives is an important element of a covered clearing
agency's risk management practices, and notes that ``skin-in-the-game''
may play a role in those risk management practices in many instances
but in other instances may not be essential to a robust governance
framework.
c. Final Rule
As discussed above, the Commission is adopting Rule 17Ad-22(e)(2)
with modifications.\230\ First, the Commission is adopting new
paragraph (v), which requires a covered clearing agency's governance
arrangements to specify clear and direct lines of responsibility, as
discussed above.
---------------------------------------------------------------------------
\230\ See Rule 17Ad-22(e)(2), infra Part VI.
---------------------------------------------------------------------------
Second, the Commission is adopting new paragraph (vi) to require a
covered clearing agency's governance arrangements to consider the
interests of participants' customers, securities issuers and holders,
and other relevant stakeholders of the covered clearing agency. The
comments received in response to Rule 17Ad-22(e)(2) expressed concern
as to whether a covered clearing agency will have governance
arrangements sufficiently robust to incorporate the views of the
relevant stakeholders and to withstand the influence of potentially
improper incentives. The Commission believes that this modification
alleviates these concerns by adding a requirement to consider the
interests of the relevant stakeholders.
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(2), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining its
policies and procedures:
Whether it has objectives that place a high priority on
the safety and efficiency of the covered clearing agency and explicitly
support financial stability and other relevant public interest
considerations; \231\
---------------------------------------------------------------------------
\231\ For these purposes, the relevant public interest
considerations are the public interest requirements in Section 17A
of the Exchange Act. See Rule 17Ad-22(e)(2)(iii), infra Part VI.
---------------------------------------------------------------------------
whether it has documented governance arrangements that
provide clear and direct lines of responsibility and accountability,
and whether these arrangements are disclosed to owners, relevant
authorities, participants, and, at a more general level, the public;
whether the roles and responsibilities of its board of
directors are clearly specified, and whether there are documented
procedures for the functioning of the board of directors, such as
procedures for identifying, addressing, and managing member conflicts
of interest, and for reviewing the board's overall performance and the
performance of its individual members regularly;
whether the board of directors contains suitable members
with the appropriate skills and incentives to fulfill the board's
multiple roles, and whether the board of directors should include non-
executive board members;
whether the roles and responsibilities of management have
been clearly specified and whether management has the appropriate
experience, mix of skills, and the integrity necessary to discharge
their responsibilities for the operation and risk management of the
covered clearing agency;
whether the board of directors has established a clear,
documented risk-management framework that includes the covered clearing
agency's risk-tolerance policy, assigns responsibilities and
accountability for risk decisions, and addresses decision making in
crises and emergencies, and whether the governance arrangements ensure
that the risk-management and internal control functions have sufficient
authority, independence, resources, and access to the board; and
whether the board of directors has ensured that the
covered clearing
[[Page 70807]]
agency's design, rules, overall strategy, and major decisions reflect
appropriately the legitimate interests of its direct and indirect
participants and other relevant stakeholders, and whether major
decisions have been clearly disclosed to relevant stakeholders and,
where this is broad market impact, the public.\232\
---------------------------------------------------------------------------
\232\ For a discussion of relevant stakeholders, see Part
II.C.2.b.i.
---------------------------------------------------------------------------
A covered clearing agency also generally should consider the
specific qualifications, experience, competence, character, skills,
incentives, integrity or other relevant attributes to support a
conclusion that an individual nominee can appropriately serve as a
board member or on senior management. Policies and procedures under
Rule 17Ad-22(e)(2)(iv) could consider, among other things, requirements
as to industry experience relevant to the services provided by the
covered clearing agency, educational background, the absence of a
disciplinary record, or other factors relevant to the qualifications of
nominees being considered. With respect to Rules 17Ad-22(e)(2)(iv) and
(v), the Commission notes that a covered clearing agency generally
should seek to ensure that board members and senior management do not
have conflicts of interest because conflicts of interest could
undermine the decision-making process within a covered clearing agency
or interfere with the ability of board members and senior management to
discharge their duties and responsibilities.
In addition, the Commission believes that processes concerning
decision-making by a covered clearing agency during a crisis generally
should consider the views of member representatives and relevant
stakeholders before the covered clearing agency takes any material
action. Further any such policies and procedures must be consistent
with the fair representation requirement in Section 17A(b)(3)(C) of the
Exchange Act and the requirement in Section 17A(b)(3)(F) of the
Exchange Act that a clearing agency's rules be designed, in general, to
protect investors and the public interest.\233\ Based on these
requirements, the Commission expects that views of members will be well
represented in the governance of the covered clearing agency, including
in the design of governance processes for crisis or emergency decision-
making. In light of the variation of business models across covered
clearing agencies, the Commission believes each covered clearing agency
generally should consider how best to involve members and other
relevant stakeholders in the decision-making of the covered clearing
agency, provided that each covered clearing agency's decision-making
process is designed to be consistent with the fair representation,
investor protection, and public interest requirements of Section 17A of
the Exchange Act.
---------------------------------------------------------------------------
\233\ See 15 U.S.C. 78q-1(b)(3)(C), (F).
---------------------------------------------------------------------------
3. Rule 17Ad-22(e)(3): Framework for the Comprehensive Management of
Risks
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(3) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain a sound risk management
framework for comprehensively managing legal, credit, liquidity,
operational, general business, investment, custody, and other risks
that arise in or are borne by the covered clearing agency.\234\
Proposed Rule 17Ad-22(e)(3)(i) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for risk management policies,
procedures, and systems designed to identify, measure, monitor, and
manage the range of risks that arise in or are borne by the covered
clearing agency, and subject them to review on a specified periodic
basis and approval by the board of directors annually. Proposed Rule
17Ad-22(e)(3)(ii) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to ensure that it establishes plans for the
recovery and orderly wind-down of the covered clearing agency
necessitated by credit losses, liquidity shortfalls, losses from
general business risk, or any other losses. Proposed Rule 17Ad-
22(e)(3)(iii) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide risk management and internal audit
personnel with sufficient authority, resources, independence from
management, and access to the board of directors. Proposed Rule 17Ad-
22(e)(3)(iv) would also require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide risk management and internal audit
personnel with oversight by and a direct reporting line to a risk
management committee and an audit committee of the board of directors,
respectively. Finally, proposed Rule 17A-22(e)(3)(v) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for an
independent audit committee.\235\
---------------------------------------------------------------------------
\234\ See CCA Standards proposing release, supra note 5, at
29522-24.
\235\ See id.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
i. General Comments
Multiple commenters expressed support for the proposed rule.\236\
One commenter expressed support for the added attention in the proposed
rules to managing the risks faced by clearing agencies, emphasizing in
particular the proposed requirements for recovery and wind-down
plans.\237\ The commenter stated that a recovery and wind-down plan is
essential to containing wide-spread contagion and noted that the
requirement would be appropriate for all registered clearing
agencies.\238\ The same commenter expressed support for requiring
independence for those conducting audits, as such would be necessary
for establishing good corporate practices and the integrity of the
audit process.\239\ The commenter, however, also expressed concern that
the proposed rule could be insufficient in preventing systemic failure
of covered clearing agency systems during a financial panic as a result
of new financial products not performing as expected during times of
market stress.\240\ Similarly, a second commenter stated that, given
the role CCPs play in, and the risks they pose to, the financial
markets, CCPs must benefit from the full panoply of risk-management
tools, including strong loss absorbing capital, margin, and regular
stress testing requirements (including assessing how the failure of
multiple, large clearing members would affect the CCP).\241\
---------------------------------------------------------------------------
\236\ See CFA Institute at 1; SRC at 1-2; OCC at 6.
\237\ See CFA Institute at 1.
\238\ See id. at 1, 7. The Commission notes that it is beyond
the scope of this rulemaking to establish new requirements for
clearing agencies other than covered clearing agencies.
\239\ See id. at 7.
\240\ See id.
\241\ See SRC at 1-2.
---------------------------------------------------------------------------
With respect to the latter two comments, the Commission believes
that proposed Rule 17Ad-22(e), taken as a whole, is designed to
mitigate the potential for systemic failures and the failures of CCPs
more generally by requiring a covered clearing agency to establish
policies and procedures relating to their governance and operation.
Specifically, requirements in
[[Page 70808]]
Rule 17Ad-22(e) address capital,\242\ margin,\243\ and stress testing
\244\--in addition to other areas of risk management, such as
collateral,\245\ credit risk,\246\ liquidity risk,\247\ links,\248\ and
participant default \249\--to help ensure that covered clearing
agencies benefit from a range of risk management tools and can continue
operating in times of market stress. Moreover, Rule 17Ad-22(e)(3)
includes requirements for policies and procedures that reflect a
comprehensive framework for risk management and includes additional
requirements for policies and procedures that specifically establish an
independent audit committee and recovery and wind-down plans. The
Commission discusses these elements of Rule 17Ad-22(e)(3) further in
Parts II.C.3.b.ii and iii below.
---------------------------------------------------------------------------
\242\ See infra Part II.C.15 (describing requirements under Rule
17Ad-22(e)(15)).
\243\ See infra Part II.C.6 (describing requirements under Rule
17Ad-22(e)(6)).
\244\ See infra Parts II.C.4 and 7 (describing requirements
under Rules 17Ad-22(e)(4) and (7)).
\245\ See infra Part II.C.5 (describing requirements under Rule
17Ad-22(e)(5)).
\246\ See infra Part II.C.4 (describing requirements under Rule
17Ad-22(e)(4)).
\247\ See infra Part II.C.7 (describing requirements under Rule
17Ad-22(e)(7)).
\248\ See infra Part II.C.20 (describing requirements under Rule
17Ad-22(e)(20)).
\249\ See infra Part II.C.13 (describing requirements under Rule
17Ad-22(e)(13)).
---------------------------------------------------------------------------
ii. Independence of the Audit Committee
One commenter stated that the Commission struck an appropriate
balance in requiring policies and procedures that provide for an
independent audit committee and permitting the board of directors to
establish the criteria for independence.\250\ The commenter expressed
the view that the definition of independence should be judged in the
context of the particular covered clearing agency, noting that there is
value in having persons with extensive industry experience serving on
its audit committee, and it would not want to preclude from service
such persons most likely to have the relevant experience.
---------------------------------------------------------------------------
\250\ See OCC at 6.
---------------------------------------------------------------------------
iii. Recovery and Wind-Down Plans
Multiple commenters expressed views on proposed requirements
concerning recovery and wind-down plans.\251\ One commenter stated that
covered clearing agencies should create robust and credible resolution
plans to ensure that they and policymakers can plan for and mitigate
the potential systemic consequences of a CCP failure without taxpayer
support.\252\ The commenter noted that important portions of these
plans, including the size and nature of loss-absorbing buffers, should
be made public so that the public and counterparties can assess the
risks associated with the CCP and its members.\253\ With respect to the
disclosure of important aspects of these plans, the Commission notes
that Rules 17Ad-22(e)(23)(iv) and (v), discussed below,\254\ would
require policies and procedures that provide for a comprehensive public
disclosure that describes material rules, policies, and procedures
regarding a covered clearing agency's recovery and wind-down plans,
updated every two years or more frequently as necessary so that the
disclosure remains accurate in all material respects.
---------------------------------------------------------------------------
\251\ See SRC at 2. In addressing comments regarding recovery
and wind-down plans, the Commission generally understands that: (i)
When a financial company becomes non-viable as a going concern or
insolvent, recovery refers to actions taken that allow the financial
company to sustain its critical operations and services; (ii)
resolution (or wind-down), by contrast, refers to the transferring
of the financial company's critical operations and services to an
alternate entity.
\252\ See SRC at 2.
\253\ See id.
\254\ See infra Part II.C.23.
---------------------------------------------------------------------------
Another commenter noted that wind-down may not be a workable option
for critical market infrastructure providers that are the sole
providers in a given market. The commenter expressed the view that
while covered clearing agencies should analyze the feasibility of an
orderly wind-down in their plans and include it when appropriate,
recovery strategies (i.e., strategies to allocate losses outside of,
and without requiring, an orderly wind-down and before the need to
initiate resolution proceedings) are the most effective way to promote
financial stability, ensure the continuation of services, and
distribute losses in a fair and economically efficient manner.\255\ The
Commission is mindful of this concern and believes that, in conducting
its planning, a covered clearing agency generally should consider sole
provider status as one of many factors in a range of potential
considerations related to recovery or wind-down, including a
consideration of which options may be the most feasible or workable.
The Commission does not believe, however, that a covered clearing
agency's sole provider status necessarily precludes wind-down and,
thus, a covered clearing agency is required to have policies and
procedures to establish plans for both recovery and orderly wind-down
pursuant to Rule 17Ad-22(e)(3)(ii).
---------------------------------------------------------------------------
\255\ See DTCC at 6.
---------------------------------------------------------------------------
A third commenter stated that, while the CCA Standards proposing
release helps draw attention to the importance of recovery and wind-
down plans having a sound legal basis, the release provides little
guidance with regard to the content of such plans or stakeholder
consultation procedures with respect to their adoption.\256\ The
commenter noted that, because the issues surrounding the recovery and
resolution of CCPs are novel and complex, new rules, policies, and
procedures addressing recovery and resolution that go beyond existing,
capped assessment powers would be appropriate subject matter for a
detailed review by the Commission and public comment.\257\ To
facilitate a review and public comment, the commenter expressed the
view that the Commission should articulate principles-based standards
against which orderly recovery and wind-down plans could be assessed,
including limited and predictable liabilities of clearing participants;
non-disruption of expectations regarding close-out netting sets;
consistency with accounting criteria for the netting of cleared
exposures for financial statement and regulatory capital purposes; a
requirement that loss-allocation rules not put any non-defaulting
clearing member or customer of a clearing member in a worse position
than under a liquidation in the event of the insolvency of the covered
clearing agency; due consideration of the effects on incentives for
participation in the default management process and clearing agency
moral hazard risks; and transparency in relation to the default
management process, loss allocations, and the decision-making process
governing recovery and wind-down.\258\
---------------------------------------------------------------------------
\256\ See ISDA at 3.
\257\ See id.
\258\ See id.
---------------------------------------------------------------------------
First, the Commission believes that the factors described by the
commenter, among others, are factors that a covered clearing agency
could consider in developing its recovery and wind-down plans, but the
Commission is declining to articulate requirements for all recovery and
wind-down plans. The Commission believes that, given the nature of
recovery and resolution planning, such plans are likely to closely
reflect the specific characteristics of the covered clearing agency,
including its ownership, organizational, and operational structures, as
well as the size, systemic importance, global reach, and/or the risks
inherent in the products it
[[Page 70809]]
clears.\259\ In particular, the Commission notes that the available
recovery tools will vary depending on the products cleared. Second, the
Commission also believes that recovery and wind-down plans should be
subject to public comment and Commission review. The Commission
believes that recovery and wind-down plans, and material changes
thereto, would constitute a proposed rule change under Section 19(b) of
the Exchange Act and, for designated clearing agencies, an advance
notice under the Clearing Supervision Act because such plans and
material changes thereto would constitute changes to a stated policy,
practice or interpretation of the covered clearing agency and, for
designated clearing agencies, a proposed change to its rules,
procedures, or operations that could materially affect the nature or
level of risks presented by the designated clearing agency.\260\
---------------------------------------------------------------------------
\259\ See supra Parts II.A.2 and II.C.2.b.i (further discussing
the differing characteristics of a covered clearing agency related
to its ownership structure, organizational form, markets served, and
products cleared).
\260\ See supra Part I.C.5 (further describing the obligations
of a clearing agency with respect to proposed rule changes under
Rule 19b-4 and advance notices under the Clearing Supervision Act).
---------------------------------------------------------------------------
The commenter further stated that recovery tools such as forced
allocation, initial margin haircutting of non-defaulting clearing
members, invoicing back, or partial non-voluntary tear-ups should be
avoided, and that pro-rata reduction in a covered clearing agency's
payment obligations should be considered only as a loss allocation
measure of last resort after all the resources in the clearing
waterfall have been exhausted.\261\ The commenter noted that this
method is transparent and predictable, creating incentives for
surviving participants to actively engage in the default management
process and to bid aggressively in the resulting auction process.\262\
The commenter acknowledged, however, that the sequencing and
application of any recovery mechanisms may vary by product type and the
nature of the covered clearing agency's participants, such as, for
example, how certain mechanisms would apply to retail
participants.\263\
---------------------------------------------------------------------------
\261\ See ISDA at 3. Similarly, two other commenters also
recommend that the Commission specifically prohibit covered clearing
agencies from using variation margin and initial margin haircutting
as recovery tools to continue operation in times of financial
distress. See Fidelity at 3-4; see also ICI at 13-14.
\262\ See ISDA at 3.
\263\ See id. at 4.
---------------------------------------------------------------------------
As a general matter, the Commission believes it is not productive
to apply such requirements for recovery and wind-down plans in a one-
size-fits-all approach for covered clearing agencies. The Commission
believes that recovery and wind-down plans should be considered
holistically, taking into consideration the covered clearing agency's
governance structure, products cleared, loss allocation rules, and
mutualized structure, as applicable, because it is not possible to
assess the utility of a particular recovery tool in isolation and
without the context of the recovery plan as a whole. The Commission
also believes that transparent governance arrangements can help ensure
that members, their customers, and, as appropriate, the public have
sufficient means to provide input on any recovery tools ultimately
included in recovery and wind-down plans. In Part II.C.3.c below, the
Commission provides guidance regarding the types of considerations that
a covered clearing agency generally should consider in developing its
recovery tools.
Finally, the commenter suggested that the Commission's rule should
state explicitly that covered clearing agencies' recovery and wind-down
plans must define the quantitative and qualitative criteria that would
trigger the implementation of each type of plan.\264\ The commenter did
not specify what types of quantitative or qualitative criteria should
trigger implementation.
---------------------------------------------------------------------------
\264\ See ISDA at 4.
---------------------------------------------------------------------------
After careful consideration, the Commission declines to establish a
requirement that recovery and wind-down plans have qualitative and
quantitate trigger criteria. The Commission believes that such a
requirement would not sufficiently take into account the unique
characteristics of each covered clearing agency. The Commission
believes it is not possible to assess the utility of a particular
approach in isolation and without the context of the recovery plan and
the covered clearing agency as a whole. Further, the Commission
believes that transparent governance arrangements can help ensure that
members, their customers, and, as appropriate, the public have
sufficient means to provide input on any recovery tools ultimately
included in recovery and wind-down plans and therefore believes that
consideration of such elements of a covered clearing agency's recovery
and wind-down plan is best left to the applicable rule filings and
advance notice processes discussed previously.
iv. Additional Requirements
One commenter supported the proposed requirements in Rule 17Ad-
22(e)(3) but urged the Commission to establish additional requirements
in three areas to ensure accountability and independence.\265\
---------------------------------------------------------------------------
\265\ See Better Markets at 8-9.
---------------------------------------------------------------------------
First, the commenter encouraged the Commission to require the risk
management framework at covered clearing agencies to assign
responsibilities and accountabilities for risk decisions and address
crisis and emergency decision-making. The Commission believes that Rule
17Ad-22(e)(2), as modified and discussed in Part II.C.2 above,
appropriately addresses these concerns. Specifically, Rule 17Ad-
22(e)(2)(v), as adopted, requires that a covered clearing agency's
policies and procedures document the responsibilities of the board of
directors and senior management and specify clear and direct lines of
responsibility. In the above discussion, the Commission also
specifically noted the importance of clear and direct lines of
responsibility in addressing crises and facilitating appropriate
decision-making in emergency situations.\266\
---------------------------------------------------------------------------
\266\ See supra Part II.C.2.b.iii.
---------------------------------------------------------------------------
Second, the commenter urged the Commission to require the board of
directors to have a risk committee comprised of and led by a majority
of independent directors; the risk committee to have a clear mandate
and operating procedures; and the risk committee to have access to
external expert advice.\267\ The commenter also encouraged the
Commission to implement enhanced measures to ensure that important risk
management functions are appropriately insulated from conflicts of
interest among board members representing clearing members. The
Commission believes that the rule as proposed already addresses these
concerns. Rule 17Ad-22(e)(3)(iii) requires a covered clearing agency's
policies and procedures to provide risk management and internal audit
personnel with, among other things, sufficient independence from
management and access to the board of directors. In addition, proposed
Rule 17Ad-22(e)(3)(iv) requires policies and procedures that provide
risk management and internal audit personnel with a direct reporting
line to, and oversight by, a risk management committee and an audit
committee of the board of directors, respectively. With respect to
having a risk committee comprised of and led by a majority of
independent directors, the Commission
[[Page 70810]]
notes that although it may be appropriate for a risk committee to be
comprised of and led by a majority of independent directors, the
Commission believes that the covered clearing agency would have to
consider its particular facts and circumstances, and that it is
inappropriate to prescribe a particular structure for risk committees
in Rule 17Ad-22(e)(3). The Commission further notes that the definition
of independence should reflect the objective of establishing and
maintaining robust risk management.
---------------------------------------------------------------------------
\267\ See Better Markets at 9.
---------------------------------------------------------------------------
Third, the commenter requested that the Commission require a
covered clearing agency to have a chief risk officer responsible for
implementing the risk management framework and making recommendations
to the risk management committee or board of directors. The Commission
believes that establishing a chief risk officer is one way to structure
a risk management framework consistent with Rule 17Ad-22(e)(3) and
notes that, currently, each covered clearing agency has a chief risk
officer responsible for implementing the covered clearing agency's risk
management framework. The Commission recognizes that these
responsibilities are critically important but does not believe it is
necessary to prescribe a chief risk officer because other distributions
of responsibility among the roles within a covered clearing agency may
also be consistent with the requirements of the Exchange Act, provided
that the responsibilities are clearly specified, the persons occupying
the specified roles have appropriate experience and skills to discharge
their duties and responsibilities, and the responsibilities
comprehensively encompass the risk management needs of the clearing
agency.
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(3) with one
modification. To make clear that the audit committee described in Rule
17Ad-22(e)(3)(iv) and the independent audit committee described in Rule
17Ad-22(e)(3)(v) are not separate audit committees, the Commission is
adding ``independent'' before audit committee in Rule 17Ad-
22(e)(3)(iv).\268\ In addition, because the Commission recognizes that
there may be a number of ways to address compliance with Rule 17Ad-
22(e)(3), the Commission is providing the following guidance that a
covered clearing agency generally should consider in establishing and
maintaining policies and procedures for its framework for the
comprehensive management of risk:
---------------------------------------------------------------------------
\268\ See Rule 17Ad-22(e)(3), infra Part VI.
---------------------------------------------------------------------------
Whether it has risk management policies, procedures, and
systems that enable it to identify, measure, monitor, and manage the
range of risks that arise in or are borne by the covered clearing
agency and whether the risk management frameworks are subject to
periodic review;
whether it provides incentives to participants and, where
relevant, their customers to manage and contain the risks they pose to
the covered clearing agency;
whether it regularly reviews the material risks it bears
from and poses to other entities (including other clearing agencies,
settlement banks, liquidity providers, and service providers) as a
result of interdependencies and develop appropriate risk management
tools to address these risks;
whether it can identify scenarios that may potentially
prevent it from being able to provide its critical operations and
services as a going concern and assess the effectiveness of a full
range of options for recovery or orderly wind-down, and whether it has
prepared appropriate plans for its recovery or orderly wind-down based
on the results of that assessment; and
whether it has provided relevant authorities with the
information needed for purposes of recovery and resolution planning.
The Commission notes that a comprehensive approach to risk
management means policies and procedures should be designed
holistically, be consistent with each other, and work effectively
together to mitigate the risk of financial losses to a covered clearing
agency's members and participants in the markets it serves. The
Commission further notes that each covered clearing agency must have
its own policies and procedures encompassing a framework for the
``comprehensive'' management of risks. For example, if a covered
clearing agency's parent or holding company were to adopt a company-
wide risk management framework, the covered clearing agency
nevertheless would itself need to adopt or ratify those policies and
procedures pursuant to the requirements of the rule filing process
under Rule 19b-4 and, if applicable, the advance notice process under
the Clearing Supervision Act,\269\ with respect to its own business to
meet the requirements of Rule 17Ad-22(e)(3).
---------------------------------------------------------------------------
\269\ See supra Parts I.A.1 and 2.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(e)(3)(i), the board of directors of a
covered clearing agency generally should consider whether to subject
all material components of the covered clearing agency's risk
management policies and procedures to review due to the critical role
that risk management plays in promoting prompt and accurate clearance
and settlement. Further, such review generally should take a holistic
view of the full range of risk management policies, procedures, and
systems, rather than consider each on an individual or case-by-case
basis. In addition, a covered clearing agency generally should perform
the annual review under Rule 17Ad-22(e)(3)(i) once every twelve months.
With respect to recovery and wind-down plans, each covered clearing
agency generally should develop its plans expeditiously to facilitate
regulatory review by the Commission and other relevant regulatory
bodies. In particular, the Commission believes that a covered clearing
agency generally should have policies and procedures to provide the
relevant resolution authorities with information needed for the
purposes of resolution planning under applicable authority, including
any plans prepared pursuant to Rule 17Ad-22(e)(3). The Commission works
with the FDIC and other resolution authorities, as appropriate, to help
ensure the development of effective resolution strategies for covered
clearing agencies; providing the Commission and the FDIC information
for resolution planning would promote the ongoing development of these
strategies.
In addition, with respect to recovery tools, a covered clearing
agency generally should consider the following when developing its
recovery tools: (i) Whether the set of recovery tools comprehensively
addresses how the covered clearing agency would continue to provide
critical services in all relevant scenarios; (ii) the extent to which
each tool is reliable, timely, and has a strong legal basis; (iii)
whether the tools are transparent and designed to allow those who would
bear losses and liquidity shortfalls to measure, manage, and control
their potential losses and liquidity shortfalls; (iv) whether the tools
create appropriate incentives for the covered clearing agency's owners,
direct and indirect participants, and other relevant stakeholders; and
(v) whether the tools are designed to minimize the negative impact on
direct and indirect participants and the financial system more broadly.
4. Rule 17Ad-22(e)(4): Credit Risk
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(4) would require a covered clearing
agency
[[Page 70811]]
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
exposures arising from its payment, clearing, and settlement processes,
including by, at a minimum, meeting the seven requirements specified in
the rule.\270\
---------------------------------------------------------------------------
\270\ See CCA Standards proposing release, supra note 5, at
29525-27.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(4)(i) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain sufficient financial
resources to cover its credit exposure to each participant fully with a
high degree of confidence. Proposed Rule 17Ad-22(e)(4)(ii) would
require a covered clearing agency that provides CCP services, and that
is ``systemically important in multiple jurisdictions'' or ``a clearing
agency involved in activities with a more complex risk profile,'' to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain additional financial
resources, to the extent not already maintained pursuant to proposed
Rule 17Ad-22(e)(4)(i), at a minimum level necessary to enable it to
cover a wide range of foreseeable stress scenarios, including but not
limited to the default of the two participant families that would
potentially cause the largest aggregate credit exposure for the covered
clearing agency in extreme but plausible market conditions (hereinafter
the ``cover two'' requirement). The Commission also proposed Rule 17Ad-
22(a)(19) to define ``systemically important in multiple
jurisdictions'' to mean a covered clearing agency that has been
determined by the Commission to be systemically important in more than
one jurisdiction pursuant to Rule 17Ab2-2.\271\ Proposed Rule 17Ad-
22(e)(4)(iii) would require a covered clearing agency that is not
subject to proposed Rule 17Ad-22(e)(4)(ii) to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain additional financial resources, to the extent not
already maintained pursuant to proposed Rule 17Ad-22(e)(4)(i), at the
minimum to enable it to cover a wide range of foreseeable stress
scenarios, including the default of the participant family that would
potentially cause the largest aggregate credit exposure for the covered
clearing agency in extreme but plausible market conditions (hereinafter
the ``cover one'' requirement). Proposed Rule 17Ad-22(e)(4)(iv) would
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to include
prefunded financial resources, excluding assessments for additional
guaranty fund contributions or other resources that are not prefunded,
when calculating the financial resources available to meet the
standards under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable. Proposed Rule 17Ad-22(e)(4)(v) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to maintain the financial
resources required under proposed Rules 17Ad-22(e)(4)(i) through (iii),
as applicable, in combined or separately maintained clearing or
guaranty funds.
---------------------------------------------------------------------------
\271\ See id. at 29525. The Commission received no comments
regarding the proposed definition and is adopting it as proposed.
Because of other modifications to Rule 17Ad-22(a), the definition of
``systemically important in multiple jurisdictions'' is being moved
to Rule 17Ad-22(a)(18). See Rule 17Ad-22(a)(18), infra Part VI.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(4)(vi) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to test the sufficiency of its total
financial resources available to meet the minimum financial resource
requirements under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable, by conducting a stress test of its total financial
resources at least once each day using standard predetermined
parameters and assumptions.\272\ The Commission also proposed Rule
17Ad-22(a)(18) to define ``stress testing'' to mean the estimation of
credit and liquidity exposures that would result from the realization
of extreme but plausible price changes or changes in other valuation
inputs and assumptions.\273\ Proposed Rule 17Ad-22(e)(4)(vi) would also
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to conduct
a comprehensive analysis on at least a monthly basis of the existing
stress testing scenarios, models, and underlying parameters and
assumptions, and consider modifications to ensure they are appropriate
for determining the covered clearing agency's required level of default
protection in light of current market conditions. When the products
cleared or markets served by a covered clearing agency display high
volatility or become less liquid, and when the size or concentration of
positions held by the entity's participants increases significantly,
the proposed rule would require a covered clearing agency to have
policies and procedures for conducting comprehensive analyses of stress
testing scenarios, models, and underlying parameters and assumptions
more frequently than monthly. Proposed Rule 17Ad-22(e)(4)(vi) would
also require a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to provide for the reporting of the results of this analysis
to the appropriate decision makers at the covered clearing agency,
including its risk management committee or board of directors, and to
require the use of the results to evaluate the adequacy of and to
adjust its margin methodology, model parameters, and any other relevant
aspects of its credit risk management policies and procedures, in
supporting compliance with the minimum financial resources requirements
in proposed Rules 17Ad-22(e)(4)(i) through (iii), as applicable.\274\
---------------------------------------------------------------------------
\272\ See id. at 29526-27.
\273\ See id. at 29527. The Commission received no comments
regarding the proposed definition and, based on its supervisory
experience, is adopting it with modifications, as discussed further
below. Because of other modifications to Rule 17Ad-22(a), the
definition of ``stress testing'' is also being moved to Rule 17Ad-
22(a)(17). See Rule 17Ad-22(a)(17), infra Part VI.
\274\ See id. at 29526-27.
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-22(e)(4)(vii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to require a conforming
model validation for its credit risk models to be performed not less
than annually or more frequently as may be contemplated by the covered
clearing agency's risk management policies and procedures.\275\ The
Commission also proposed to define ``conforming model validation'' in
Rule 17Ad-22(a)(5) to mean an evaluation of the performance of each
material risk management model used by a covered clearing agency,
including initial margin models, liquidity risk models, and models used
to generate guaranty fund requirements, along with the related
parameters and assumptions associated with such models.\276\ The
proposed definition would further require that the model validation be
performed by a qualified person who is free from influence from the
persons responsible for the development or operation of the models or
policies
[[Page 70812]]
being validated so that risk models can be candidly assessed.\277\
---------------------------------------------------------------------------
\275\ See id. at 29527.
\276\ See id.
\277\ The Commission is modifying the definition to strike the
word ``conforming,'' as described in Part II.C.4.c below. Because of
this and other modifications to Rule 17Ad-22(a), the Commission is
moving the definition of ``model validation'' to Rule 17Ad-22(a)(9).
See infra Part VI.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
i. Distinguishing CCPs From CSDs
One commenter stated that proposed Rule 17Ad-22(e)(4) should
distinguish between the types of risks faced by CCPs versus central
securities depositories (``CSDs'') (e.g., the requirement that CSDs
hold the financial resources they maintain to cover the risk of
participant default in a guaranty or clearing fund).\278\ The commenter
recommended that the provision be revised to clarify the portions of
proposed Rule 17Ad-22(e)(4) that are intended to apply to covered
clearing agencies that are CCPs, and those that should apply to covered
clearing agencies that are CSDs.\279\ As a general matter, the
Commission believes that Rule 17Ad-22(e)(4) appropriately distinguishes
between the risks inherent in CCPs and CSDs. For example, Rule 17Ad-
22(e)(4)(ii) requires policies and procedures that meet ``cover two''
for CCPs that are systemically important or engaged in activities with
a more complex risk profile, while Rules 17Ad-22(e)(4)(i) and (iii)
require policies and procedures for financial resources for all other
covered clearing agencies, including CSDs.\280\ With respect to Rule
17Ad-22(e)(4)(v), which requires a covered clearing agency to have
policies and procedures for maintaining the financial resources
required under Rules 17Ad-22(e)(4)(i) through (iii) in combined or
separately maintained clearing or guaranty funds, ``clearing or
guaranty fund'' would also include the participant fund of a CSD.\281\
The Commission believes that this statement clarifies how Rule 17Ad-
22(e)(4) would apply to both CCPs and CSDs, and therefore addresses the
concern raised by the commenter.
---------------------------------------------------------------------------
\278\ See DTCC at 5.
\279\ See id. at 5; id. at A-1 (suggesting drafting
clarifications to proposed Rule 17Ad-22(e)(4)).
\280\ See supra Part II.C.4.a.
\281\ See id. at 5.
---------------------------------------------------------------------------
ii. Prefunded Financial Resources
One commenter expressed support for proposed Rule 17Ad-22(e)(4)(iv)
but sought clarification on the role of using default insurance to
satisfy the rule.\282\ The Commission is aware that default insurance
has been discussed among industry participants as a tool to help CCPs
manage credit risk. While the viability of any particular default
insurance plan would necessarily depend on the particulars of the
underlying insurance agreement, the Commission notes that the financial
resource requirements in Rule 17Ad-22(e)(4) must be prefunded and may
not be conditional as is typical with insurance payments. Therefore,
the use of default insurance generally would not be consistent with the
requirement that certain financial resources be prefunded under Rule
17Ad-22(e)(4)(iv).
---------------------------------------------------------------------------
\282\ See Barnard at 2.
---------------------------------------------------------------------------
While generally supportive of the rule, another commenter expressed
concern that members of covered clearing agencies may have difficulty
meeting their obligations to the covered clearing agency if the covered
clearing agency delays in exercising its authority to require members
to provide additional guaranty funds after such funds are exhausted
following the default of a member.\283\ To address this concern, the
commenter stated that it would be appropriate to ensure that such
guaranty funds are properly funded in advance of market stress. The
Commission believes that the provisions in proposed Rule 17Ad-22(e)(4)
adequately address whether the guaranty fund is properly funded in
advance of market stress and is therefore declining to modify the rule.
Rule 17Ad-22(e)(4)(i) requires policies and procedures for maintaining
sufficient financial resources to cover a covered clearing agency's
credit exposure to each participant fully with a high degree of
confidence through its margin system and collateral requirements, while
Rules 17Ad-22(e)(4)(ii) and (iii) require a covered clearing agency to
have policies and procedures that meet either ``cover two'' or ``cover
one'' on an ongoing basis. In addition, the Commission notes that Rule
17Ad-22(e)(4)(iv) excludes assessments for additional guaranty fund
contributions when calculating the financial resources available,
preventing a covered clearing agency from considering among its
financial resources contributions that are not prefunded.
---------------------------------------------------------------------------
\283\ See CFA Institute at 7-8.
---------------------------------------------------------------------------
A third commenter stated that, in addition to pre-funded capital
and guaranty funds, it should be clear, in advance, that clearing
members (and not the FRB or taxpayers) stand behind the organization
should it run into financial trouble.\284\ The Commission notes that
Rule 17Ad-22(e)(3)(ii) requires policies and procedures reasonably
designed to ensure that a covered clearing agency establishes plans for
the recovery or wind-down of a covered clearing agency necessitated by
credit losses, liquidity shortfalls, losses from general business risk,
or any other losses. The Commission believes that such recovery and
wind-down plans are an effective tool that can help a covered clearing
agency establish policies and procedures for managing losses in excess
of its default management and general business risk resources.\285\ The
provisions of Rule 17Ad-22(e)(5), discussed below, are also intended to
help ensure that a covered clearing agency is resilient in times of
market stress by requiring policies and procedures that limit the
assets it accepts as collateral to those with low credit, liquidity,
and market risks, and that set and enforce appropriately conservative
haircuts and concentration limits on collateral the covered clearing
agency accepts to manage its or its participants' credit exposure.\286\
Requirements for stress testing in Rule 17Ad-22(e)(4) and margin in
Rule 17Ad-22(e)(6) further support the resiliency of a covered clearing
agency by requiring the covered clearing agency to have policies and
procedures that are designed to appropriately size guaranty fund
contributions and margin to market risks.\287\ In addition,
requirements in Rule 17Ad-22(e)(18) for policies and procedures
relating to participation in the covered agency require (i) objective
and risk-based criteria for participation, (ii) participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the covered clearing agency,
and (iii) monitor compliance with such participation criteria on an
ongoing basis.\288\ Taken as a whole, the Commission believes that the
requirements in Rule 17Ad-22(e) comprehensively promote the resiliency
of a covered clearing agency and, in particular, its ability to
withstand periods of market stress.
---------------------------------------------------------------------------
\284\ See SRC at 2.
\285\ See supra Part II.C.3.b.iii.
\286\ See infra Part II.C.5.
\287\ See infra Parts II.C.4.b.iv (discussing stress testing)
and II.C.6 (discussing margin).
\288\ See infra Part II.C.18.
---------------------------------------------------------------------------
iii. Segregation of Guaranty Funds
One commenter suggested that, to prevent the spread of losses from
one product or asset type to participants or customers participating in
another product or asset type, as well as to avoid the inequitable
treatment of participants clearing less liquid product or asset types,
the Commission should require a covered clearing agency to implement
policies and procedures that would,
[[Page 70813]]
upon the insolvency of a particular clearing service or the clearing
agency as a whole, contain related losses within the particular
clearing service.\289\ The commenter stated that the Commission should
require covered clearing agencies to maintain separate clearing or
guaranty funds for product or asset types that exhibit materially
different liquidity profiles.\290\ The commenter also stated that
combined clearing or guaranty funds, in contrast, transmit losses from
one product or asset type to participants and customers participating
in another product or asset type in a manner that promotes contagion
and systemic risk, which the commenter believes is inconsistent with
the PFMI.\291\ The commenter further argued that combined clearing or
guaranty funds are not consistent with the requirement for the
equitable treatment of participants in Section 17A(b)(3)(D) of the
Exchange Act where the cleared products display materially different
liquidity characteristics.\292\
---------------------------------------------------------------------------
\289\ See The Clearing House at 3, 17.
\290\ See id. at 17.
\291\ See id.
\292\ See id. (citing 15 U.S.C. 78q-1(b)(3)(D)).
---------------------------------------------------------------------------
First, the Commission notes that Section 17A(b)(3)(D), which sets
forth one of the determinations that the Commission must make in
registering a clearing agency, does not concern clearing or guaranty
fund contributions; rather Section 17A(b)(3)(D) of the Exchange Act
states that the rules of the clearing agency must provide for the
equitable allocation of reasonable dues, fees, and other charges among
its participants.\293\
---------------------------------------------------------------------------
\293\ For purposes of this section, the Commission is assuming
that ``clearing fund,'' in contrast to guaranty fund, refers to a
combined pool of both margin collections and guaranty fund
contributions.
---------------------------------------------------------------------------
Second, the Commission believes that a clearing agency can use both
margin--targeted to the risk profile of the participant and used to
satisfy losses attributed to the participant--and guaranty or clearing
fund contributions--targeted to the risk profile of the participant and
then mutualized in a pooled fund to satisfy losses attributable to the
clearing agency--to help mitigate the transmission of losses across
participants. The Commission disagrees with the commenter's suggestion
that a pooled fund necessarily promotes contagion and systemic risk; a
pooled fund may offer certain benefits. For instance, a pooled fund can
help mitigate the possibility that participants in the clearing agency
will be called upon to help satisfy losses when a defaulting
participant is unable to satisfy those losses, and a clearing agency
should carefully assess the structure of its default waterfall to
analyze the potential risk mitigation tools that might be employed in
the default waterfall, including the use of margin and the use of a
guaranty or clearing fund. To the extent that a clearing agency uses
guaranty or clearing fund contributions to mutualize risk across
participants, the clearing agency generally should value margin and
guaranty fund contributions so that the contributions are commensurate
to the risks posed by the participants' activity. The clearing agency
also generally should consider the appropriate balance of
individualized and pooled elements within its default waterfall, with a
careful consideration of whether the balance of those elements
mitigates risk and to what extent an imbalance among those elements
might encourage moral hazard, in that one participant may take more
risks because the other participants bear the costs of those risks.
The commenter also suggested that, to facilitate effective risk
management and better protect participant/customer collateral, the
Commission should require covered clearing agencies to calculate,
collect, and maintain clearing or guaranty fund contributions and
participants' initial margin requirements independent of each other,
subject to an appropriate transition period.\294\ The commenter
observed that some covered clearing agencies do not maintain separate
clearing or guaranty fund requirements and initial margin requirements,
making it more difficult for participants to model and manage the risks
they face from the covered clearing agency.\295\ In addition, the
commenter stated that commingling the treatment of clearing or guaranty
fund contributions with initial margin exposes non-defaulting
participants (and potentially their customers) to the risk of losing
their initial margin in the event of another participant's default, a
result inconsistent with the protection of non-defaulting participant/
customer collateral.\296\ The commenter stated that initial margin of
non-defaulting participants and their clearing customers should not be
at risk as part of the default waterfall.\297\
---------------------------------------------------------------------------
\294\ See The Clearing House at 3, 17, 18.
\295\ See id. at 17.
\296\ See id.
\297\ See id. at 17, 18.
---------------------------------------------------------------------------
Further, the commenter recommended that the Commission modify
proposed Rule 17Ad-22(e)(4)(v) to require a covered clearing agency
that provides clearing services for two or more product or asset types
that have materially different liquidity characteristics to segregate
the clearing services for each such product or asset type and organize
and structure itself and adopt such rules as shall be necessary to (i)
continue operations for other clearing services notwithstanding the
need to wind down operations for a particular clearing service and (ii)
prevent the use of a particular clearing service's resources to cover
losses that occur in a separate clearing service.\298\
---------------------------------------------------------------------------
\298\ See The Clearing House at 18.
---------------------------------------------------------------------------
The Commission is declining to incorporate these specific
recommendation into Rule 17Ad-22(e)(4)(v). To the extent that these
types of commingled arrangements are employed, they must be prefunded
and therefore agreed to by the participants ex ante, prior to becoming
members of the covered clearing agency. The Commission acknowledges
that loss mutualization and other pooling-of-resources arrangements
involve trade-offs that a clearing agency generally should carefully
assess and balance. A covered clearing agency may be better able to
manage multiple defaults in extreme conditions more efficiently using
pooled resources because the pooled resources would be greater than the
resources of any single defaulting participant. Further, because the
arrangements are prefunded, participants can model and manage the risks
they face from the clearing agency while being able to take into
account the amount of resources that they have provided to the clearing
agency. The pooling of resources, however, can increase
interdependencies among, and therefore the potential risks to,
participants of the clearing agency. The Commission believes that
considering the use of loss mutualization and other pooling-of-
resources arrangements generally should, to minimize systemic risk,
balance the safety and soundness of the covered clearing agency against
the potential for increased exposures among participants that may arise
from the manner the covered clearing agency holds financial resources.
The Commission further notes that, pursuant to Rule 17Ad-22(e)(23), a
covered clearing agency must establish, implement, maintain, and
enforce written policies reasonably designed to disclose, among other
things, key aspects of its default rules and procedures and the risks,
fees, and other material costs participants incur by participating in
the covered clearing agency. The availability of these policies and
procedures should allow participants to understand in advance a covered
clearing agency's reliance on
[[Page 70814]]
either on a defaulter-pays approach or a pooling-of-resources
approach.\299\
---------------------------------------------------------------------------
\299\ See infra Parts II.C.18 and II.C.23 (describing
requirements under Rule 17Ad-22(e) for access and participation and
disclosure of rules, key procedures, and market data).
---------------------------------------------------------------------------
iv. Stress Testing
Commenters generally supported the use of stress testing and model
validation and the approach taken in Rule 17Ad-22(e)(4),\300\ but one
commenter recommended that the rule also include a requirement for
reverse stress testing. In the commenter's view, reverse stress testing
is a useful tool to manage expectations and to help anticipate
financial resource requirements in extreme conditions.\301\ The
Commission also believes that reverse stress testing can be a useful
tool to evaluate the adequacy of financial resources, but the
Commission is declining to modify Rule 17Ad-22(e)(4) to specifically
mandate this practice so that each covered clearing agency retains
flexibility, subject to its obligations and responsibilities as an SRO
under the Exchange Act, to develop its stress testing framework in
light of the ever-evolving challenges and risks inherent in the
securities markets. Below the Commission provides additional guidance
on the requirement that relates to stress testing in the rule.
---------------------------------------------------------------------------
\300\ See, e.g., CFA Institute at 8; OCC at 9.
\301\ See Barnard at 2.
---------------------------------------------------------------------------
c. Final Rule
As previously noted, the Commission is adopting the definition
``systemically important in multiple jurisdictions'' as proposed, but
because of other modifications to Rule 17Ad-22(a), the definition is
being moved to Rule 17Ad-22(a)(18).\302\ The Commission is modifying
the definition of ``stress testing'' to mean the estimation of credit
or liquidity exposures that would result from the realization of
potential stress scenarios, such as extreme price changes, multiple
defaults, or changes in other valuation inputs and assumptions. The
Commission believes that this modification, and in particular the
removal of ``but plausible,'' helps ensure that policies and procedures
for stress testing comprehensively consider a range of stress scenarios
that may be used in sizing the guaranty fund, in light of the variation
in markets served and products cleared by covered clearing
agencies.\303\ Because of other modifications to Rule 17Ad-22(a), the
definition is being moved to Rule 17Ad-22(a)(17).\304\ The Commission
is also modifying the definition of ``conforming model validation'' by
striking ``conforming'' since the Commission has not separately defined
``model validation'' in Rule 17Ad-22(a). Because of this and other
modifications to Rule 17Ad-22(a), the definition of ``model
validation'' has been moved to Rule 17Ad-22(a)(9).\305\
---------------------------------------------------------------------------
\302\ See supra note 271; see also Rule 17Ad-22(a)(18), infra
Part VI.
\303\ The Commission notes that this does not alter the coverage
requirements in Rules 17Ad-22(e)(4)(ii) and (iii), which require
policies and procedures that enable a covered clearing agency to
maintain financial resources at a minimum level necessary to enable
it to cover a wide range of foreseeable stress scenarios, including
but not limited to the default of the participant family (in the
case of ``cover one'') or two participant families (in the case of
``cover two'') that would potentially cause the largest aggregate
credit exposure for the covered clearing agency in extreme but
plausible market conditions. See infra Part VI.
\304\ See supra note 271; see also Rule 17Ad-22(a)(17), infra
Part VI.
\305\ See Rule 17Ad-22(a)(9), infra Part VI. The Commission is
also striking ``conforming'' from Rules 17Ad-22(e)(6)(vii) and
(e)(7)(vii) consistent with the new ``model validation'' term. See
infra Parts II.C.6.c and II.C.7.c.
---------------------------------------------------------------------------
In addition, the Commission is adopting Rule 17Ad-22(e)(4) with
modifications.\306\ First, the Commission is modifying Rule 17Ad-
22(e)(4)(v) so that it references only paragraphs (e)(4)(ii) and (iii)
(and not paragraph (e)(4)(i)) because a covered clearing agency may
hold financial resources consistent with Rule 17Ad-22(e)(4)(i), such as
initial margin, separately from the guaranty or clearing fund.\307\
Second, the Commission is modifying Rule 17Ad-22(e)(4)(vii) to conform
to the revised definition of ``model validation'' and striking ``to be
performed'' from the rule to be consistent with the corresponding
requirement for model validation of liquidity risk models in Rule 17Ad-
22(e)(7)(vii). Third, the Commission is making a technical correction
to Rule 17Ad-22(e)(4)(iv) to make clear that prefunded financial
resources should be exclusive of assessments for additional guaranty
fund contributions or other resources that are not prefunded by
modifying Rule 17Ad-22(e)(4)(iv) to state ``exclusive of'' assessments
rather than ``excluding'' assessments. Fourth, the Commission is
modifying Rule 17Ad-22(e)(4)(vi)(A) to refer to ``stress testing''
rather than ``a stress test'' to improve consistency with the
definition of ``stress testing'' in Rule 17Ad-22(a)(17). Fifth, the
Commission is revising Rule 17Ad-22(e)(4)(vi)(C) to replace ``and''
with ``or'' so that the criteria for conducting analysis more
frequently than monthly are disjunctive rather than conjunctive, since
the criteria described may not be correlated to each other. This
modification is consistent with the Commission's description of the
proposed rule in the CCA Standards proposing release.\308\ Sixth, the
Commission is correcting a technical error in Rule 17Ad-
22(e)(4)(vi)(D): references to paragraphs (e)(4)(iv)(B) and (C) will be
changed to paragraphs (e)(4)(vi)(B) and (C) respectively. Sixth, the
Commission is moving requirements proposed in Rule 17Ad-22(e)(13) to
Rule 17Ad-22(e)(4) so that all requirements pertinent to a covered
clearing agency's management of credit risk are contained in one rule.
This modification and the related rule text are discussed in Part
II.C.13.c.
---------------------------------------------------------------------------
\306\ See Rule 17Ad-22(e)(4), infra Part VI.
\307\ See CCA Standards proposing release, supra note 5, at
29526.
\308\ See id. at 29526 (for Rule 17Ad-22(e)(4)(iv)), 29526-27
(for Rule 17Ad-22(e)(4)(vi)(C)).
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(4), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address credit risk:
Whether it has established a robust framework to manage
its credit exposures to its participants and the credit risks arising
from its payment, clearing, and settlement processes, mindful that
credit exposures may arise from current exposures, potential future
exposures,\309\ or both;
---------------------------------------------------------------------------
\309\ See infra Part II.C.6 (discussing potential future
exposures in more detail).
---------------------------------------------------------------------------
whether it has identified sources of credit risk and can
routinely measure and monitor credit exposures, using appropriate risk
management tools to control these risks;
if it provides CCP services, whether it has covered its
current and potential future exposures to each participant fully with a
high degree of confidence using margin and other prefunded financial
resources, and (i) if it is involved in activities with a more-complex
risk profile or is systemically important in multiple jurisdictions,
whether it maintains additional financial resources to cover a wide
range of potential stress scenarios including but not limited to the
default of the two participants and their affiliates that would
potentially cause the largest aggregate credit exposure for the covered
clearing agency in extreme but plausible market conditions, or (ii) in
the case of all other covered clearing agencies, whether it maintains
additional financial resources sufficient to cover a wide range of
potential stress scenarios including but not limited to the default of
the participant and its affiliates that would potentially cause
[[Page 70815]]
the largest aggregate credit exposure for the covered clearing agency
in extreme but plausible market conditions;
if it provides CCP services, whether it has, consistent
with Rules 17Ad-22(e)(2) and (e)(3), documented its supporting
rationale for, and has appropriate governance arrangements relating to,
the amount of total financial resources it maintains;
if it provides CCP services: whether it determines the
amount and regularly tests the sufficiency of its total financial
resources available in the event of a default or multiple defaults in
extreme but plausible market conditions through rigorous stress
testing; whether it has clear procedures to report the result of its
stress tests to the appropriate decision makers at the covered clearing
agency and can use these results to evaluate the adequacy of and any
appropriate adjustments to its total financial resources; whether it
performs stress tests daily using standard and predetermined parameters
and assumptions; whether it performs, on at least a monthly basis, a
comprehensive and thorough analysis of stress testing scenarios,
models, and underlying parameters and assumptions used to ensure they
are appropriate for determining the covered clearing agency's required
level of default protection in light of current and evolving market
conditions; whether it performs this analysis more frequently when the
products cleared or markets served display high volatility, become less
liquid, or when the size or concentration of positions held by its
participants increases significant; and whether it performs a full
validation of its risk management model at least annually;
if it provides CCP services, whether it considers, in
conducting stress testing, the effect of a wide range of relevant
stress scenarios in terms of both defaulters' positions and possible
price changes in liquidation periods, and whether scenarios include
relevant peak historic price volatilities, shifts in other market
factors such as price determinants and yield curves, multiple defaults
over various time horizons, simultaneous pressures in funding and asset
markets, and a spectrum of forward-looking stress scenarios in a
variety of extreme but plausible market conditions; and
whether it has established explicit rules and procedures
that address fully any credit losses the covered clearing agency may
face as a result of any individual or combined default among its
participants with respect to any of their obligations to the covered
clearing agency, addressing how potentially uncovered credit losses
would be allocated, including the repayment of any funds the covered
clearing agency may borrow from liquidity providers, and indicating the
covered clearing agency's process to replenish any financial resources
that the covered clearing agency may employ during a stress event so it
can continue to operate in a safe and sound manner.
With respect to Rule 17Ad-22(e)(4)(i), ``high degree of
confidence'' generally refers to the meaning of the term as it is used
in statistical analysis.\310\ With respect to Rule 17Ad-22(e)(4)(ii)
and (iii), a covered clearing agency generally should use statistical
methods to develop models that estimate the financial resources
required. With respect to the relationship among Rules 17Ad-
22(e)(4)(i), (ii), and (iii), the Commission notes that the
requirements to examine credit exposure under foreseeable stress
scenarios including extreme but plausible market conditions in proposed
Rules 17Ad-22(e)(4)(ii) and (iii), as applicable, means a covered
clearing agency generally should consider how its credit exposure
modeled under such conditions differs from its credit exposure modeled
under normal market conditions to positions of such participants, which
it would also be required to measure, pursuant to proposed Rule 17Ad-
22(e)(4)(i). With respect to Rule 17Ad-22(e)(4)(iv), the Commission
notes the following:
---------------------------------------------------------------------------
\310\ See, e.g., Arthur S. Goldberger, A Course in Econometrics
122-23 (Harvard Univ. Press, 2003) (defining confidence intervals
for parameter estimates).
---------------------------------------------------------------------------
While the ability to assess participants for contributions
under applicable covered clearing agency governing documents, rules, or
agreements could not be included in this calculation until an
assessment has been levied and collected, previously paid-in
participant contributions to the covered clearing agency's default fund
could be counted, to the extent the covered clearing agency's rules,
policies, or procedures permit such resources to be used in a manner
equivalent to other financial resources in the default fund.
Other sources of prefunded resources, such as margin
previously posted to the clearing agency by participants, may also be
treated in this manner.
The ability to draw down under a revolving loan facility
could not be counted towards prefunded resources because funds from
such a loan facility would not be in the covered clearing agency's
immediate possession until they were drawn down, but the covered
clearing agency could count borrowed funds already drawn down, such as
under a term loan or other credit facility.
With respect to stress testing under Rule 17Ad-22(e)(4)(vi) as a
general matter, the Commission believes that reverse stress testing can
be a useful tool to evaluate the adequacy of financial resources. The
Commission believes that a covered clearing agency generally should
consider incorporating the use of reverse stress testing into its
policies and procedures under Rule 17Ad-22(e)(4)(vi), and if a covered
clearing agency determines not to use reverse stress testing, it
generally should indicate why in its policies and procedures. With
respect to the references to ``high volatility'' and ``less liquid''
referenced in Rule 17Ad-22(e)(4)(vi), the Commission notes that what
would constitute such circumstances may vary across asset classes.
With respect to the definition of ``model validation'' and its use
in Rule 17Ad-22(e)(4)(vii), a covered clearing agency generally should
consider a person free from influence when that person does not perform
functions associated with the clearing agency's models and does not
report to a person who performs these functions. The definition of
``model validation'' does not require policies and procedures for
separating model review from model development or for maintaining two
separate quantitative teams within the clearing agency. With respect to
Rule 17Ad-22(e)(4)(vii) and policies and procedures for performing the
model validation not less than annually, a covered clearing agency
generally should perform the model validation not less than once every
twelve months.
With respect to Rule 17Ad-22(e)(4)(viii), the Commission notes that
managing a member default may involve hedging open positions, funding
collateral so that the positions can be closed out over time, or both.
A covered clearing agency may decide to auction or allocate open
positions to its participants, but, to the extent possible, a covered
clearing agency generally should allow non-defaulting members to
continue to manage their positions in the ordinary course. In
developing policies and procedures pursuant to Rule 17Ad-22(e)(4)(ix),
a covered clearing agency generally should consider specifying the
order of use of different types of resources, including (i) assets
provided by the defaulting member (such as margin or other collateral),
(ii) the guaranty fund of the covered clearing agency, (iii) capital
calls on members, and (iv) credit
[[Page 70816]]
facilities. A covered clearing agency generally should have policies
and procedures that describe (i) how resources that have been depleted
as a result of a member default would be replenished over time and (ii)
what burdens a non-defaulting member may bear.
5. Rule 17Ad-22(e)(5): Collateral
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(5) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to limit the assets it accepts as
collateral to those with low credit, liquidity, and market risks, and
set and enforce appropriately conservative haircuts and concentration
limits if the covered clearing agency requires collateral to manage its
own or its participants' credit exposures. In addition, Rule 17Ad-
22(e)(5) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to include a not-less-than-annual review of the
sufficiency of a covered clearing agency's collateral haircuts and
concentration limits.\311\
---------------------------------------------------------------------------
\311\ See CCA Standards proposing release, supra note 5, at
29528.
---------------------------------------------------------------------------
b. Comments Received
Commenters were generally supportive of the proposed approach, but
two commenters supported further clarification regarding the type of
collateral a covered clearing agency can accept.\312\
---------------------------------------------------------------------------
\312\ See CFA Institute at 8; OCC at 9.
---------------------------------------------------------------------------
One commenter stressed that the ability to accept equity securities
as collateral is critically important to its systemic risk mitigation
efforts and believes that it should be permitted to continue accepting
such securities as collateral within its existing framework.\313\ The
commenter sought to clarify that an appropriately designed portfolio
margining system that permits the use of equity collateral complies
with the requirements of proposed Rule 17Ad-22(e)(5) with respect to
quality of collateral. In response, the Commission believes that, for a
portfolio margining system to comply with Rule 17Ad-22(e)(5), it would
necessarily have to consider whether such equity collateral has low
credit, liquidity, and market risk. This may require a consideration of
whether the collateral carries wrong-way risk. The Commission provides
further guidance on this point in Part II.C.5.c below.
---------------------------------------------------------------------------
\313\ See OCC at 10.
---------------------------------------------------------------------------
One commenter recommended that the Commission consider establishing
prescriptive standards for eligible collateral.\314\ Among other
things, the commenter recommended limiting initial margin to cash in
highly liquid currencies, obligations guaranteed by a sovereign that
are highly liquid, corporate bonds that are highly liquid, equities
that are highly liquid, and gold. The commenter further recommended
limiting the assets that a covered clearing agency may accept as
initial margin to collateral that a central bank would accept under an
ordinary-course facility, is deliverable against the collateralized
exposure, or is otherwise subject to conservative risk management
practices that the Commission has determined to be adequate to mitigate
the incremental risks associated with the collateral because a central
bank would not accept it under an ordinary-course facility and it is
not deliverable against the collateralized exposure. The commenter
further recommended aggregate limits on each type of collateral posted
as initial margin. The commenter also recommended that the Commission
prohibit a covered clearing agency from accepting as initial margin
securities issued by a participant or any of its affiliates.\315\
---------------------------------------------------------------------------
\314\ See The Clearing House at 2-3, 9-11.
\315\ See id. at 10.
---------------------------------------------------------------------------
The Commission is mindful of the concerns raised by the commenter
but, given the range of products that covered clearing agencies clear,
declines to restrict the types of collateral to the assets identified
by the commenter. A covered clearing agency should have flexibility,
consistent with the requirements in Rule 17Ad-22(e)(5), to react to
changing market conditions. The Commission notes that a covered
clearing agency is required under Rule 17Ad-22(e)(5) to have policies
and procedures that assess what assets have low credit, liquidity, and
market risks in light of its broader risk management framework and,
likewise, what haircuts and concentration limits are necessary to
effectively manage its credit exposure.
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(5) as proposed.\316\
Because the Commission recognizes that there may be a number of ways to
address compliance with Rule 17Ad-22(e)(5), the Commission is providing
the following guidance that a covered clearing agency generally should
consider in establishing and maintaining policies and procedures that
address collateral:
---------------------------------------------------------------------------
\316\ See Rule 17Ad-22(e)(5), infra Part VI.
---------------------------------------------------------------------------
Whether it has generally limited the assets it accepts as
collateral to those with low credit, liquidity, and market risks;
whether it has established prudent valuation practices and
developed haircuts that are regularly tested and take into account
stressed market conditions;
to reduce the need for procyclical adjustments, whether it
has established stable and conservative haircuts that have been
calibrated to include periods of stressed market conditions, to the
extent practical and prudent;
whether it has avoided concentrated holdings of certain
assets where this would significantly impair the ability to liquidate
such assets quickly without significant adverse price affects;
if it accepts cross-border collateral, whether it has
mitigated the risks associated with the use of cross-border collateral
and ensured that the collateral can be used in a timely manner; and
whether it uses a collateral management system that has
been well-designed and is operationally flexible.
In assessing what assets have low credit, liquidity, and market risks,
a covered clearing agency's policies and procedures also generally
should account for wrong-way risk, such as the risk that arises from
accepting as initial margin securities issued by a participant or any
of its affiliates.\317\ Policies and procedures for haircuts and
concentration limits generally should account for wrong-way risk by
limiting the acceptance of collateral that would likely lose value in
the event that the participant providing the collateral defaults. For
example, this would be true when accepting equity securities of the
participant itself or its affiliates. Further, to reduce the need for
procyclical adjustments,\318\ a covered clearing agency generally
should consider establishing stable and
[[Page 70817]]
conservative haircuts that are calibrated to include periods of
stressed market conditions, to the extent practicable and prudent.
---------------------------------------------------------------------------
\317\ Wrong-way risk can be either general or specific. General
wrong-way risk arises at a CCP when the potential losses of either a
participant's portfolio or a participant's collateral is correlated
with the default probability of that participant. Specific wrong-way
risk arises at a CCP when an exposure to a participant is highly
likely to increase when the creditworthiness of that participant is
deteriorating.
\318\ In this context, procyclicality typically refers to
changes in risk-management practices that are positively correlated
with market, business, or credit cycle fluctuations that may cause
or exacerbate financial stability. While changes in collateral
values tend to be procyclical, collateral arrangements can increase
procyclicality if haircut levels fall during periods of low market
stress and increase during periods of high market stress.
---------------------------------------------------------------------------
In addition, with respect to policies and procedures for reviewing
the sufficiency of its collateral haircuts and concentration limits not
less than annually, a covered clearing agency generally should perform
the review not less than once every twelve months using persons who are
independent from management and have appropriate technical skills.
6. Rule 17Ad-22(e)(6): Margin
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(6) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to cover
its credit exposures to its participants by establishing a risk-based
margin system that is monitored by management on an ongoing basis and
regularly reviewed, tested, and verified.\319\ Proposed Rule 17Ad-
22(e)(6)(i) would require a covered clearing agency that provides CCP
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in a margin system that,
at a minimum, considers and produces margin levels commensurate with
the risks and particular attributes of each relevant product,
portfolio, and market. Proposed Rule 17Ad-22(e)(6)(ii) would require a
covered clearing agency that provides CCP services to establish
implement, maintain and enforce written policies and procedures
reasonably designed to ensure that the margin system would mark
participant positions to market and collect margin, including variation
margin or equivalent charges if relevant, at least daily, and include
the authority and operational capacity to make intraday margin calls in
defined circumstances. Proposed Rule 17Ad-22(e)(6)(iii) would require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to calculate margin sufficient to cover its
potential future exposure to participants in the interval between the
last margin collection and the close out of positions following a
participant default. The Commission also proposed Rule 17Ad-22(a)(14)
to define ``potential future exposure'' to mean the maximum exposure
estimated to occur at a future point in time with an established
single-tailed confidence level of at least 99% with respect to the
estimated distribution of future exposure.\320\ Proposed Rule 17Ad-
22(e)(6)(iv) would require a covered clearing agency that provides CCP
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it uses reliable
sources of timely price data and procedures and sound valuation models
for addressing circumstances in which pricing data are not readily
available or reliable. Proposed Rule 17Ad-22(e)(6)(v) would require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to ensure the use of an appropriate method for
measuring credit exposure that accounts for relevant product risk
factors and portfolio effects across products.
---------------------------------------------------------------------------
\319\ See CCA Standards proposing release, supra note 5, at
29528-31.
\320\ See id. at 29529. The Commission received no comments
regarding the proposed definition and is adopting it as proposed.
Because of other modifications to Rule 17Ad-22(a), the definition of
``potential future exposure'' is being moved to Rule 17Ad-22(a)(13).
See infra Part VI.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(6)(vi) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to
regularly review, test, and verify its risk-based margin system by
conducting backtests at least once each day and conducting a conforming
sensitivity analysis of its margin resources and its parameters and
assumptions for backtesting at least monthly, and considering
modifications to ensure the backtesting practices are appropriate for
determining the adequacy of its margin resources. Proposed Rule 17Ad-
22(e)(6)(vi) would also require a covered clearing agency's policies
and procedures to include conducting a conforming sensitivity analysis
more frequently than monthly when the products cleared or markets
served display high volatility or become less liquid, and when the size
or concentration of positions held by participants increases or
decreases significantly. Proposed Rule 17Ad-22(e)(6)(vi) would also
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to report
the results of such conforming sensitivity analysis to appropriate
decision makers at the covered clearing agency, including its risk
management committee or board of directors, and use these results to
evaluate the adequacy of and adjust its margin methodology, model
parameters, and any other relevant aspects of its credit risk
management policies and procedures.\321\
---------------------------------------------------------------------------
\321\ See id. at 29530.
---------------------------------------------------------------------------
With respect to proposed Rule 17Ad-22(e)(6)(vi), the Commission
proposed Rule 17Ad-22(a)(1) to define ``backtesting'' to mean an ex-
post comparison of actual outcomes with expected outcomes derived from
the use of margin models.\322\ The Commission received no comments
regarding the proposed definition and is adopting it as proposed.\323\
The Commission also proposed to define ``sensitivity analysis'' to mean
an analysis that involves analyzing the sensitivity of a model to its
assumptions, parameters, and inputs.\324\ The Commission also proposed
to define ``conforming sensitivity analysis'' to mean a sensitivity
analysis that considers the impact on the model of both moderate and
extreme changes in a wide range of inputs, parameters, and assumptions,
including correlations of price movements or returns if relevant, which
reflect a variety of historical and hypothetical market conditions and
actual and hypothetical portfolios of proprietary positions and, where
applicable, customer positions.\325\ Under the proposed definition, a
conforming sensitivity analysis, when performed by or on behalf of a
covered clearing agency involved in activities with a more complex risk
profile, would consider the most volatile relevant periods, where
practical, that have been experienced by the markets served by the
clearing agency. The proposed definition would also require a
conforming sensitivity analysis to test the sensitivity of the model to
stressed market conditions, including the market conditions that may
ensue after the default of a member and other extreme but plausible
conditions as defined in a covered clearing agency's risk
policies.\326\
---------------------------------------------------------------------------
\322\ See id.
\323\ See Rule 17Ad-22(a)(1), infra Part VI.
\324\ See CCA Standards proposing release, supra note 5, at
29530.
\325\ See id.
\326\ See CCA Standards proposing release, supra note 5, at
29530. The Commission received no comments regarding the proposed
definitions, and the Commission is combining them into one
definition of ``sensitivity analysis'' to avoid the use of both
``sensitivity analysis'' and ``conforming sensitivity analysis'' in
Rule 17Ad-22, as discussed further below. See infra Part II.C.6.c.
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-22(e)(6)(vii) would require a covered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to require not less than annually a conforming model
validation of the
[[Page 70818]]
covered clearing agency's margin system and related models.\327\
---------------------------------------------------------------------------
\327\ See CCA Standards proposing release, supra note 5, at
29531; see also supra note 305 and accompanying text (modifying the
term ``conforming model validation'' to ``model validation,'' and
moving it to Rule 17Ad-22(a)(9)).
---------------------------------------------------------------------------
b. Comments Received and Commission Response
i. Minimum Liquidation Periods for Initial Margin
One commenter expressed the view that the requirements in Rule
17Ad-22(e)(6) are reasonable.\328\ In contrast, another commenter noted
that the proposed rules would address initial margin liquidation period
requirements through the Commission's supervisory process rather than
establish a minimum liquidation period as part of the covered clearing
agency's initial margin methodology.\329\ The commenter stated that, at
a minimum, the Commission should establish minimum liquidation period
standards that, as a supervisory matter, are transparent to the public.
To promote transparency and international consistency, the commenter
also stated that the Commission should modify Rule 17Ad-22(e)(6)(iii)
to establish minimum liquidation periods for initial margin calculation
that are consistent with international standards.\330\
---------------------------------------------------------------------------
\328\ See CFA Institute at 1, 8-9.
\329\ See The Clearing House at 14.
\330\ See id. at 3, 14, 15.
---------------------------------------------------------------------------
The Commission is declining to establish minimum liquidation
periods as part of a covered clearing agency's initial margin
methodology. The Commission recognizes that liquidation periods are a
critical assumption for any margin methodology and vary by product
type. Accordingly, liquidation periods generally should be tailored to
the market conditions and risks of the products being cleared. Because
market conditions vary and the risks of the products being cleared over
time may change, the Commission believes that a rule or rules
establishing criteria for minimum liquidation periods may not be
sufficiently tailored to changing circumstances as financial markets
evolve. A covered clearing agency generally should consider reviewing
liquidation periods as part of its regular review, testing, and
verification of its margin system under Rule 17Ad-22(e)(6).
ii. Model Validation
One commenter supported the proposed requirement that a qualified
person who is free from influence should perform the annual model
validation for credit and margin risk, but the commenter asked the
Commission to go further with the ``free from influence''
requirement.\331\ The commenter noted the inevitable and indirect
pressures employees may face and suggested that the models be validated
annually by a qualified and independent organization with no financial
stake in the outcome.\332\ The Commission previously addressed comments
on this topic when it adopted Rule 17Ad-22(b)(4). At that time, the
Commission stated that it was not persuaded that model validation must
be performed by an outside, independent expert.\333\ The Commission
believes that objectivity can be preserved where the person performing
the model validation is an employee of the covered clearing agency by a
variety of means, including, for example, separating employees
responsible for model validation from those in the covered clearing
agency responsible for the day-to-day functioning of the model and the
business lines that use the model. As a general matter, mechanisms
ensuring that any employees responsible for model validation remain
independent from those responsible for using the model on a day-to-day
basis would satisfy this requirement of the rule.
---------------------------------------------------------------------------
\331\ See Better Markets at 9. The Commission notes that this
``free from influence'' requirement applies to model validation
requirements in Rules 17Ad-22(e)(4), (e)(6), and (e)(7). See Rule
17Ad-22(a)(9), infra Part VI.
\332\ See Better Markets at 9-10.
\333\ See Clearing Agency Standards adopting release, supra note
5, at 66238.
---------------------------------------------------------------------------
iii. Intraday Margin on a Net Basis and Multilateral Netting Across
CCPs
One commenter supported intraday margin on a net basis and
encouraged multilateral netting across CCPs. The commenter stated that,
to prevent intraday variation margin calls from having destabilizing
effects, the Commission should, pending the development of market-wide
solutions, require a covered clearing agency making an intraday margin
call to simultaneously net variation margin that is payable to
participants.\334\
---------------------------------------------------------------------------
\334\ See The Clearing House at 3, 14.
---------------------------------------------------------------------------
After careful consideration, the Commission declines to accept the
commenter's suggestion because it would be inconsistent with the
overall approach to Rule 17Ad-22(e). The Commission notes that the
circumstances that could give rise to intraday margin calls at a
covered clearing agency may vary significantly (e.g., intraday
volatility, large changes in participant positions), and may present
varied challenges. Although there may be circumstances where it would
be appropriate for a covered clearing agency to incorporate policies
and procedures such as those suggested by the commenter, the
Commission's approach to Rule 17Ad-22(e) is to provide flexibility to
covered clearing agencies, subject to their obligations and
responsibilities as SROs under the Exchange Act, to design and
structure their policies and procedures to take into account the
differences among clearing agencies. With respect to intraday margin as
a general matter, Rule 17Ad-22(e)(6)(ii) requires policies and
procedures for having the capacity to collect intraday margin in
defined circumstances, which generally would include margin calls on
both a scheduled and unscheduled basis.
c. Final Rule
As previously discussed, the Commission is adopting the definitions
of ``backtesting'' and ``potential future exposure'' as proposed.\335\
As noted above, the Commission is combining the definitions of
``sensitivity analysis'' and ``conforming sensitivity analysis.'' In
addition, the Commission believes that while hypothetical portfolios
are often useful and important in conducting a sensitivity analysis,
hypothetical portfolios may not be appropriate in certain cases. The
Commission is modifying the definition so that, under new Rule 17Ad-
22(a)(16), ``sensitivity analysis'' means an analysis that involves
analyzing the sensitivity of a model to its assumptions, parameters,
and inputs that: (i) Considers the impact on the model of both moderate
and extreme changes in a wide range of inputs, parameters, and
assumptions, including correlations of price movements or returns if
relevant, which reflect a variety of historical and hypothetical market
conditions. Sensitivity analysis must use actual and, where applicable,
hypothetical portfolios that reflect the characteristics of proprietary
positions and customer positions; (ii) when performed by or on behalf
of a covered clearing agency involved in activities with a more complex
risk profile, considers the most volatile relevant periods, where
practical, that have been experienced by the markets served by the
clearing agency; and (iii) tests the sensitivity of the model to
stressed market conditions, including the market conditions that may
ensue after the default of a member and other extreme but plausible
[[Page 70819]]
conditions as defined in a covered clearing agency's risk
policies.\336\ The Commission believes that this reduces the potential
for confusion resulting from the use of two separate definitions.
---------------------------------------------------------------------------
\335\ See supra notes 320 and 323. Due to modifications to Rule
17Ad-22(a), the definition of ``potential future exposure'' is being
moved to Rule 17Ad-22(a)(13). The definition of ``backtesting''
remains in Rule 17Ad-22(a)(1). See infra Part VI.
\336\ See Rule 17Ad-22(a)(16), infra Part VI.
---------------------------------------------------------------------------
The Commission is also adopting modifications to Rule 17Ad-
22(e)(6).\337\ First, the Commission is modifying Rule 17Ad-22(e)(6) to
remove references to ``conforming'' consistent with the modification to
the definitions of ``sensitivity analysis'' discussed above and of
``model validation'' discussed in Part II.C.4.c. Second, to improve
clarity, the Commission is modifying Rule 17Ad-22(e)(6)(v) to require
policies and procedures that use reliable sources of timely price data
and that ``use'' procedures and sound valuation models for addressing
circumstances in which pricing data are not readily available or
reliable. Third, because backtests are conducted with respect to the
margin model and not the margin resources themselves, the Commission is
modifying Rule 17Ad-22(e)(6)(vi)(A) to replace the phrase ``margin
resources'' with ``margin model.'' Fourth, to avoid conflating
sensitivity analysis with backtesting, the Commission is modifying
Rules 17Ad-22(e)(6)(vi)(B) and (C) to clarify that a sensitivity
analysis should be conducted of the margin model and not of margin
resources. Specifically, the rule text will replace the phrase ``margin
resources'' with the phrase ``margin model.'' The modifications to
Rules 17Ad-22(e)(6)(vi)(A), (B), and (C) are consistent with the
discussion of the proposed rule in the CCA Standards proposing
release.\338\ Fifth, the Commission is modifying Rule 17Ad-
22(e)(6)(vi)(C) to replace ``and'' with ``or'' so that the criteria for
conducting analysis more frequently than monthly are disjunctive rather
than conjunctive, since the criteria described may not be correlated to
each other. This modification is consistent with the Commission's
description of the proposed rule in the CCA Standards proposing
release.\339\
---------------------------------------------------------------------------
\337\ See Rule 17Ad-22(e)(6), infra Part VI.
\338\ See CCA Standards proposing release, supra note 5, at
29530-31.
\339\ See id. at 29530.
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(6), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures for margin:
Whether its margin system has established margin levels
commensurate with the risks and particular attributes of each product,
portfolio, and market it serves;
whether it has a reliable source of timely price data for
its margin system and policies and procedures, including sound
valuation models, for addressing circumstances in which pricing data
are not readily available or reliable;
whether it has adopted initial margin models and
parameters that are risk-based and generate margin requirements
sufficient to cover its potential future exposure to participants in
the interval between the last margin collection and the close out of
positions following a participant default;
whether initial margin meets an established single-tailed
confidence level of at least 99 percent with respect to the estimated
distribution of future exposure; whether, if it calculates margin at
the portfolio level, this applies to each portfolio's distribution of
future exposure; whether, if it calculates margin at more granular
levels, such as at the sub-portfolio level or by product, this is met
for the corresponding distributions of future exposure; and whether the
model (i) uses a conservative estimate of the time horizons for the
effective hedging or close out of the particular types of products
cleared by the covered clearing agency (including in stressed market
conditions), (ii) has an appropriate method for measuring credit
exposure that accounts for relevant product risk factors and portfolio
effects across products, and (iii) to the extent practicable and
prudent, limits the need for destabilizing, procyclical changes;
whether it marks participant positions to market and
collects variation margin at least daily to limit the build-up of
current exposures and has the authority and operational capacity to
make intraday margin calls and payments, both scheduled and
unscheduled, to participants;
in calculating margin requirements, whether it allows
offsets or reductions in required margin across products that it clears
or between products that it and another clearing agency clear, if the
risk of one product is significantly and reliably correlated with the
risk of the other product; and where two or more clearing agencies are
authorized to offer cross-margining, whether they have appropriate
safeguards and harmonized overall risk management systems;
whether it analyzes and monitors its model performance and
overall margin coverage by conducting rigorous daily backtesting and at
least monthly, and more frequent when appropriate, sensitivity
analysis; whether it regularly conducts an assessment of the
theoretical and empirical properties of its margin model for all
products it clears; in conducting sensitivity analysis of the model's
coverage, whether the covered clearing agency has taken into account a
wide range of parameters and assumptions that reflect possible market
conditions, including the most volatile periods that have been
experienced by the markets the covered clearing agency serves and
extreme changes in the correlations between prices; and
whether it regularly reviews and validates its margin
system.
With respect to Rule 17Ad-22(e)(6)(iii), and policies and
procedures related to margin calculations, a covered clearing agency
generally should consider whether it calculates margin sufficient to
cover its potential future exposure to each participant.
With respect to Rule 17Ad-22(e)(6)(iv) and policies and procedures
for price data, the Commission notes that in selecting price data
sources, a covered clearing agency generally should consider the
ability of the provider to provide data in a variety of market
conditions, including periods of market stress, and not select data
sources based on their cost alone to ensure that such price data
sources are reliable.
With respect to Rule 17Ad-22(e)(6)(v) and policies and procedures
for measuring portfolio effects, the Commission notes that measuring
portfolio effects across products means a covered clearing agency
generally should take into account netting procedures or offsets
through which credit exposure may be reduced in measuring credit
exposure, including the use of portfolio margining procedures across
products where applicable.
With respect to Rule 17Ad-22(e)(6)(vii) and policies and procedures
for performing the model validation not less than annually, a covered
clearing agency generally should perform the model validation not less
than once every twelve months using persons who are independent from
management and have appropriate technical skills.
7. Rule 17Ad-22(e)(7): Liquidity Risk
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(7) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively measure, monitor, and
manage the liquidity risk that arises in or is borne
[[Page 70820]]
by it, by meeting, at a minimum, the ten requirements specified in the
rule.\340\
---------------------------------------------------------------------------
\340\ See CCA Standards proposing release, supra note 5, at
29531-37.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(i) would require that a covered
clearing agency's policies and procedures be reasonably designed to
ensure that it maintains sufficient liquid resources in all relevant
currencies to effect same-day and, where appropriate, intraday and
multiday settlement of payment obligations with a high degree of
confidence under a wide range of potential stress scenarios that
includes the default of the participant family that would generate the
largest aggregate payment obligation for it in extreme but plausible
market conditions.\341\
---------------------------------------------------------------------------
\341\ See id. at 29531.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(ii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it holds qualifying
liquid resources sufficient to meet the minimum liquidity resource
requirement in each relevant currency for which the covered clearing
agency has payment obligations owed to clearing members.\342\ The
Commission also proposed Rule 17Ad-22(a)(15) to define ``qualifying
liquid resources,'' which would include three types of assets, in each
relevant currency:
---------------------------------------------------------------------------
\342\ See id.
---------------------------------------------------------------------------
Cash held either at the central bank of issue or at
creditworthy commercial banks;
assets that are readily available and convertible into
cash through either:
[cir] Prearranged funding arrangements without material adverse
change limitations, such as committed lines of credit, foreign exchange
swaps, and repurchase agreements, or
[cir] other prearranged funding arrangements determined to be
highly reliable even in extreme but plausible market conditions by the
board of directors of the covered clearing agency following a review
conducted for this purpose not less than annually; and
other assets that are readily available and eligible for
pledging to (or conducting other appropriate forms of transactions
with) a relevant central bank, if the covered clearing agency has
access to routine credit at such central bank.\343\
---------------------------------------------------------------------------
\343\ See id.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(iii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it uses accounts and
services at a Federal Reserve Bank, pursuant to Section 806(a) of the
Clearing Supervision Act,\344\ or other relevant central bank, when
available and where determined to be practical by the board of
directors of the covered clearing agency, to enhance its management of
liquidity risk.
---------------------------------------------------------------------------
\344\ See 12 U.S.C. 5465(a).
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(iv) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it undertakes due
diligence to confirm that it has a reasonable basis to believe each of
its liquidity providers, whether or not such liquidity provider is a
clearing member, has sufficient information to understand and manage
the liquidity provider's liquidity risks, and the capacity to perform
as required under its commitments to provide liquidity.
Proposed Rule 17Ad-22(e)(7)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency maintains and, on at least an annual basis, tests with each
liquidity provider, to the extent practicable, its procedures and
operational capacity for accessing each type of relevant liquidity
resource.
Proposed Rule 17Ad-22(e)(7)(vi)(A) through (C) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to determine the
amount and regularly test the sufficiency of the liquid resources held
for purposes of meeting the minimum liquid resource requirement of
proposed Rule 17Ad-22(e)(7)(i) by (A) conducting a stress test of its
liquidity resources at least once each day using standard and
predetermined parameters and assumptions; (B) conducting a
comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources, and considering modifications to ensure
they are appropriate for determining the covered clearing agency's
identified liquidity needs and resources in light of current and
evolving market conditions at least once each month; and (C) conducting
a comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources more frequently when products cleared or
markets served display high volatility or become less liquid, when the
size or concentration of positions held by participants increases
significantly, or in other circumstances described in the covered
clearing agency's policies and procedures. Proposed Rule 17Ad-
22(e)(7)(vi)(D) would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to result in reporting the results of
the analyses performed under proposed Rule 17Ad-22(e)(7)(vi)(B) and (C)
to appropriate decision makers, including the risk management committee
or board of directors, at the covered clearing agency for use in
evaluating the adequacy of and adjusting its liquidity risk management
framework.\345\
---------------------------------------------------------------------------
\345\ See CCA Standards proposing release, supra note 5, at
29534.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(vii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in performing an annual or
more frequent conforming model validation of its liquidity risk
models.\346\
---------------------------------------------------------------------------
\346\ See id.; see also supra notes 275-305 and accompanying
text (discussing generally the requirements accompanying the
definition of ``model validation'').
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(viii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to address foreseeable liquidity
shortfalls that would not be covered by its liquid resources and seek
to avoid unwinding, revoking, or delaying the same-day settlement of
payment obligations.
Proposed Rule 17Ad-22(e)(7)(ix) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to describe its process for
replenishing any liquid resources that it may employ during a stress
event.\347\
---------------------------------------------------------------------------
\347\ See CCA Standards proposing release, supra note 5, at
29534.
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-22(e)(7)(x) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure that it, at least
once a year, evaluates the feasibility of maintaining sufficient liquid
resources at a minimum in all relevant currencies to effect same-day
and, where appropriate, intraday and multiday settlement of payment
obligations with a high degree of confidence under a wide range of
foreseeable stress scenarios that includes, but is not limited to, the
default of the two participant families that would potentially cause
the largest
[[Page 70821]]
aggregate payment obligation for the covered clearing agency in extreme
but plausible market conditions if the covered clearing agency provides
CCP services and is either systemically important in multiple
jurisdictions or a clearing agency involved in activities with a more
complex risk profile.
b. Comments Received and Commission Response
i. General Approach
Six commenters expressed general support for the proposed
rule.\348\ Of these, one commenter stated that proposed Rule 17Ad-
22(e)(7) was prudent and appropriate in light of the need for covered
clearing agencies to maintain adequate liquidity to minimize systemic
risks and that, by requiring ongoing testing and monitoring of
underlying assumptions, covered clearing agencies should be able to
identify potential problems with sufficient time to respond without
significant disruptions.\349\ Four commenters expressed support for the
Commission's proposed approach to qualifying liquid resources other
than committed funding arrangements,\350\ which is discussed further
below in Part II.C.7.b.iii.
---------------------------------------------------------------------------
\348\ See, e.g., Barnard at 1 (supporting the proposal,
especially as to its proposed financial risk management and
liquidity risk requirements); CFA Institute at 9; CME at 4; DTCC at
6; The Clearing House at 3, 13; OCC at 11.
\349\ See CFA Institute at 9.
\350\ See CME at 4; DTCC at 6 (noting the appropriate balance in
the proposed rule between the need to have sufficient reliable
liquidity resources to meet ongoing settlement obligations in the
event of participant default, and the realities of the availability
and costs of committed liquidity funding); OCC at 11 (supporting the
expansion of qualifying liquid resources beyond committed funding
arrangements); The Clearing House at 3, 13 (noting that the proposed
rule's use of highly reliable funding arrangements, in addition to
committed arrangements, provides needed flexibility and is
consistent with the PFMI).
---------------------------------------------------------------------------
ii. Due Diligence for Liquidity Providers
Two commenters stated that the requirement in proposed Rule 17Ad-
22(e)(7)(iv) regarding policies and procedures to perform due diligence
of liquidity providers must take into account the context of the due
diligence being performed.\351\ One of these commenters stated that
commercial lenders are not likely to provide their borrowers with non-
public information on their internal policies and controls,\352\ and
that accordingly covered clearing agencies should not be expected to
evaluate a commercial lender's internal risk controls.\353\ First, in
the experience of Commission staff, liquidity facilities may not
consist only of traditional commercial loans. For example, a covered
clearing agency may seek out committed repurchase agreement facilities
with counterparties other than traditional commercial lenders. In such
a circumstance, the commenter's experience with such counterparties may
be different than with a traditional commercial lender.\354\
Accordingly, in contrast to the commenter's assertion, a covered
clearing agency may engage in a relationship with a liquidity provider
that is not a typical commercial lender and therefore may be more
willing to facilitate due diligence. Second, while the Commission
acknowledges that a lender may choose not to provide their borrowers
with non-public information on certain internal policies and controls,
the proposed rule does not require a covered clearing agency's policies
and procedures regarding due diligence for liquidity providers to
specifically review all internal policies and controls. Rather, it
requires due diligence policies and procedures that confirm the covered
clearing agency has a reasonable basis to believe that a liquidity
provider understands and manages the liquidity provider's liquidity
risks and the capacity to perform as required under its commitments to
provide liquidity to the covered clearing agency. If, in performing due
diligence consistent with its policies and procedures formulated in
accordance with the rule, a covered clearing agency cannot confirm that
it has a reasonable basis to believe both of the required criteria,
then the covered clearing agency would not have a liquidity provider
consistent with Rule 17Ad-22(e)(7)(iv).
---------------------------------------------------------------------------
\351\ See DTCC at 7; LCH at 4.
\352\ See DTCC at 7.
\353\ See id.
\354\ See infra Part II.C.7.b.iii (further discussing such
repurchase agreement facilities).
---------------------------------------------------------------------------
The second commenter stated that it is not appropriate to require a
covered clearing agency to perform due diligence on a central bank
acting as its liquidity provider and requests that the rules clarify
that the requirements under Rule 17Ad-22(e)(7)(iv) do not apply where a
central bank is a liquidity provider for a covered clearing
agency.\355\ The Commission does not believe that the rule needs to be
modified to account for this circumstance, however, as the policies and
procedures of the covered clearing agency could account for the
different circumstances that arise when a central bank is acting as a
liquidity provider.
---------------------------------------------------------------------------
\355\ See LCH at 4.
---------------------------------------------------------------------------
A third commenter expressed the view that the Commission should
clarify the due diligence requirements of proposed Rule 17Ad-
22(e)(7)(iv) to expressly require a covered clearing agency to take
into account the potential wrong-way risk associated with reliance on
participants or their affiliates as liquidity providers.\356\ The
commenter further stated that the Commission should take additional
steps to mitigate wrong-way risk by requiring a covered clearing agency
to ensure the appropriate diversification of its liquidity providers
and limit its reliance on its participants or their affiliates as
potential sources of liquidity.\357\ The Commission believes that
diversifying liquidity providers may be helpful because such
diversification would result in less concentrated, and potentially more
manageable, financial commitments among a covered clearing agency's
liquidity providers. For example, a covered clearing agency generally
should conduct an assessment of the liquidity provider's business in
light of both the covered clearing agency's own business and the
composition of its existing liquidity providers. In turn, a covered
clearing agency could assess the likelihood that a liquidity provider
might be unable to meet its own liquidity demands at the same time as
the covered clearing agency was facing a liquidity shortfall and
attempting to draw on liquidity from its liquidity provider, allowing
the covered clearing agency to account for the potential wrong-way risk
associated with reliance on participants or their affiliates as
liquidity providers. Although there may be circumstances where it would
be appropriate for a covered clearing agency to incorporate the
policies and procedures such as those suggested by the commenter, the
Commission's approach to Rule 17Ad-22(e) focuses on principles. The
circumstances may vary, and a covered clearing agency should
appropriately manage its risks as they arise, considering the full set
of tools available and its risk management framework. Accordingly,
after careful consideration, the Commission declines to accept the
commenter's suggestion with respect to wrong-way risk because it would
be inconsistent with the overall approach to Rule 17Ad-22(e).\358\
---------------------------------------------------------------------------
\356\ See The Clearing House at 13.
\357\ See id. at 3.
\358\ See supra Part II.B.
---------------------------------------------------------------------------
In addition, the commenter stated that the reliance on committed
funding arrangements in proposed Rule 17Ad-22(a)(15) may lead to this
overreliance on participants or their affiliates for liquidity.\359\
The Commission addresses
[[Page 70822]]
this aspect of the comment below in Part II.C.7.b.iii.
---------------------------------------------------------------------------
\359\ See The Clearing House at 3.
---------------------------------------------------------------------------
iii. Qualifying Liquid Resources
Commenters generally supported the Commission's proposed approach
to determining qualifying liquid resources. One commenter supported the
Commission's overall approach and, in particular, the inclusion of
assets that are readily available and convertible into cash through
repurchase agreements.\360\ Another commenter supported the
Commission's approach to the definition of ``qualifying liquid
resources,'' and expressed the view that expansion of qualifying liquid
resources beyond committed funding arrangements is necessary to ensure
the proper functioning of covered clearing agencies.\361\ The commenter
noted that a committed liquidity facility would generally be preferable
over a non-committed facility, but the commenter also acknowledged that
other aspects of a facility (e.g., size or cost of the facility) may
tip the balance toward selection of the non-committed facility. In
particular, the commenter emphasized the unique liquidity needs of
clearing entities, the limited number and capacity of liquidity
providers in the market that are willing and able to participate in
committed liquidity facilities for clearing entities, and the
commercial and regulatory realities that could constrain the
availability of committed facilities for covered clearing
agencies.\362\ The Commission is mindful of these concerns, but notes
that policies and procedures providing for the use of uncommitted
facilities must also satisfy the terms of Rule 17Ad-22(e)(15) to
address general business and operational risk that could arise from
such uncommitted facilities.
---------------------------------------------------------------------------
\360\ See CME at 4.
\361\ See OCC at 11.
\362\ See id. at 11-12.
---------------------------------------------------------------------------
One commenter stated that requiring covered clearing agencies to
rely on committed funding arrangements in all cases could increase a
covered clearing agency's reliance on its participants or their
affiliated banks and potentially exacerbate a liquidity crisis by
transferring the risk of a covered clearing agency to its liquidity
providers and vice versa.\363\ However, the comment assumes that the
rule prohibits reliance on other types of facilities or prearranged
funding arrangements, which is not the case. To some degree, the
purpose of a liquidity facility is to transfer risk from the covered
clearing agency to its liquidity providers. Further, the resources
described in the definition of ``qualifying liquid resources'' should
be viewed as part of a hierarchy, where cash should be the primary
source of liquid resources, followed first by prearranged funding
arrangements and last by other assets readily available and eligible
for pledging to a relevant central bank in a jurisdiction that permits
such pledges. In addition, within the class of prearranged funding
arrangements, available committed arrangements without material adverse
change (``MAC'') provisions generally should be obtained before seeking
to obtain other prearranged funding arrangements determined to be
highly reliable even in extreme but plausible market conditions by the
covered clearing agency's board of directors. The Commission believes
that a covered clearing agency generally should consider having
policies and procedures that establish a preference for cash and
prearranged funding arrangements, but the Commission acknowledges that
a covered clearing agency's policies and procedures may need to account
for the extent to which such resources are available to them given the
size of their liquidity demands.
---------------------------------------------------------------------------
\363\ See The Clearing House at 13.
---------------------------------------------------------------------------
With respect to whether and how repurchase agreements might fit
within the definition of qualifying liquid resources, one commenter
stated that prearranged and highly reliable funding arrangements may be
demonstrated through non-committed repurchase agreement facilities with
major bank-dealers.\364\ According to the commenter, a covered clearing
agency relying on such a facility would need to ensure that it is
structured appropriately to be highly reliable, taking into account the
fact that a facility may be used in a clearing member default scenario
in extreme market circumstances. The commenter also stated that a
covered clearing agency's procedures for making draws on uncommitted
repurchase facilities should specifically contemplate the timing of
close-out arrangements for defaulted clearing members and should
provide for draws on such facilities to be made by specified times
during business day mornings to ensure that dealer banks have
sufficient time to facilitate liquidation of the U.S. Treasury
securities. The commenter believed this approach would be fully
consistent with the PFMI.\365\ The Commission notes that this type of
approach, reflected in the policies and procedures of a covered
clearing agency as part of a broader attempt to define qualifying
liquid resources comprehensively, could be consistent with the
Commission's definition of prearranged funding arrangements determined
to be highly reliable even in extreme but plausible market conditions
by the board of directors of the covered clearing agency, assuming it
was subject to a not less than annual review.\366\ The Commission
believes that the board of directors of a covered clearing agency
generally should rely on rigorous analysis of the properties of a
prearranged funding arrangement, in making a determination that it was
highly reliable in extreme but plausible market conditions.
---------------------------------------------------------------------------
\364\ See ISDA at 4.
\365\ See id.
\366\ Such policies and procedures should also address the due
diligence of the liquidity provider, as discussed above. See supra
Part II.C.7.b.ii.
---------------------------------------------------------------------------
With respect to the rule's reference to ``material adverse change
provisions,'' two commenters recommended that the reference be removed.
One commenter noted that the proposed rule text appears to be in
tension with the preamble of the CCA Standards proposing release
because it includes, among qualifying liquid resources, prearranged
funding arrangements other than committed arrangements, but only where
such arrangements have no MAC provisions.\367\ The commenter stated
that, by definition, a non-committed facility is uncommitted and
therefore MAC provisions are inapplicable.\368\ The commenter further
noted that this is a liquidity standard not set forth in the PFMI,
which will lead to confusion and inconsistency in attempting to apply
the standard. The commenter recommended that the reference to MAC
clauses in the proposed definition of ``qualifying liquid resources''
be removed.\369\ The second commenter similarly recommended that the
Commission remove the reference to MAC clauses in the definition of
qualifying liquid resources for prearranged funding arrangements other
than committed arrangements, noting that Master Repurchase Agreements
do not have MAC clauses because they are uncommitted facilities.\370\
---------------------------------------------------------------------------
\367\ See ISDA at 5.
\368\ See id.
\369\ See id.
\370\ See CME at 4.
---------------------------------------------------------------------------
In response to the comments, the Commission is modifying the
proposed definition of ``qualifying liquid resources'' so that only
paragraph (A) includes a prohibition on MAC clauses. For uncommitted
facilities, because they are by their terms uncommitted, the party
providing an uncommitted facility generally would have no need to
include a MAC clause. In contrast, a party providing a committed
facility could choose to contract into an
[[Page 70823]]
arrangement with or without a MAC clause, at the party's discretion. As
noted above, the Commission believes that a covered clearing agency
generally should consider having policies and procedures that establish
a preference for cash and prearranged funding arrangements. Within the
category of prearranged funding arrangements, the Commission also
believes that a covered clearing agency generally should preference
committed arrangements over other types of prearranged funding
arrangements, and that within the category of committed arrangements, a
covered clearing agency generally should preference those without MAC
clauses over those with MAC clauses. The Commission notes that a
covered clearing agency would, when relying on a committed funding
arrangement with a MAC clause pursuant to the definition of
``qualifying liquid resources,'' also need to have policies and
procedures demonstrating that such committed facility was a prearranged
funding arrangement determined to be highly reliable even in extreme
but plausible market conditions by the board of directors following a
review conducted for this purpose no less than annually. The Commission
also believes that, as a general matter, policies and procedures
regarding qualifying liquid resources, including those related to
prearranged funding arrangements, would constitute a proposed rule
change under Section 19(b) of the Exchange Act and, for designated
clearing agencies, an advance notice under the Clearing Supervision
Act.
c. Final Rule
The Commission is adopting two modifications to the definition of
``qualifying liquid resources'' and, because of other modifications to
Rule 17Ad-22(a), moving the definition to Rule 17Ad-22(a)(14).\371\ The
Commission is modifying paragraph (ii) so that the reference to MAC
clauses is tied to committed arrangements rather than prearranged
funding arrangements more generally, as previously described in Part
II.C.7.b.iii. In addition, because not all central banks permit
pledging certain assets that are readily available and eligible for
pledging, the Commission is modifying paragraph (iii) to clarify that
practices with respect to routine credit at a central bank may vary
across jurisdictions.
---------------------------------------------------------------------------
\371\ See Rule 17Ad-22(a)(14), infra Part VI.
---------------------------------------------------------------------------
The Commission is also adopting Rule 17Ad-22(e)(7) with
modifications.\372\ First, the Commission is modifying Rule 17Ad-
22(e)(4)(vi)(A) to refer to ``stress testing'' rather than ``a stress
test'' to improve consistency with the definition of ``stress testing''
in Rule 17Ad-22(a)(17). Second, the Commission is modifying Rule 17Ad-
22(e)(7)(vi)(C) in two ways. To improve consistency with Rule 17Ad-
22(e)(4)(vi)(C), the Commission is adding ``or'' to link ``display high
volatility'' with ``become less liquid'' because these concepts are
intended to describe events related to the products cleared or markets
served. This change corrects a typographical error in the CCA Standards
proposing release.\373\ The Commission is also replacing ``and'' with
``or'' in Rule 17Ad-22(e)(7)(vi)(C) so that the criteria for conducting
analysis more frequently than monthly are disjunctive rather than
conjunctive, since the list of criteria is open to other appropriate
circumstances described in a covered clearing agency's policies and
procedures and may not be correlated. Third, the Commission is making
two modifications in adopting Rule 17Ad-22(e)(7)(vi)(D) to correct
technical errors in the proposed rule text: (i) References to
paragraphs (e)(6)(vii)(B) and (C) will be changed to paragraphs
(e)(7)(vi)(B) and (C) respectively; and (ii) the rule will refer to the
covered clearing agency's ``liquidity'' risk management framework,
rather than its ``credit'' risk management framework. These
modifications are consistent with the Commission's discussion of the
proposed rule in the CCA Standards proposing release.\374\ Fourth, the
Commission is striking ``conforming'' from Rule 17Ad-22(e)(7)(vii) to
be consistent with the modifications to the definition of ``model
validation'' discussed in Part II.C.4.c.
---------------------------------------------------------------------------
\372\ See Rule 17Ad-22(e)(7), infra Part VI.
\373\ See CCA Standards proposing release, supra note 5, at
29534.
\374\ See id.
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(7), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address liquidity risk:
Whether it has a robust framework to manage its liquidity
risks from its participants, settlement banks, nostro agents, custodian
banks, liquidity providers, and other entities;
whether it 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;
whether it maintains sufficient liquid resources in all
relevant currencies to settle securities-related payments, make
required variation margin payments, and meet other payment obligations
on time with a high degree of confidence under a wide range of
potential stress scenarios, including but not limited to the default of
the participant and its affiliates that would generate the largest
aggregate payment obligation to the covered clearing agency in extreme
but plausible market conditions;
for the purpose of meeting its minimum liquid resource
requirement, whether its qualifying liquid resources in each currency
include cash at the central bank of issue and at creditworthy
commercial banks, committed lines of credit, committed foreign exchange
swaps, and committed repos, as well as highly marketable collateral
held in custody and investments that are readily available and
convertible into cash with prearranged and highly reliable funding
arrangements, even in extreme but plausible market conditions;
whether it supplements its qualifying liquid resources
with other forms of liquid resources and, if so, whether these liquid
resources are in the form of assets likely to be saleable or acceptable
as collateral for lines of credit, swaps, or repos on an ad hoc basis
following a default, even if this cannot be reliably prearranged or
guaranteed in extreme market conditions;
if it does not have access to routine central bank credit,
whether it takes account of what collateral is typically accepted by
the relevant central bank, as such assets may be more likely to be
liquid in stressed circumstances, and does not assume the availability
of emergency central bank credit as a part of its liquidity plan;
whether it obtains a high degree of confidence, through
rigorous due diligence, that each provider of its minimum required
qualifying liquid resources, whether a participant of the FMI or an
external party, has sufficient information to understand and to manage
its associated liquidity risks, and that it has the capacity to perform
as required under its commitment;
where relevant to assessing a liquidity provider's
performance reliability with respect to a particular currency, whether
a liquidity provider's potential access to credit from the central bank
of issue may be taken into account;
whether it regularly tests its procedures for accessing
its liquid resources at a liquidity provider;
[[Page 70824]]
if it has access to central bank accounts, payment
services, or securities services, whether it uses these services, where
practical, to enhance its management of liquidity risk;
whether it determines the amount and regularly tests the
sufficiency of its liquid resources through rigorous stress testing;
whether it has clear procedures to report the results of its stress
tests to appropriate decision makers at the covered clearing agency and
to use these results to evaluate the adequacy of and adjust its
liquidity risk-management framework;
in conducting stress testing, whether it considers a wide
range of relevant scenarios, including relevant peak historic price
volatilities, shifts in other market factors such as price determinants
and yield curves, multiple defaults over various time horizons,
simultaneous pressures in funding and asset markets, and a spectrum of
forward-looking stress scenarios in a variety of extreme but plausible
market conditions;
whether such scenarios take into account the design and
operation of the covered clearing agency, include all entities that
might pose material liquidity risks to the covered clearing agency
(such as settlement banks, nostro agents, custodian banks, liquidity
providers, and linked clearing agencies), and where appropriate, cover
a multiday period, and, whether, in all cases, it documents its
supporting rationale for, and has appropriate governance arrangements
relating to, the amount and form of total liquid resources it
maintains;
whether it has explicit rules and procedures that enable
the covered clearing agency to effect same-day and, where appropriate,
intraday and multiday settlement of payment obligations on time
following any individual or combined default among its participants;
whether these rules and procedures address unforeseen and
potentially uncovered liquidity shortfalls and should aim to avoid
unwinding, revoking, or delaying the same-day settlement of payment
obligations; \375\ and
---------------------------------------------------------------------------
\375\ The Commission notes that while Rule 17Ad-22(e)(7)(viii)
requires policies and procedures to address foreseeable liquidity
shortfalls, a covered clearing agency also generally should consider
how best to identify unforeseen and potentially uncovered liquidity
shortfalls. For example, a covered clearing agency may be able to
identify unforeseen liquidity shortfalls using hypothetical stress
scenarios and reverse stress testing of liquid resources.
---------------------------------------------------------------------------
whether these rules and procedures indicate the covered
clearing agency's process to replenish any liquidity resources it may
employ during a stress event, so that it can continue to operate in a
safe and sound manner.
In addition, with respect to creditworthy commercial banks under Rule
17Ad-22(a)(14), a covered clearing agency generally should assess the
creditworthiness of its commercial banks, such as by considering their
particular circumstances in which they operate and the markets which
they service.
With respect to assets convertible into cash under Rule 17Ad-
22(a)(14), the Commission notes that the mere ownership of assets that
a covered clearing agency may consider readily available and
convertible into cash--based on factors such as the historical volume
of trading in a particular market for such asset--depending on the
circumstances may not count towards its ``qualifying liquid resources''
unless one of the prearranged funding arrangements in place would allow
the covered clearing agency to receive cash in a timely manner. With
respect to the requirements for qualifying liquid resources more
generally, the Commission notes that a covered clearing agency
generally should consider the lower of the value of the assets capable
of being pledged and the amount of the commitment (or the equivalent
availability under a highly reliable prearranged facility) as the
amount that counts towards qualifying liquid resources in the event
there is any expected difference between the two.\376\
---------------------------------------------------------------------------
\376\ For purposes of complying with Rule 17Ad-22(e)(7)(ii),
factors that may be relevant for a covered clearing agency to
consider when defining its qualifying liquid resources could include
(i) the portion of its default fund that is held as cash, (ii) the
portion of its default fund that is held as securities, (iii) the
portion of any excess default fund contributions held as cash that
could be used by the covered clearing agency to meet liquidity
needs, (iv) the portion of any excess default fund contributions
held as securities that could be used by the covered clearing agency
to meet liquidity needs, (v) the amount at any given time of
securities or cash delivered by members that a covered clearing
agency may be able to use to meet liquidity needs upon the default
of a member, and (vi) the borrowing limits under any committed
funding arrangement.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(e)(7)(ii), the Commission notes that,
for example, if payment obligations were denominated in U.S. dollars,
the minimum liquidity resource requirement would refer to a U.S. dollar
amount.
With respect to Rule 17Ad-22(e)(7)(iii) and access to routine
credit at a central bank, the Commission notes that a covered clearing
agency is not required to use central bank account services but,
rather, is required to establish, implement, maintain and enforce
written policies and procedures reasonably designed facilitate such use
when available and practical. As noted above, whether the services are
available or considered to be practical may vary across
jurisdictions.\377\ Access to routine credit at a relevant central
bank, and the collateral required by such central bank to be posted to
secure a loan, may be determined at the discretion of the central bank.
---------------------------------------------------------------------------
\377\ The Commission notes that the term ``central bank'' is not
limited to a Federal Reserve Bank. A covered clearing agency based
in or operating outside of the United States that has access to
routine credit at other central banks would be able to take this
into consideration when assessing the amount of its qualifying
liquid resources.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(e)(7)(iv) and the policies and
procedures for due diligence required thereunder, ``due diligence'' has
the same meaning as is commonly understood by market participants. A
covered clearing agency generally should not rely solely on
representations made by a liquidity provider but instead should conduct
an assessment of the liquidity provider's business, in light of the
covered clearing agency's own business and the composition of its
existing liquidity providers. Policies and procedures to develop a
reasonable basis under Rule 17Ad-22(e)(7)(iv) could include
interviewing the liquidity provider's staff and reviewing both public
and non-public documents that would allow the covered clearing agency
to gather information about relevant factors, including but not limited
to the strength of the liquidity provider's financial condition, its
risk management capabilities, and its internal controls.
With respect to Rule 17Ad-22(e)(7)(v), a covered clearing agency
generally should test its access to liquidity resources by verifying
that a liquidity provider is able to provide the relevant liquidity
resources in the manner intended under the terms of a funding
arrangement and without undue delay by, for example, promptly funding a
draw on the covered clearing agency's credit facility. The Commission
recognizes that testing procedures also could include test draws funded
by the liquidity provider or tests of electronic connectivity between
the covered clearing agency and the liquidity provider. Testing with
liquidity providers may not always be practicable in the absence of
committed liquidity arrangements. In addition, a covered clearing
agency generally should conduct the testing not less than once every
twelve months.
[[Page 70825]]
With respect to Rule 17Ad-22(e)(7)(vii) and policies and procedures
for performing the model validation not less than annually, a covered
clearing agency generally should perform the model validation not less
than once every twelve months.
With respect to Rule 17Ad-22(e)(7)(viii) and foreseeable liquidity
shortfalls, foreseeable liquidity shortfalls could include potential
shortfalls that can be identified through testing a covered clearing
agency's financial resources.\378\ The Commission recognizes that
foreseeable liquidity shortfalls could occur even when a covered
clearing agency is in compliance with the proposed requirements of Rule
17Ad-22(e)(7), such as when the covered clearing agency is unable to
obtain liquidity pursuant to prearranged funding arrangements that are
uncommitted.
---------------------------------------------------------------------------
\378\ See supra note 375.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(e)(7)(x), a covered clearing agency is
not required to adopt a ``cover two'' standard for liquidity risk but
is responsible for undertaking such an analysis at least once a year,
pursuant to the covered clearing agency's policies and procedures under
Rule 17Ad-22(e)(7)(x). In making any determination regarding the sizing
of a covered clearing agency's liquid resources to exceed ``cover
one,'' a covered clearing agency could consider, among other things,
(i) the business model of the covered clearing agency, such as a
utility model (which may be also referred to as an ``at cost'' model)
versus a for-profit model; (ii) diversification of its members'
business models as they impact the members' ability to supply liquidity
to the covered clearing agency; (iii) concentration of membership of
the covered clearing agency, as the breadth of the membership may
affect the ability to draw liquidity from members; (iv) levels of usage
of the covered clearing agency's services by members, as the
concentration of demand on the covered clearing agency's services may
bear upon potential liquidity needs; (v) the relative concentration of
members' market share in the cleared products; (vi) the degree of
alignment of interest between member ownership of the covered clearing
agency and the provision of funding to the covered clearing agency; and
(vii) the nature of, and risks associated with, the products cleared by
the covered clearing agency.
8. Rule 17Ad-22(e)(8): Settlement Finality
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(8) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to define the point at which
settlement is final no later than the end of the day on which the
payment or obligation is due and, where necessary or appropriate,
intraday or in real time.\379\
---------------------------------------------------------------------------
\379\ See CCA Standards proposing release, supra note 5, at
29537-38.
---------------------------------------------------------------------------
b. Comments Received
The Commission received no comments regarding the proposed rule.
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(8) with one
modification.\380\ To remove potential ambiguity as to the timing of
settlement finality under the rule, the Commission is modifying Rule
17Ad-22(e)(8) to state that the point at which settlement is final is
``to be'' no later than the end of the day on which the payment or
obligation is due and, where necessary or appropriate, intraday or in
real time. As modified, Rule 17Ad-22(e)(8) identifies the point at
which settlement is final, which must be defined in a covered clearing
agency's written policies and procedures, and removes the potential
ambiguity that could have allowed an alternative interpretation of the
rule that did not clearly link the concept of settlement finality to
``no later than the end of the day on which the payment or obligation
is due and, where necessary or appropriate, intraday or in real time.''
---------------------------------------------------------------------------
\380\ See Rule 17Ad-22(e)(8), infra Part VI.
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(8), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address settlement finality:
Whether its policies and procedures clearly define the
point at which settlement is final;
whether it completes final settlement no later than the
end of the value date, and preferably intraday or in real time, to
reduce settlement risk; and
whether it clearly defines the point after which unsettled
payments, transfer instructions, or other obligations may not be
revoked by a participant.
In addition, clearly defining the point at which settlement is final
might include adopting policies and procedures (i) establishing that a
cut-off point after which unsettled payments, transfer instructions, or
other obligations may not be revoked by a clearing member and (ii)
providing clearing members with guidance regarding extensions for
members with operating problems, such as the approval or duration of
such extensions. Policies or procedures creating material uncertainty
regarding when final settlement will occur or that permit the back-
dating or ``as of'' dating of a transaction that settles after the end
of the day on which the payment or obligation is due generally would
not comply with Rule 17Ad-22(e)(8). With respect to policies and
procedures requiring intraday or real-time finality to reduce risk,
such efforts would be necessary and appropriate when, for example, the
risks in question are material or when the opportunity to require
intraday or real-time finality is available and would be reasonable,
whether in economic or other terms, to implement.
9. Rule 17Ad-22(e)(9): Money Settlements
As proposed, Rule 17Ad-22(e)(9) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to conduct its money settlements in
central bank money, where available and determined to be practical by
the board of directors of the covered clearing agency, and minimizes
and manages credit and liquidity risk arising from conducting its money
settlements in commercial bank money if central bank money is not used
by the covered clearing agency.\381\
---------------------------------------------------------------------------
\381\ See CCA Standards proposing release, supra note 5, at
29538-39.
---------------------------------------------------------------------------
The Commission received no comments regarding the proposed rule and
is adopting it as proposed.\382\ Because the Commission recognizes that
there may be a number of ways to address compliance with Rule 17Ad-
22(e)(9), the Commission is providing the following guidance that a
covered clearing agency generally should consider in establishing and
maintaining policies and procedures that address money settlements:
---------------------------------------------------------------------------
\382\ See Rule 17Ad-22(e)(9), infra Part VI.
---------------------------------------------------------------------------
Whether it conducts its money settlements in central bank
money, where practical and available, to avoid credit and liquidity
risks;
if it does not use central bank money, whether it conducts
its money settlements using a settlement asset with little or no credit
or liquidity risk;
[[Page 70826]]
if it settles in commercial bank money, whether it
monitors, manages, and limits its credit and liquidity risks arising
from commercial settlement banks by, for example, establishing and
monitoring adherence to strict criteria for its settlement banks that
take account of, among other things, their regulation and supervision,
creditworthiness, capitalization, access to liquidity, and operational
reliability, and whether it monitors and manages the concentration of
credit and liquidity exposures to its commercial settlement banks;
if it conducts money settlements on its own books, whether
it minimizes and strictly controls its credit and liquidity risks; and
whether its legal agreements with any settlement banks
state clearly when transfers on the books of individual settlement
banks are expected to occur, that transfers are to be final when
effected, and that funds received are transferable as soon as possible
at a minimum by the end of the day, and ideally intraday, to enable the
covered clearing agency and its participants to manage credit and
liquidity risks.
While Rule 17Ad-22(e)(9) would permit a covered clearing agency to use
multiple settlement banks to monitor and manage concentration of
payments among its commercial settlement banks, in such circumstances
its policies and procedures generally should consider the degree to
which concentration of a covered clearing agency's exposure to a
commercial settlement bank is affected or increased by multiple
relationships with the settlement bank, including (i) where the
settlement bank is also a participant in the covered clearing agency,
or (ii) where the settlement bank provides back-up liquidity resources
to the covered clearing agency.
In addition, the Commission believes that a covered clearing agency
generally should consider using commercial bank money only when central
bank money is not practicable or available. In some cases, the use of
central bank money may not be practical because direct access to
central bank accounts and payment services may not be available to all
clearing agencies or members in all circumstances. For example, when a
covered clearing agency operates in multiple currencies, certain
central bank accounts may not be operational at the time money
settlements occur.
10. Rule 17Ad-22(e)(10): Physical Delivery Risks
As proposed, Rule 17Ad-22(e)(10) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish and maintain
transparent written standards that state its obligations with respect
to the delivery of physical instruments and operational practices that
identify, monitor, and manage the risk associated with such physical
deliveries.\383\
---------------------------------------------------------------------------
\383\ See CCA Standards proposing release, supra note 5, at
29539-40.
---------------------------------------------------------------------------
The Commission received no comments regarding the proposed rule and
is adopting it as proposed.\384\ Because the Commission recognizes that
there may be a number of ways to address compliance with Rule 17Ad-
22(e)(10), the Commission is providing the following guidance that a
covered clearing agency generally should consider in establishing and
maintaining policies and procedures that address physical delivery
risks:
---------------------------------------------------------------------------
\384\ See Rule 17Ad-22(e)(10), infra Part VI.
---------------------------------------------------------------------------
Whether its rules clearly state its obligations with
respect to the delivery of physical instruments or commodities; and
whether it has identified, monitored, and managed the
risks and costs associated with the storage and delivery of physical
instruments or commodities.
The Commission notes that practices regarding physical delivery vary
based on the types of assets that a covered clearing agency settles.
Nevertheless, a covered clearing agency generally should consider
having policies and procedures that state clearly which asset classes
it accepts for physical delivery and the procedures surrounding the
delivery of each. In addition, physical delivery may require the
involvement of multiple parties, including the clearing agency itself,
its members, customers, custodians, and transfer agents. In particular,
a covered clearing agency generally should consider having policies and
procedures that address its relationship with transfer agents generally
and, in particular, with respect to instructions for deposit and
withdrawal at a custodian.
A covered clearing agency could employ several different
arrangements pursuant to the requirements of Rule 17Ad-22(e)(10). For
example, if a covered clearing agency takes physical delivery of
securities from its members in return for payments of cash, then it
generally should inform its members of the extent of the clearing
agency's obligations to make payment. A covered clearing agency
generally should employ policies and procedures that clearly state any
obligations it incurs to members for losses incurred in the delivery
process. Policies and procedures generally should also clearly state
rules or obligations regarding definitions for acceptable physical
instruments, the location of delivery sites, rules for storage and
warehouse operations, and the timing of delivery. Such policies and
procedures can help mitigate operational risks associated with physical
deliveries by including provisions to review and assess the
qualifications of potential employees, including, among other things,
reference and background checks and employee training. Such policies
and procedures could also relate to theft, loss, counterfeiting,
deterioration of or damage to assets, and employee duties for the
recordkeeping for and holding of physical assets.
11. Rule 17Ad-22(e)(11): CSDs
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(11)(i) would require a covered
clearing agency that provides CSD services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain securities in an immobilized or dematerialized
form for their transfer by book entry, ensure the integrity of
securities issues, and minimize and manage the risks associated with
the safekeeping and transfer of securities. Proposed Rule 17Ad-
22(e)(11)(ii) would require a covered clearing agency that provides CSD
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to implement internal auditing and
other controls to safeguard the rights of securities issuers and
holders, prevent the unauthorized creation or deletion of securities,
and conduct periodic and at least daily reconciliation of securities
issues it maintains. Finally, proposed Rule 17Ad-22(e)(11)(iii) would
require a covered clearing agency that provides CSD services to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to protect assets against custody risk
through appropriate rules and procedures consistent with relevant laws,
rules, and regulations in jurisdictions where it operates.\385\
---------------------------------------------------------------------------
\385\ See CCA Standards proposing release, supra note 5, at
29540-43.
---------------------------------------------------------------------------
b. Comment Received and Commission Response
The Commission received one comment regarding proposed Rule 17Ad-
22(e)(11). The commenter expressed concern that the language in
proposed Rule 17Ad-22(e)(11)(i), which requires the policies and
procedures of a covered clearing agency providing
[[Page 70827]]
CSD services to be reasonably designed to ensure the integrity of
securities issues, differs materially from PFMI Principle 11 and FRB's
Regulation HH, both of which require that an entity ``help'' ensure the
integrity of securities issues.\386\ The commenter also expressed the
concern that no covered clearing agency is in a position to guarantee
the integrity of the securities.\387\ As a result, the commenter urged
the Commission to include the words ``to help'' before ``ensure,'' to
avoid any interpretation that clearing agencies providing CSD services
are held to a materially higher standard than the commenter believes is
the Commission's intention.\388\ In the alternative, the commenter
proposed the substitution of another phrase (e.g., ``to promote'' or
``to protect'') that accurately characterized the cooperative nature of
CSDs.\389\
---------------------------------------------------------------------------
\386\ See DTCC at 7 (emphasis in original).
\387\ See id. at 7.
\388\ See id. at 8.
\389\ See id.
---------------------------------------------------------------------------
In response to the comment received, the Commission notes that the
rule text does not require a covered clearing agency to ensure or
guarantee the integrity of securities issues; rather, Rule 17Ad-
22(e)(11) requires policies and procedures reasonably designed to
ensure the integrity of securities issues. The Commission believes that
the policies and procedures nature of the rule mitigates the concern
raised by the commenter because the rule requires a covered clearing
agency to ensure that its policies and procedures are reasonably
designed to ensure the integrity of securities issues and it does not
require a covered clearing agency to ensure the integrity of securities
issues. The Commission is not modifying proposed Rule 17Ad-22(e)(11) to
add the words ``to help'' before ``ensure'' because, in the
Commission's view, such an addition would inappropriately weaken the
rule. Although the rule does not require a guarantee of the integrity
of securities issues, the rule does require reasonably designed
policies and procedures. Rule 17Ad-22(e)(11) recognizes that reasonably
designed policies and procedures with respect to the integrity of
securities issues is important for investor protection. In this regard,
the Commission believes that such policies and procedures generally
should be designed to prohibit overdrafts and debit balances in
securities accounts, which can create unauthorized issuances of
securities that undermine the integrity of the covered clearing
agency's services.
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(11) as proposed.\390\
Because the Commission recognizes that there may be a number of ways to
address compliance with Rule 17Ad-22(e)(11), the Commission is
providing the following guidance that a covered clearing agency
generally should consider in establishing and maintaining policies and
procedures that address CSD services:
---------------------------------------------------------------------------
\390\ See Rule 17Ad-22(e)(11), infra Part VI.
---------------------------------------------------------------------------
Whether it has appropriate rules, procedures, and
controls, including robust accounting practices, to safeguard the
rights of securities issuers and holders, to prevent the unauthorized
creation or deletion of securities, and to conduct periodic and at
least daily reconciliation of the securities it maintains;
whether it prohibits overdrafts and debit balances in
securities accounts;
whether it maintains securities in an immobilized or
dematerialized form for their transfer by book entry and, where
appropriate, whether it provides incentives to immobilize or
dematerialize securities;
whether it protects assets against custody risk through
appropriate rules and procedures consistent with its legal framework;
whether it employs a robust system that ensures
segregation between its own assets and the securities of its
participants and segregation among the securities of participants; and
whether it identifies, measures, monitors, and manages its
risks from other activities that it may perform and whether additional
tools may be necessary to address such risks.
In addition, the Commission notes that Rule 17Ad-22(e)(11)(i) is not
intended to prohibit a covered clearing agency from continuing to hold
physical certificates on behalf of its members where such securities
currently exist in paper form or from providing other custody-only
services.\391\ The Commission's rules do not prohibit, and in some
respects contemplate, the issuance of securities certificates. For
example, Rule 17Ad-22(e)(11)(i) would not prohibit a covered clearing
agency from holding American depositary shares in custody.\392\
---------------------------------------------------------------------------
\391\ For example, the Commission understands that, in the
United States, CSD services currently include the provision of
custody-only services, in addition to book-entry transfer and
related services that may also include providing custody.
\392\ An American depositary receipt (``ADR''), whether in a
program sponsored or unsponsored by a foreign issuer, is the
physical certificate that evidences American depositary shares,
which represent an ownership interest in a specified number of
securities of a foreign issuer that have been deposited with a
depositary. See Securities Act Release No. 33-6894 (May 23, 1991) 56
FR 24420, 24421 n.5 (May 30, 1991). The shares of a foreign issuer
that underlie an ADR are usually held by a custodian appointed by
the depositary in the country of incorporation of the foreign
issuer, may be in paper certificate form, and may be in the ultimate
custody of the CSD.
---------------------------------------------------------------------------
The Commission also notes that the custody risk described in Rule
17Ad-22(e)(11)(iii) may be related to both physical delivery risk and
operational risk, the latter including risks such as theft, loss,
counterfeiting, and deterioration or damage to assets. To mitigate such
risks, a covered clearing agency could consider obtaining insurance
coverage to help ensure that (i) records of securities held in custody
accurately reflect holdings, and (ii) employee duties for the
recordkeeping and holding of securities are separate and discrete
duties. The Commission notes that dematerialization of securities alone
does not eliminate the applicability of any requirements to protect
against custody risk and instead may create new sources of risk, such
as hacking or digital piracy.
12. Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems
As proposed, Rule 17Ad-22(e)(12) would require a covered clearing
agency, for transactions that involve the settlement of two linked
obligations, to establish, implement, maintain and enforce written
policies and procedures reasonably designed to eliminate principal risk
by conditioning the final settlement of one obligation upon the final
settlement of the other, regardless of whether the covered clearing
agency settles on a gross or net basis and when finality occurs.\393\
---------------------------------------------------------------------------
\393\ See CCA Standards proposing release, supra note 5, at
29543-44.
---------------------------------------------------------------------------
In response to a request for comment as to whether there are
circumstances where it is not feasible or practicable, in an exchange-
of-value settlement context, to ensure that the settlement of one
obligation is final if and only if the settlement of the corresponding
obligation is final, the Commission received one comment. The commenter
stated that such a situation occurs when the settlement of a CDS
contract occurs following a credit event.\394\ In this case, the
commenter stated that there may be some non-delivery versus payment
obligations to be settled, such as loans, and that at least one CCP has
policies and procedures to address this situation to secure settlement.
The commenter expressed the belief that Rule 17Ad-
[[Page 70828]]
22(e)(12) should encompass this situation.\395\
---------------------------------------------------------------------------
\394\ See LCH at 4.
\395\ See id. at 4-5.
---------------------------------------------------------------------------
In response, the Commission notes that the commenter has not
described a linked obligation as contemplated under Rule 17Ad-
22(e)(12), such as the delivery of securities against payment of either
cash or securities in connection with the purchase or sale of a
security, because the commenter has described a non-delivery versus
payment obligation. The Commission therefore believes that the comment
is not within the scope of the settlement mechanisms contemplated by
Rule 17Ad-22(e)(12). While the Commission believes that a covered
clearing agency generally should have policies and procedures to
address ``free-of-payment'' deliveries or the settlement of non-
delivery versus payment obligations if it accepts non-delivery versus
payment obligations, Rule 17Ad-22(e)(12) addresses settlement
mechanisms that eliminate principal risk by ensuring that the final
settlement of one obligation occurs if and only if the final settlement
of the linked obligation occurs.
The Commission also notes that Rule 17Ad-22(e)(8) requires a
covered clearing agency to have policies and procedures to define the
point at which settlement is final. Where a covered clearing agency's
policies and procedures for ensuring settlement finality apply only
when settlement of the corresponding obligation is final, the covered
clearing agency may wish to consider corresponding policies and
procedures that address legal, contractual, operational, and other
risks.
The Commission is adopting Rule 17Ad-22(e)(12) as proposed.\396\
---------------------------------------------------------------------------
\396\ See Rule 17Ad-22(e)(12), infra Part VI.
---------------------------------------------------------------------------
13. Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(13) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency has the authority and operational capacity to take timely action
to contain losses and liquidity demands and continue to meet its
obligations in the event of a participant default. Proposed Rule 17Ad-
22(e)(13)(i) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to address the allocation of credit losses it may
face if its collateral and other resources are insufficient to fully
cover its credit exposures, including the repayment of any funds the
covered clearing agency may borrow from liquidity providers. Proposed
Rule 17Ad-22(e)(13)(ii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to describe its process to replenish any
financial resources it may use following a member default or other
event in which use of such resources is contemplated. Finally, proposed
Rule 17Ad-22(e)(13)(iii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require the covered clearing agency's
participants and, when practicable, other stakeholders to participate
in the testing and review of its default procedures, including any
close-out procedures, at least annually and following material changes
thereto.\397\
---------------------------------------------------------------------------
\397\ See CCA Standards proposing release, supra note 5, at
29544-46.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
i. Limitations on Replenishment of Resources
One commenter stated that the Commission's rule should explicitly
require that replenishment of resources through compulsory means (such
as assessments on clearing members) be subject to a well-defined
cap.\398\ The Commission is declining to modify Rule 17Ad-22(e)(13) to
impose a ``cap'' on the replenishment of resources by a covered
clearing agency. Consideration of whether a cap is appropriate depends
on a number of factors related to the covered clearing agency's
recovery plan as a whole and cannot be viewed in isolation, including,
in particular, what measures a covered clearing agency could implement
in the event that a covered clearing agency experienced losses that
exceeded the ``cap.'' Given this uncertainty and that each covered
clearing agency is structured and operated differently, and that
collectively they clear different products with different risk profiles
and employ different default management procedures, the Commission
believes that a cap may not be appropriate in all circumstances and
could potentially increase, rather than decrease, systemic risk because
it may impede the covered clearing agency's ability to replenish
resources to cover losses in the event of a participant default.\399\
---------------------------------------------------------------------------
\398\ See ISDA at 4.
\399\ See infra Part III.B.3.a.viii (discussing the economic
effects of Rule 17Ad-22(e)(13)).
---------------------------------------------------------------------------
As a general matter, the Commission also believes that the
commenters' recommendation would be inconsistent with the principles-
based approach set forth in Rule 17Ad-22(e).\400\ The Commission
believes that establishing prescriptive standards (such as a cap) that,
on an absolute and ex ante basis, prohibit a covered clearing agency's
use of particular tools for replenishment would make it more difficult
for a covered clearing agency to maintain an appropriate balance
between affording its participants predictability and certainty, and
ensuring that the covered clearing agency can effectively manage risk.
The Commission also notes that policies and procedures related to such
caps or other alternative approaches to limitations on the
replenishment of resources would be related to the development of a
covered clearing agency's recovery and wind-down plans under Rule 17Ad-
22(e)(3).\401\ The Commission has previously stated in Part
II.C.3.b.iii above that, given the nature of recovery planning--as here
with caps--such plans are likely to closely reflect the unique
characteristics of the covered clearing agency and will vary depending
on the products cleared. The Commission believes that these mechanisms
under Rule 17Ad-22(e) would help a covered clearing agency to
appropriately consider, review, and address the need for a cap on
replenishment, pursuant to its governance arrangements.
---------------------------------------------------------------------------
\400\ See supra Part II.B.
\401\ See supra Part II.C.3.b.iii.
---------------------------------------------------------------------------
ii. Risks of Certain Loss Allocation and Limiting Participant Liability
Two commenters recommended models for loss allocation to non-
defaulting customers of clearing members.\402\ One of these commenters
urged the Commission to provide clarification and guidance that Rule
17Ad-22(e)(13) would (i) ensure participant liability is limited,
ascertainable, and manageable and (ii) require a covered clearing
agency to adopt rules specifying and providing risk disclosure
regarding so-called ``end of waterfall'' scenarios.\403\ The commenter
stated that guidance is necessary to ensure that Rule 17Ad-22(e)(13)
complements the requirements
[[Page 70829]]
of Rule 17Ad-22(b)(1),\404\ certain guidance in the Consultative
Recovery Report,\405\ and a number of risk management practices
relevant for participants of covered clearing agencies.\406\ In this
regard, the commenter noted that participants are subject to single
counterparty credit limits, certain accounting criteria for netting
their positions cleared at a CCP, and regulatory capital
requirements.\407\ The commenter also noted that such guidance is
necessary to ensure that a covered clearing agency does not become a
transmission mechanism for systemic risk. As a general matter, the
commenter expressed opposition to any CCP risk management practice that
constitutes an unpredictable and uncontrollable loss allocation
arrangement or a restriction on participant withdrawal. For this
purpose, the commenter asked the Commission to adopt the following
clarification and guidance that: (i) A covered clearing agency must
address the consequences of circumstances in which the covered clearing
agency's credit losses upon the default of one or more participants
exceed the resources designated to absorb such losses; (ii) a covered
clearing agency may not provide for (1) the forced allocation of a
defaulted portfolio to a non-defaulting participant other than through
a successfully completed auction process or otherwise with the
participant's agreement, (2) invoicing to non-defaulting participants
of losses on cleared positions in the portfolio(s) of one or more
defaulting participants or (3) non-voluntary tear-ups of previously
matched and cleared positions; and (iii) a covered clearing agency must
clearly specify the process for, and effective time of, withdrawal from
participant status such that a participant may withdraw upon the later
of (1) the closeout or transfer of all its positions and (2) a
reasonable prior notice period, without subjecting such withdrawal to a
discretionary or subjective approval requirement or subjecting the
withdrawing participant to liability for increased exposures after the
effective time of withdrawal.\408\ The remainder of the requested
clarification and guidance would entail affording participants
increased certainty regarding what exposures and obligations might
arise where a CCP encounters an ``end of waterfall'' scenario. For this
reason, the commenter also asked the Commission to clarify that a
covered clearing agency may not redefine the economic terms of
outstanding cleared contracts without a reasonable prior notice and
transition period prior to effectiveness.\409\
---------------------------------------------------------------------------
\402\ See The Clearing House at 4; Vanguard at 6-7.
\403\ See The Clearing House at 4. With respect to these
comments, the Commission understands an ``end of waterfall''
scenario to be a scenario where a covered clearing agency suffers
losses that, due to the default of one or more participants, exceed
in the aggregate the loss-absorbing resources in the covered
clearing agency's default risk management waterfall.
\404\ See 17 CFR 240.17Ad-22(b)(1). Rule 17Ad-22(b)(1) states
that a clearing agency that performs CCP services shall establish,
implement, maintain and enforce written policies and procedures
reasonably designed to measure its credit exposures to its
participants at least once a day and limit its exposures to
potential losses from defaults by its participants under normal
market conditions so that the operations of the clearing agency
would not be disrupted and non-defaulting participants would not be
exposed to losses that they cannot anticipate or control.
\405\ See supra note 126.
\406\ See The Clearing House at 4.
\407\ See The Clearing House at 5.
\408\ See id. at 6. The commenter has also sought clarification
and guidance regarding emergency authority or decision-making at
covered clearing agencies and disclosures regarding such decision-
making and participant-default rules and procedures. See The
Clearing House at 6-7. These comments have been addressed separately
in Parts II.C.2.b and II.C.23.b.
\409\ See id. at 7.
---------------------------------------------------------------------------
The second commenter urged the Commission to prohibit the use of
non-defaulting customer initial, variation and excess margin to aid in
the recovery of a covered clearing agency in the event of financial
stress, such as from credit losses, liquidity shortfalls, or other
losses.\410\ According to the commenter, in such a case losses would
effectively be allocated to participants who have not contributed to
the loss. The commenter contended that such exposure is not present in
the OTC swaps market, where customer assets are protected in segregated
custody accounts. The commenter also stated that participants have no
means to assess and mitigate such risk, since they do not have
transparency into the financial health and risk management practices of
their fellow participants, security-based swap dealers, or the covered
clearing agency itself. The commenter instead urged the Commission to
consider the development of enhanced recordkeeping and reporting,
enhanced oversight and compliance, enhanced risk management and
mitigation, increased contributions by SBSDs and increased
contributions to, and management of, the covered clearing agency
guaranty fund.\411\
---------------------------------------------------------------------------
\410\ See Vanguard at 6-7.
\411\ See id. at 7.
---------------------------------------------------------------------------
Much of the clarification and guidance sought by the commenters, in
the Commission's view, would entail broad, ex ante prohibitions on a
number of specific default management practices of CCPs, including the
use of uncapped assessment authority, prohibitions on the use of non-
defaulting customer initial, variation, and excess margin to aid in
recovery, forced allocations of defaulted clearing portfolios,
invoicing back of losses arising from a defaulting participant's
positions, and partial non-voluntary tear-ups of previously matched and
cleared positions. As discussed further above,\412\ Rule 17Ad-22(e)
does not prescribe a specific tool or arrangement to achieve its
requirements. The Commission believes that when determining the content
of its policies and procedures with respect to default management, each
covered clearing agency must have the ability to enhance its policies
and procedures to meet the evolving challenges and risks in the
securities market that the covered clearing agency serves. Consistent
with the goals sought by the commenters, the Commission has developed
through the amendments to Rule 17Ad-22 and new Rule 17Ab2-2, an
enhanced oversight and compliance framework that includes enhanced
requirements for the policies and procedures of a covered clearing
agency that govern financial risk management generally and, in
particular, the risk management of guaranty or clearing funds. The
Commission therefore is not adopting the changes sought by these
commenters.
---------------------------------------------------------------------------
\412\ See supra Part II.B.
---------------------------------------------------------------------------
The Commission believes that each covered clearing agency generally
should consider evaluating the strengths and weaknesses of respective
tools so that the covered clearing agency can choose the set most
appropriate for each relevant recovery scenario, including the sequence
in which they should be used. As previously noted in Part II.C.13.b.i,
ensuring that a covered clearing agency does not become a transmission
mechanism for systemic risk means, in part, striking an appropriate
balance between affording its participants predictability and
certainty, on the one hand, and ensuring that the covered clearing
agency can effectively manage risk so that it can effectively continue
its risk mitigating function within the broader financial system, on
the other. As a general matter, the Commission believes that striking
such a balance can be difficult using broadly prescriptive standards
that, on an absolute and ex ante basis, prohibit a covered clearing
agency's application of certain risk management tools. Furthermore,
particular requirements under Rule 17Ad-22(e) should not be viewed in
isolation but instead should be considered holistically and in light of
other requirements under the Exchange Act and the Clearing Supervision
Act.
The Commission believes that policies and procedures for
participant default generally should be established,
[[Page 70830]]
maintained, and enforced pursuant to the covered clearing agency's
governance process, which must be consistent with the requirements of
Section 17A of the Exchange Act, Section 19 of the Exchange Act, and
the rules and regulations thereunder, including Rule 19b-4. The
individual topics raised by the commenters would have implications for
the development of a covered clearing agency's recovery and wind-down
plans; however, as noted in Part II.C.3.b.iii above in connection with
the Commission's prior discussion of recovery and wind-down plans, the
impact of such recovery tools the covered clearing agency's recovery
and wind-down plan can only be considered in the context of the plan as
a whole and not in isolation. The organizational and governance
structures of covered clearing agencies vary, as do the composition of
their members and the products they clear, and each is relevant to
consideration of potential loss allocation mechanisms.
iii. Stakeholder Participation in Periodic Testing
One commenter expressed concern that the requirement in proposed
Rule 17Ad-22(e)(13)(iii) for policies and procedures to require
participants and, where practicable, other stakeholders in the covered
clearing agency to participate in periodic testing and review of its
default procedures may be read to require a covered clearing agency to
mandate the participation of all its participants in such tests.\413\
The commenter expressed concern that such a requirement would not be
realistically achievable, of sufficient benefit to outweigh the time
and costs, or appropriate given the sensitive nature of information
involved in such tests. The commenter expressed the belief that covered
clearing agencies can accomplish the objective of proposed Rule 17Ad-
22(e)(13)(iii) by methods other than mandating participation in annual
closeout tests and requested discretion and flexibility to achieve such
objective.\414\
---------------------------------------------------------------------------
\413\ See DTCC at 8-9.
\414\ See id.
---------------------------------------------------------------------------
First, the Commission notes that the commenter provided no estimate
of the time or costs of testing.\415\ More generally, the Commission
notes that the testing requirements in proposed Rule 17Ad-
22(e)(13)(iii) are similar to requirements for members or participants
to participant in business continuity and disaster recovery plans
testing under Regulation SCI, and therefore registered clearing
agencies are already subject to requirements for members to participate
in such testing and have had to consider how to treat sensitive
material in such testing. As with Rule 1004 of Regulation SCI, the
Commission continues to believe that participation rates by members and
participants in voluntary industry-led testing has generally been low,
and that mandatory participation is the best means to achieve effective
and coordinated testing with assured participation by the more
significant members and participants.\416\ The Commission notes,
however, that proposed Rule 17Ad-22(e)(13)(iii) does not specify that
all participants in the clearing agency participate in every periodic
test and review of its default procedures. A covered clearing agency
may designate in its policies and procedures that certain participants,
or certain categories of participants, be designated for participation
in certain tests.
---------------------------------------------------------------------------
\415\ See supra Part III.B.3.a.viii (discussing the economic
effect of Rule 17Ad-22(e)(13)(iii)).
\416\ See Regulation SCI adopting release, supra note 30, at
72349.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(13) with one
modification.\417\ As previously noted,\418\ the Commission is moving
the requirements in proposed Rules 17Ad-22(e)(13)(i) and (ii) to Rules
17Ad-22(e)(4)(viii) and (ix), respectively, to consolidate requirements
for management of a covered clearing agency's default waterfall within
a single rule. The Commission believes this modification improves
consistency between Rules 17Ad-22(e)(4) and (7). Specifically, Rule
17Ad-22(e)(4) includes requirements intended to facilitate the
management of credit risk, and proposed Rules 17Ad-22(e)(13)(i) and
(ii) include requirements to address the allocation of credit losses
and the replenishment of funds. Similarly, Rule 17Ad-22(e)(7) includes
requirements intended to facilitate the management of liquidity risk,
and Rules 17Ad-22(e)(7)(viii) and (ix) include requirements to address
liquidity shortfalls and replenish liquid resources. In contrast, Rule
17Ad-22(e)(13) requires a covered clearing agency to have policies and
procedures addressing its authority and operational capacity to take
timely action to contain losses and liquidity demands, and proposed
Rule 17Ad-22(e)(13)(iii) included requirements for the testing of
default procedures. Accordingly, the rules have been reorganized.
---------------------------------------------------------------------------
\417\ See Rule 17Ad-22(e)(13), infra Part VI.
\418\ See supra Part II.C.4.c.
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(13), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address participant-default rules and
procedures:
Whether it has default rules and procedures that enable it
to continue to meet its obligations in the event of a participant
default and that address the replenishment of resources following a
default;
whether it is well prepared to implement its default rules
and procedures, including any appropriate discretionary procedures
provided for in its rules;
whether it publicly discloses key aspects of its default
rules and procedures;
whether it involves its participants and other
stakeholders in the testing and review of its default procedures,
including any close-out procedures; and
whether such testing and review is conducted at least
annually or following material changes to the rules and procedures to
ensure that the testing and review are practical and effective.
In addition, a covered clearing agency that has financial and
operational triggers for default generally should clearly define these
triggers.\419\ Where triggers are not automatic through the application
of objective standards or thresholds, the Commission believes the
discretion afforded a covered clearing agency to declare defaults
should be clearly defined. For example, a clear definition may include
defining which person or group exercises discretionary authority in the
event of default and providing specific examples of when the exercise
of discretion is appropriate.
---------------------------------------------------------------------------
\419\ See Clearing Agency Standards, supra note 5, at 29544. An
operational default may occur when a participant is not able to meet
its obligations due to an operational problem, such as a failure in
information technology systems. Rule 17Ad-22(e)(17) includes
requirements related to operational risk management. See infra Part
II.C.17. In addition, the Commission has also adopted Regulation
SCI, which establishes requirements for SROs, among other entities,
with respect to operational risk management. See supra note 30 and
accompanying text.
---------------------------------------------------------------------------
With respect to policies and procedures related to managing a
participant default, the Commission believes that such policies and
procedures generally should address, among other things (i) accessing
credit facilities, (ii) managing (which may include hedging open
positions and
[[Page 70831]]
funding collateral positions it is not prudent to close out
immediately), transferring (such as through allocation or auction to
other members) and/or closing out a defaulting member's positions; and
(iii) transferring and/or liquidating applicable collateral. Based on
its supervisory experience, the Commission believes that default
procedures would generally set forth (i) the action that may be taken
(e.g., exercising mutualization of losses); (ii) who may take those
actions (e.g., the division of responsibilities when clearing agencies
operate links to other clearing agencies); (iii) the scope of the
actions that may be taken (e.g., any limits on the total losses that
would be mutualized); (iv) potential changes to the normal settlement
practices, should these changes be necessary in extreme circumstances,
to ensure timely settlement; (v) the management of transactions at
different stages of processing; (vi) the sequencing of actions; (vii)
the roles, obligations, and responsibilities of the various parties,
including non-defaulting members; (viii) the mechanisms to address a
covered clearing agency's obligations to non-defaulting members (e.g.,
the process for clearing trades guaranteed by the covered clearing
agency to which a defaulting member is a party); and (ix) the
mechanisms to address the defaulting member's obligations to its
customers (e.g., the process for dealing with a defaulting member's
accounts).
With respect to the operational capacity necessary to comply with
requirements to contain losses, the Commission believes that the
following measures could help promote operational capacity: (i)
Establishing training programs for employees involved in default
matters to ensure policies are well implemented; (ii) developing a
communications strategy for communicating with stakeholders, including
the Commission, concerning defaults; and (iii) making sure the proper
tools and resources (whether these are personnel or other) required are
available to close out, transfer, or hedge open positions of a
defaulting member promptly even in the face of rapid market movements.
With respect to the policies and procedures for testing and review
of default procedures, including any close-out procedures, a covered
clearing agency generally should perform the testing and review not
less than once every twelve months. In addition, a covered clearing
agency generally should make efforts to secure the participation of all
stakeholders in testing and review of default procedures, but the
Commission recognizes that a covered clearing agency may have limited
ability to require said participation by all such stakeholders in all
circumstances.
14. Rule 17Ad-22(e)(14): Segregation and Portability
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(14) would apply only to a covered
clearing agency that is either a security-based swap clearing agency or
a complex risk profile clearing agency. Rule 17Ad-22(e)(14) would
require such a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to enable the segregation and portability of positions of a
member's customers and the collateral provided to the covered clearing
agency with respect to those positions, and effectively protect such
positions and related collateral from the default or insolvency of that
member.\420\
---------------------------------------------------------------------------
\420\ See CCA Standards proposing release, supra note 5, at
29546-47.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
The Commission received multiple comments on Rule 17Ad-22(e)(14)
and, more generally, the Commission's regime for segregation and
portability in the U.S. securities markets. While some commenters
supported the Commission's proposed principles-based approach, a number
of commenters expressed a preference for an approach that would
prescribe, and in some instances mandate, a specific segregation and
portability framework. In addition, two commenters sought clarification
on certain aspects of the proposal relating to portability and
protection of customer assets held at a common covered clearing agency
participant. The Commission discusses these three groups of comments in
turn below.
One commenter strongly supported efforts to improve the protection
of customer positions and collateral.\421\ Another commenter also
expressed general support for the Commission's objective of protecting
customer collateral posted in connection with clearing security-based
swaps, and stated that the implementation of a regulatory structure
that provided for appropriate protection of collateral would reduce
systemic risk by bolstering confidence that losses related to
counterparty risk would be manageable.\422\
---------------------------------------------------------------------------
\421\ See OCC at 12.
\422\ See Fidelity at 1.
---------------------------------------------------------------------------
Several commenters, however, urged the Commission to modify the
proposed rule's approach to the treatment of customer positions,
particularly with respect to security-based swaps. Three commenters
noted the importance of coordinating efforts with other regulators to
ensure that the Commission's rules are consistent with other regulatory
regimes.\423\ Two commenters expressed related concerns that the
proposal could result in significantly weaker protections for security-
based swaps than exist in the OTC market or in the rules for cleared
swaps adopted by the CFTC.\424\ Of these, one commenter opposed the
Commission's approach of providing covered clearing agencies with
discretion to adopt policies and procedures regarding holding of margin
for security-based swaps.\425\ The commenter stated that the Commission
should instead adopt a mandatory threshold level of protection for
customer margin for security-based swaps that is consistent with the
protections afforded to swaps and that is appropriate to the breadth
and depth of the security-based swap market.\426\ Moreover, the same
commenter, along with two other commenters, recommended that the
Commission explicitly adopt the LSOC model as a framework for the
segregation and portability of customer positions,\427\ and two of the
three commenters also urged that the Commission's LSOC regime be
mandatory and uniform.\428\
---------------------------------------------------------------------------
\423\ See id. at 4-5 (noting CFTC requirements); LCH at 5
(noting both CFTC requirements and requirements under EMIR);
Vanguard at 2 (noting CFTC requirements).
\424\ See Fidelity at 1-4; Vanguard at 2.
\425\ See Vanguard at 4.
\426\ See id. (referencing the objectives and principles for the
risk management standards prescribed under 12 U.S.C. 5464(b)); see
also supra note 18.
\427\ See Fidelity at 1-4; ICI at 4, 6; Vanguard at 2.
\428\ See ICI at 4; Fidelity at 3-4.
---------------------------------------------------------------------------
In addition, one commenter that urged the Commission to adopt a
specific LSOC mandate also expressed several other related comments.
The commenter expressed the need for covered clearing agencies to
provide individual segregation as an option for customers.\429\ The
commenter also recommended that both initial and variation margin be
passed on to the covered clearing agency, with all excess margin held
in a segregated account (the ``LSOC with excess'' model).\430\ The
commenter further expressed the belief that security-based swap dealers
and broker-dealers should not be authorized to rehypothecate or use
customer margin or excess margin in its
[[Page 70832]]
business.\431\ Finally, in conjunction with another commenter, this
commenter also submitted a second comment letter noting that, to
implement LSOC for security-based swap positions, the Commission would
need to undertake several initiatives in addition to revising Rule
17Ad-22(e)(14), including amending rules under SIPA, revising proposed
Rule 18a-4 under the Exchange Act, amending Rule 15c3-3 under the
Exchange Act, and permanently extending the relief provided in the
Portfolio Margining order.\432\
---------------------------------------------------------------------------
\429\ See ICI at 12-13.
\430\ See id. at 4-5.
\431\ See id. at 5. Because the commenter's recommendation would
govern the activities of security-based swap dealers and broker-
dealers, the Commission notes that it is beyond the scope of Rule
17Ad-22.
\432\ See AMG-ICI at 8-12. The commenter also noted that the
adoption of a sound and workable segregation regime is essential to
ensure that counterparties are protected in bankruptcy. See ICI at
11-12. The Commission agrees that the development of a covered
clearing agency's segregation and portability regime should consider
the operational and bankruptcy implications of such a regime. The
Commission also notes that the tools available to a covered clearing
agency considering such implications will necessarily depend on the
legal regime applicable to the covered clearing agency. The
commenter recommended that the Commission articulate in a proposal
the operational and bankruptcy implications of such a structure to
provide market participants the opportunity to comment on these
issues. See id. at 4. The Commission believes, however, that the
operational and bankruptcy implications will depend on the
particular tools that a covered clearing agency employs in its
segregation and portability regime and also on the legal regimes
within which the covered clearing agency operates. Because the
Commission is taking a principles-based approach in Rule 17Ad-22(e),
the Commission is not making such a proposal under Rule 17Ad-22(e).
---------------------------------------------------------------------------
After careful consideration, the Commission declines to modify Rule
17Ad-22(e)(14) to explicitly prescribe or mandate the segregation and
portability frameworks described immediately above. The Commission
notes that Rule 17Ad-22(e)(14) provides covered clearing agencies with
flexibility, subject to their obligations and responsibilities as SROs
under the Exchange Act, to determine policies and procedures with
respect to the means of segregation and portability consistent with the
rule. Furthermore, in contrast with the views expressed by the
commenters above, the Commission believes that Rule 17Ad-22(e)(14)
already requires a mandatory threshold level of protection for customer
margin for security-based swaps similar to the threshold level of
protection for swaps because it requires policies and procedures
reasonably designed to both (i) enable the segregation and portability
of positions of a participant's customers and the collateral provided
to the covered clearing agency with respect to those positions, and
(ii) protect such positions and related collateral from the default or
insolvency of that participant.
The Commission believes that prescribing the particular frameworks
identified by the commenters would be inconsistent with the
Commission's principles-based approach to Rule 17Ad-22(e).\433\
Although a tool or method like LSOC might be appropriate for a covered
clearing agency operating in certain domestic markets to meet the
requirements of Rule 17Ad-22(e)(14), in other markets other tools or
methods, such as an individual segregation method, may also provide the
threshold level of protection sought by the commenters while being
consistent with the rule. Moreover, in contrast to the markets for cash
and listed options in the United States, where the structure for
segregation and portability is primarily maintained at the broker-
dealer level,\434\ in the market for security-based swaps the
segregation and portability structure resides in CCPs, and those
entities have taken different approaches reflective of the needs of
their different structures, members, markets served, and products
cleared. For example, the Commission notes that one commenter
understood Rule 17Ad-22(e)(14) to permit a covered clearing agency to
employ either an LSOC model, consistent with the requirements set forth
by the CFTC, or an individual segregation model, consistent with
EMIR.\435\ Accordingly, the Commission does not believe, as requested
by the commenters, that the Commission should mandate LSOC on a uniform
basis across security-based swap and complex risk profile clearing
agencies.
---------------------------------------------------------------------------
\433\ See supra Part II.A.4.
\434\ Exchange Act Rule 15c3-3 requires broker-dealers that
maintain custody of customer securities and cash (a ``carrying
broker-dealer'') to take two primary steps to safeguard these
assets. The steps are designed to protect customers by segregating
their securities and cash from the broker-dealer's proprietary
business activities. If the broker-dealer fails financially, the
securities and cash should be readily available to be returned to
customers. In addition, if the failed broker-dealer is liquidated in
a formal proceeding under the Securities Investor Protection Act of
1970, the securities and cash would be isolated and readily
identifiable as ``customer property'' and, consequently, available
to be distributed to customers ahead of other creditors.
The first step required by Rule 15c3-3 is that a carrying broker
must maintain physical possession or control of all fully paid and
excess margin securities of their customers. See 17 CFR 240.15c3-3.
Physical possession or control means the broker-dealer must hold
these securities in one of several locations specified in Rule 15c3-
3 and free of liens or any other interest that could be exercised by
a third party to secure an obligation of the broker-dealer.
Permissible locations include a bank, as defined in section 3(a)(6)
of the Exchange Act, and a clearing agency. As described herein,
holding jumbo/global positions in the record name and custody of a
clearing agency is a fundamental part of current U.S. market
structure in which many holders hold indirectly through ``street
name.''
The second step is that a carrying broker-dealer must maintain a
reserve of cash or qualified securities in an account at a bank that
is at least equal in value to the net cash owed to customers,
including cash obtained from the use of customer securities. The
account must be titled ``Special Reserve Bank Account for the
Exclusive Benefit of Customers.'' The amount of net cash owed to
customers is computed pursuant to a formula set forth in Exhibit A
to Rule 15c3-3. Under the customer reserve formula, the broker-
dealer adds up customer credit items (e.g., cash in customer
securities accounts and cash obtained through the use of customer
margin securities) and then subtracts from that amount customer
debit items (e.g., margin loans). If credit items exceed debit
items, the net amount must be on deposit in the customer reserve
account in the form of cash and/or qualified securities. A broker-
dealer cannot make a withdrawal from the customer reserve account
until the next computation and then only if the computation shows
that the reserve requirement has decreased. The broker-dealer must
make a deposit into the customer reserve account if the computation
shows an increase in the reserve requirement. See 17 CFR 240.15c3-3.
In addition, records of customer positions are subject to
broker-dealer recordkeeping rules. Exchange Act Rules 17a-3 and 17a-
4 require records be kept for certain periods of time, such as three
or six year periods depending upon the type of record. See 17 CFR
240.17a-3, 17a-4.
See also 15 U.S.C. 78c-5 (providing for segregation with respect
to security-based swaps); Exchange Act Release No. 34-68071 (Oct.
18, 2012), 77 FR 70213, (Nov. 23, 2012) (proposing Rule 18a-4 under
the Exchange Act for segregation with respect to security-based
swaps). The Commission has also granted conditional relief under
Sections 3E(b), (d), and (e) of the Exchange Act to, among others,
clearing entities dually registered with the Commission and the CFTC
as registered clearing agencies and DCOs, respectively. See Exchange
Act Release No. 34-68433 (Dec. 14, 2012), 77 FR 75211 (Dec. 19,
2012).
\435\ See LCH at 5.
---------------------------------------------------------------------------
Notwithstanding its decision not to adopt an approach that
prescribes or mandates a specific portability and segregation
framework, the Commission notes that it has been mindful of the
existing structures for segregation and portability for security-based
swaps in the United States, and has granted relief intended to allow
investors to participate in the market for security-based swaps.
Notably, the Commission has issued an order granting conditional
exemptive relief from compliance with certain provisions of the
Exchange Act in connection with a program to commingle and portfolio
margin customer positions in cleared credit default swaps, which
include both swaps and security-based swaps, in a segregated account
established and maintained in accordance with Section 4d(f) of the
Commodity Exchange Act.\436\ In this regard, the Commission observes
that the individual segregation method is one tool that provides a
[[Page 70833]]
threshold level of protection to customers and may be a tool that a
covered clearing agency determines to employ consistent with the
requirements of Rule 17Ad-22(e)(14). The Commission also observes that
under the ``LSOC with excess'' model, customer margin is segregated
from clearing member margin, and therefore that framework, like LSOC
and individual segregation as previously described, is also a tool that
may also be relevant to a covered clearing agency's consideration of
how to implement a framework consistent with the requirements of Rule
17Ad-22(e)(14).
---------------------------------------------------------------------------
\436\ See Exchange Act Release No. 34-68433 (Dec. 14, 2012), 77
FR 75211 (Dec. 19, 2012) (``Portfolio Margining order'').
---------------------------------------------------------------------------
In addition, the Commission received two comments that asked the
Commission to clarify certain aspects of Rule 17Ad-22(e)(14). One
commenter noted that there could be tension between the competing goals
of (i) customer portability and (ii) the need for a covered clearing
agency to ensure the safety and soundness of itself and the
markets.\437\ The commenter urged the Commission to recognize the need
for a covered clearing agency to balance these competing priorities and
to avoid any interpretation of proposed Rule 17Ad-22(e)(14) that
prohibits a covered clearing agency from liquidating positions,
including customer positions, where liquidation is reasonably necessary
for the protection of the covered clearing agency.\438\ In response,
the Commission believes that efforts to enable portability at security-
based swap clearing agencies should be encouraged, but the Commission
also recognizes that non-defaulting clearing members should not be
required to take on customer positions to avoid putting the non-
defaulting clearing member at risk, exceeding the member's ability to
risk manage the customer's portfolio, or existing or creating
inconsistencies with the member's risk profile. If a customer's
positions cannot be ported, they will instead be liquidated. Therefore,
the Commission does not believe the comment is inconsistent with either
current practice or Rule 17Ad-22(e)(14), which does not prohibit the
liquidation of customer positions in the event porting would be
impracticable, contrary to the customer's preferences, or pose
increased risk to the markets or non-defaulting members.
---------------------------------------------------------------------------
\437\ See OCC at 12.
\438\ See id.
---------------------------------------------------------------------------
A second commenter stated that the proposed rule is silent on the
issue of protections from fellow-customer risk (i.e., protecting the
positions and related collateral of a participant's customers from
losses associated with the positions of other customers of that
participant), and that Section 3E(e) of the Exchange Act prohibits
clearing agencies from using deposited property as belonging to any
person other than the swaps customer of the depositing broker, dealer,
or security-based swap dealer.\439\ The commenter recommended that the
Commission make explicit that a covered clearing agency's policies and
procedures must give effect to Section 3E(e) and that the covered
clearing agency should publicly disclose the manner in which its
procedures do so.\440\ In response, the Commission notes that Section
3E(e) of the Exchange Act already prohibits such activity and,
therefore any proposed rule change under Rule 19b-4 would need to be
consistent with Section 3E(e).
---------------------------------------------------------------------------
\439\ See ISDA at 5.
\440\ See id. at 5-6.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(14) as proposed. The
Commission is applying Rule 17Ad-22(e)(14) only to security-based swap
clearing agencies and complex risk profile clearing agencies because
existing rules for the cash securities and listed options markets
applicable to broker-dealers already promote segregation and
portability to protect customer positions and funds in those markets.
In proposing Rule 17Ad-22(e)(14), the Commission noted that it intended
to avoid requiring changes to the existing structure of cash securities
and listed options markets in the United States where registered
clearing agencies that provide CCP or CSD services play a central
role.\441\ This approach is consistent with the PFMI.
---------------------------------------------------------------------------
\441\ See CCA Standards proposing release, supra note 5, at
29546.
---------------------------------------------------------------------------
Transactions in the U.S. cash security and listed options markets
are characterized by the following features: (i) Customers of members
generally do not have an account at a clearing agency; \442\ (ii) the
clearing agency is not able to identify which participants' customers
beneficially own the street name positions registered in the record
name of the clearing agency (or its nominee); and (iii) the clearing
agency has no recourse to funds of customers of members. Therefore,
neither portability nor segregation occur as a practical matter at the
CCP level under the current market structure for cash securities and
listed options.\443\ Further, customer positions and funds in the cash
securities and listed options markets are protected under the
Securities Investor Protection Act of 1970 (``SIPA'').\444\
---------------------------------------------------------------------------
\442\ A customer of a member also would not have an account at
the clearing agency where holding in record name (rather than
through street name ownership). This is the case even where such
record name owner-customer does not receive a paper security
certificate but holds in book-entry form through the direct
registration system, as direct registration system accounts are
maintained by a transfer agent and not by the clearing agency. See
Exchange Act Release No. 34-63320 (Nov. 16, 2010), 75 FR 71473,
71474 (Nov. 23, 2010) (discussing the ability of registered owners
to hold their assets on the records of transfer agents in book-entry
form through the direct registration system).
\443\ See CCA Standards proposing release, supra note 5, at
29546.
\444\ See 15 U.S.C. 78eee et seq. Pursuant to SIPA, when a
broker-dealer that is a member of the Securities Investor Protection
Corporation (``SIPC'') fails and customer assets are missing, SIPC
seeks to return customer cash and securities, and supplements the
distribution of the remaining customer assets at the broker-dealer
with SIPC reserve funds of up to $500,000 per customer, including a
maximum of $250,000 for cash claims.
---------------------------------------------------------------------------
With respect to portability, the Commission notes the portability
requirement in Rule 17Ad-22(e)(14) would not apply only upon a member
default; instead, a covered clearing agency to which Rule 17Ad-
22(e)(14) applies generally should have policies and procedures that
facilitate porting in the normal course of business, such as when a
customer ends its relationship with a member to start a new
relationship with a different member, or as a result of other events,
such as a merger involving the member. Under Rule 17Ad-22(e)(14), a
security-based swap clearing agency or complex risk profile clearing
agency generally should structure its portability arrangements in a way
that makes it highly likely that the positions and collateral of a
defaulting member's customers could be effectively transferred to one
or more other members.
Consistent with its response to the commenters discussed above, the
Commission recognizes that there may be a number of ways to address
compliance with Rule 17Ad-22(e)(14). Therefore, the Commission is
providing the following guidance that a covered clearing agency subject
to Rule 17Ad-22(e)(14) generally should consider in establishing and
maintaining policies and procedures for segregation and portability:
Whether it has, at a minimum, segregation and portability
arrangements that effectively protect a participant's customers'
positions and related collateral from the default or insolvency of that
participant;
if it additionally offers protection of such customer
positions and collateral against the concurrent default of the
participant and a fellow customer, whether it takes steps to ensure
that such protection is effective;
[[Page 70834]]
whether it employs an account structure that enables it
readily to identify positions of a participant's customers and to
segregate related collateral, and whether it maintains customer
positions and collateral in individual customer accounts or in omnibus
customer accounts;
whether it structures its portability arrangements in a
way that makes it highly likely that the positions and collateral of a
defaulting participant's customers will be transferred to one or more
other participants;
whether it discloses its rules, policies, and procedures
relating to the segregation and portability of a participant's
customers' positions and related collateral, and, in particular,
whether it discloses whether customer collateral is protected on an
individual or omnibus basis; and
whether it discloses any constraints, such as legal or
operational constraints, that may impair its ability to segregate or
port a participant's customers' positions and related collateral.
15. Rule 17Ad-22(e)(15): General Business Risk
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(15) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage its
general business risk and hold sufficient liquid net assets funded by
equity to cover potential general business losses so that the covered
clearing agency can continue operations and services as a going concern
if those losses materialize.\445\ Proposed Rule 17Ad-22(e)(15)(i) would
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to
determine the amount of liquid net assets funded by equity based upon
its general business risk profile and the length of time required to
achieve a recovery or orderly wind-down, as appropriate, of its
critical operations and services if such action is taken. Proposed Rule
17Ad-22(e)(15)(ii) would require a clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide for holding liquid net assets funded by
equity equal to the greater of either six months of its current
operating expenses or the amount determined by the board of directors
to be sufficient to ensure a recovery or orderly wind-down of critical
operations and services of the covered clearing agency, as contemplated
by the plans established under proposed Rule 17Ad-22(e)(3)(ii).
Additionally, proposed Rule 17Ad-22(e)(15)(ii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for monitoring
its business operations and reducing the likelihood of losses.\446\
Finally, proposed Rule 17Ad-22(e)(15)(iii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for maintaining
a viable plan, approved by the board of directors and updated at least
annually, for raising additional equity should its equity fall close to
or below the amount required by the proposed rule as discussed
above.\447\
---------------------------------------------------------------------------
\445\ See CCA Standards proposing release, supra note 5, at
29547-48.
\446\ See id. at 29548-49.
\447\ See id. at 29549.
---------------------------------------------------------------------------
b. Comments Received
Most commenters expressed general support for the Rule 17Ad-
22(e)(15), but a number of commenters also raised specific areas of
concern and encouraged the Commission to adopt specific, and in some
cases prescriptive, requirements under the rule. The Commission
addresses each of these comments in turn below.
i. General Comments
One commenter expressed support for the proposed requirements for
clearing agencies to identify and monitor general business risk, manage
liquid assets, and maintain a viable plan for raising additional equity
when needed.\448\ The commenter believed that such requirements
contribute to avoiding disruptions in the operations of clearing
agencies, as well as the broader market. The commenter also expressed
support for the proposed rule's requirements to identify, monitor and
manage general business risk and to hold sufficient liquid assets in a
manner allowing for a recovery or orderly wind-down if necessary.\449\
A second commenter expressed support for the proposed requirement that
covered clearing agencies hold sufficient capital to cover potential
general business and operational losses and to enable continuation of
business operations and noted a belief that six months of operating
expenses is an appropriate base level of funding.\450\ A third
commenter generally endorsed the Commission's proposal to require a
covered clearing agency to maintain liquid net assets sufficient to
allow the covered clearing agency to continue to operate for no less
than six months.\451\ A fourth commenter also generally supported the
Commission's proposal.\452\ Finally, one commenter requested that the
Commission phase-in implementation of Rule 17Ad-22(e)(15),\453\ and
that comment is addressed in Part II.G above.
---------------------------------------------------------------------------
\448\ See CFA Institute at 1-2.
\449\ See id. at 10.
\450\ See DTCC at 9.
\451\ See OCC at 13.
\452\ See CFA Institute at 10.
\453\ See OCC at 15 (noting that it would be in a position to
comply with such requirement by no later than January 1, 2015).
---------------------------------------------------------------------------
ii. Application to Derivatives Clearing
One commenter expressed concern that the proposed requirement would
be inadequate to address the potential for general business losses
incurred by a covered clearing agency that clears large quantities of
bespoke swap and derivative instruments, and therefore the commenter
urged the Commission to reassess whether clearing of bespoke
instruments is appropriate in light of the potential problems in
predicting the performance of such instruments during times of
stress.\454\ The Commission notes that the purpose of proposing Rule
17Ad-22(e) was not to reassess whether the clearing of bespoke
instruments is appropriate, but to focus on the regulatory framework
for the regulation of covered clearing agencies and address, among
other things, governance and financial risk management. Therefore, the
Commission believes that the comment is beyond the scope of this
rulemaking.
---------------------------------------------------------------------------
\454\ See CFA Institute at 10.
---------------------------------------------------------------------------
iii. Liquid Net Assets
The Commission received multiple comments related to the liquid net
assets required under Rule 17Ad-22(e)(15)(ii). One commenter stated
that, in addition to pre-funded capital and guaranty funds, it should
be clear, in advance, that clearing members (and not the FRB or
taxpayers) stand behind the organization should it run into financial
trouble.\455\ The Commission believes that Rule 17Ad-22(e), taken as a
whole, already contemplates and addresses the commenter's concern. As
previously noted, the rule requires policies and procedures reasonably
designed to promote in a comprehensive way the resiliency of a covered
clearing agency and, in particular, its ability to
[[Page 70835]]
withstand periods of market stress.\456\ The Commission notes as a
general matter that the liquid net assets described in the rule should
not be confused with the accounting term ``net liquid assets.'' For
purposes of Rule 17Ad-22(e)(15)(ii), a covered clearing agency
generally should consider liquid net assets to mean cash or highly
liquid securities. When liquid net assets are funded by equity, a
covered clearing agency generally should consider equity to mean common
stock, disclosed reserves, and other related earnings. In addition, the
Commission notes that Rule 17Ad-22(e)(3)(ii) separately requires
policies and procedures for plans for recovery or orderly wind-down.
---------------------------------------------------------------------------
\455\ See SRC at 2; see also supra note 284 and accompanying
text.
\456\ See supra notes 284-288 and accompanying text (discussing
similar position from commenter regarding Rule 27Ad-22(e)(5)).
---------------------------------------------------------------------------
Two commenters urged the Commission not to take too narrow a view
of what sources of funding would be considered liquid net assets funded
by equity under the proposed rule.\457\ The first commenter believed
that in calculating its six-month liquid asset coverage, a CCP should
be allowed to include projected revenues of the CCP over the same six-
month period, subject to an appropriate haircut.\458\ The commenter
also requested that the Commission clarify that a buffer, such as a
contingent capital arrangement requiring clearing members to contribute
funds, should be considered an appropriate source of equity funding
under the rule.\459\ On these two issues, the Commission believes that
the commenter has identified policies and procedures that would not
satisfy Rule 17Ad-22(e)(15). Among other things, Rule 17Ad-
22(e)(15)(ii) requires policies and procedures for holding liquid net
assets funded by equity. If a covered clearing agency is relying on
projected revenues or on obtaining liquid net assets through contingent
arrangements, then the covered clearing agency is not holding liquid
net assets funded by equity. The focus of Rule 17Ad-22(e)(15)(ii) is
mitigating the risk that a covered clearing agency would be unable to
perform its obligations as a going concern; to minimize such
performance risk, the covered clearing agency must necessarily have
assets that are readily available, such as cash reserves or cash
equivalents. Projected revenues, like contingent funding mechanisms, do
not provide certainty that a covered clearing agency can continue to
perform its obligations when general business losses arise because the
assets may be unavailable to satisfy business losses.
---------------------------------------------------------------------------
\457\ See DTCC at 10; OCC at 13.
\458\ See OCC at 14.
\459\ See id.
---------------------------------------------------------------------------
The same commenter and a second commenter also urged the Commission
to clarify and broadly construe what constitutes equity capital to
include noncumulative perpetual preferred stock, which would be
permanently available.\460\ One of these commenters noted that such
preferred stock constitutes additional tier 1 capital under the BCBS
capital framework and expressed the belief that the elements of capital
that constitute tier 1 capital should be permitted to count as equity
under the proposed rule.\461\ In response, the Commission believes that
the question of whether a particular noncumulative preferred stock
would constitute equity capital would depend on the terms and
conditions of each instrument and therefore such instruments would need
to be assessed on a case-by-case basis. The Commission therefore
declines to adopt the position urged by the commenter.
---------------------------------------------------------------------------
\460\ See DTCC at 10; OCC at 14.
\461\ See DTCC at 10-11.
---------------------------------------------------------------------------
The same commenter further expressed an expectation that liquid net
assets funded by equity would be calculated by comparing the clearing
agency's shareholders equity to proprietary cash and liquid marketable
securities and deducting unaffiliated third-party debt.\462\ The
commenter believed that it is appropriate for a covered clearing
agency, where it has significant shareholder equity, to be able to
liquefy that equity via intercompany funding so long as the requisite
amount of cash and/or liquid securities is held and maintained at the
covered clearing agency level. The commenter also emphasized the role
that holding company structures play in funding their affiliates,
noting that the holding company may have broader access to financial
markets to liquefy the equity base of their subsidiaries.\463\ The
commenter argued that such financing would provide a high level of
flexibility to meet a covered clearing agency's needs. In response to
the commenter, the Commission is unable to opine on these particular
calculations of the commenter's liquid net assets because the
determination of whether a particular liquid net asset calculation
meets the requirements of Rule 17Ad-22(e)(15)(ii) would need to be made
on a detailed, case-by-case basis. The Commission would need to
understand and evaluate, for example, the covered clearing agency's
particular capital structure, the types of securities being held, the
nature and extent of the covered clearing agency's debt holdings, the
structure and elements of the intercompany funding arrangement
described by the commenter, and the nature of the access that the
holding company has to the relevant markets for the purposes of
liquefying any subsidiary equity and how that access differs from that
of the covered clearing agency.
---------------------------------------------------------------------------
\462\ See id. at 10.
\463\ See id.
---------------------------------------------------------------------------
In response to the commenter's position regarding the role that a
holding company structure may play in addressing the requirement of
Rule 17Ad-22(e)(15), the Commission reiterates prior statements made
above that the requirements of Rule 17Ad-22(e) apply to each covered
clearing agency registered with the Commission. Therefore, for example,
if a covered clearing agency's parent or holding company were to adopt
a company-wide framework addressing the issues covered in Rule 17Ad-
22(e)(15), the covered clearing agency nevertheless would itself need
to adopt or ratify those policies and procedures with respect to its
own business to meet the requirements of Rule 17Ad-22(e)(15).\464\ As
adopted, pursuant to Rule 17Ad-22(e)(15)(ii) each covered clearing
agency is required to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for
holding liquid net assets funded by equity equal to the greater of
either six months of its current operating expenses or the amount
determined by the board of directors to be sufficient to ensure a
recovery or orderly wind-down of critical operations and services of
the covered clearing agency.
---------------------------------------------------------------------------
\464\ See supra Part II.C.3.c.
---------------------------------------------------------------------------
iv. Viable Plan To Raise Additional Equity
With respect to the requirement for a covered clearing agency's
policies and procedures to be reasonably designed to have a viable
plan, updated annually, for raising additional equity when the covered
clearing agency's equity falls below or close to the amount required by
the proposed rule, one commenter believed that the proposed rule should
require capital-raising to occur prior to a covered clearing agency
approaching the required equity threshold.\465\ Otherwise, the
commenter stated, the covered clearing agency may be unable to raise
the needed equity due to market conditions.\466\ In response, the
[[Page 70836]]
Commission notes that Rule 17Ad-22(e)(15)(iii), as proposed, addresses
the commenter's concern by requiring that the plan be viable when the
covered clearing agency's equity falls below or close to the amount
required by the proposed rule. However, the Commission is providing
further guidance below to clarify its position further.
---------------------------------------------------------------------------
\465\ See CFA Institute at 10.
\466\ See id.
---------------------------------------------------------------------------
Another commenter expressed the belief that an annual review of the
plan for raising additional equity is unnecessary and that a biannual
review is sufficient, provided that the plan is reviewed sooner should
changes occur.\467\ The Commission continues to believe, however, that
an annual review is an appropriate interval to help ensure that each
covered clearing agency is mindful of changing market conditions. The
Commission believes that, in a two-year window between biannual
reviews, so much time passes that a covered clearing agency may find
that market conditions have changed so significantly that a once-viable
plan to raise additional equity is no longer viable. A yearly review
cycle helps ensure that the covered clearing agency remains aware of
changing market conditions, facilitating on an annual basis incremental
updates to the plan in response to said changing market conditions.
Further, the Commission believes that a covered clearing agency could
adopt policies and procedures that provide for more frequent review in
response to changing market conditions, and that such policies and
procedures would help a covered clearing agency better react to periods
of market stress. Therefore, the Commission has determined not to adopt
the commenter's suggested approach.
---------------------------------------------------------------------------
\467\ See DTCC at 11.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(15) as proposed. Because
the Commission recognizes that there may be a number of ways to address
compliance with Rule 17Ad-22(e)(15), the Commission is providing the
following guidance that a covered clearing agency generally should
consider in establishing and maintaining policies and procedures that
address general business risk:
Whether it has robust management and control systems to
identify, monitor, and manage general business risks, including losses
from poor execution of business strategy, negative cash flows, or
unexpected and excessively large operating expenses;
whether it holds liquid net assets funded by equity (such
as common stock, disclosed reserves, or other retained earnings) so
that it can continue operations and services as a going concern if it
incurs general business losses;
whether the amount of liquid net assets funded by equity
it holds is determined by its general business risk profile and the
length of time required to achieve a recovery or orderly wind-down, as
appropriate, of its critical operations and services if such action is
taken;
whether it maintains a viable recovery or orderly wind-
down plan and holds sufficient liquid net assets funded by equity to
implement this plan that, at a minimum, are funded by equity equal to
at least six months of current operating expenses, in addition to
resources held to cover participant defaults or other risks addressed
by its financial resources;
whether assets held to cover general business risk are of
high quality and sufficiently liquid to allow the covered clearing
agency to meet its current and projected operating expenses under a
range of scenarios, including in adverse market conditions; and
whether it maintains a viable plan, approved by the board
of directors and updated no less than annually, for raising additional
equity should its equity fall close to or below the amount needed.
With respect to Rule 17Ad-22(e)(15)(iii) and the policies and
procedures for maintaining a viable plan, the Commission believes that
a viable plan generally should enable the covered clearing agency to
hold sufficient liquid net assets to achieve recovery or orderly wind-
down. Therefore, the Commission believes that a covered clearing
agency's policies and procedures generally should define when a covered
clearing agency's equity falls close to the amount required by the
rule, so that the covered clearing agency has policies and procedures
that clearly define when the covered clearing agency should initiate
the plan to raise additional equity. In developing such policies and
procedures, a covered clearing agency generally should consider and
account for circumstances that may require a certain length of time
before any plan can be implemented. For example, before obtaining
shareholder approval to issue new shares, a covered clearing agency may
need to call a special meeting subject to a notice period.
In addition, with respect to the plan under Rule 17Ad-
22(e)(15)(iii) being approved by the board of directors and updated at
least annually, the board of a covered clearing agency generally should
perform the approval not less than once every twelve months.
16. Rule 17Ad-22(e)(16): Custody and Investment Risks
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(16) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to safeguard its own and its
participants' assets and minimize the risk of loss and delay in access
to these assets. Proposed Rule 17Ad-22(e)(16) would also require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to invest such
assets in instruments with minimal credit, market, and liquidity risks.
b. Comments Received and Commission Response
The Commission received one comment on proposed Rule 17Ad-
22(e)(16), which generally sought consideration of more prescriptive or
granular aspects to the Commission's approach.\468\ The commenter made
several points about the proposed rule. First, the commenter noted that
to mitigate the risks to participants from current CCP practices for
participant collateral, including commingling, rehypothetication or
title transfer arrangements, and investment practices, the Commission
should provide additional guidance regarding the specific protections a
covered clearing agency must employ to safeguard participants'
collateral and invest such collateral in instruments with minimal
credit, market, and liquidity risks.\469\ Moreover, the commenter
stated its belief that house collateral is inadequately segregated,
current investment practices expose members to unnecessary risk of
loss, and CCP investment policies and practices expose members to
interest rate and credit risk through investments in higher-risk and
longer-term instruments, putting member principal at risk.\470\
---------------------------------------------------------------------------
\468\ See The Clearing House at 3, 11-12.
\469\ See id. at 3, 11.
\470\ See id. at 11.
---------------------------------------------------------------------------
The commenter stated that, due to commingling and inadequate
traceability, participants' rights to the return of their collateral
upon the insolvency of a CCP are often uncertain and could be
impaired.\471\ The commenter also noted that some CCPs are permitted to
rehypothecate participant securities collateral or to secure their
investments using title
[[Page 70837]]
transfer arrangements, each of which exposes participants to potential
loss due to the unavailability of participant collateral (or its
liquidation value) in the CCP's insolvency.\472\
---------------------------------------------------------------------------
\471\ See id.
\472\ See id.
---------------------------------------------------------------------------
For the purpose of minimizing investment risk and the risk of loss
of participant collateral, the commenter recommended that the
Commission confirm the applicability of the following protections with
respect to a covered clearing agency's treatment of participant
collateral:
Limit a CCP's ability to encumber or impair participants'
rights in guaranty fund contributions and initial margin posted to the
CCP in support of proprietary positions.\473\
---------------------------------------------------------------------------
\473\ See id. at 11-12.
---------------------------------------------------------------------------
Specify standards for the establishment, designation, and
maintenance of accounts for the safekeeping of participant collateral,
and related requirements to ensure the treatment of such funds as
belonging to the relevant participants in the event of the insolvency
of the covered clearing agency and otherwise; \474\
---------------------------------------------------------------------------
\474\ See id. at 12.
---------------------------------------------------------------------------
Further specify the types of highly liquid investments
(and, as applicable, eligible counterparties and issuers), and related
concentration and weighted average maturity limits, applicable to the
investment of participant collateral, as well as the capital of the
covered clearing agency committed to the default waterfall; \475\
---------------------------------------------------------------------------
\475\ See id.
---------------------------------------------------------------------------
Prohibit the rehypothecation of non-cash collateral of
non-defaulting participants and limit such rehypothecation in the case
of a defaulting participant to circumstances where an immediate
liquidation of the non-cash collateral would lead to severe asset value
depreciation; \476\ and
---------------------------------------------------------------------------
\476\ See id.
---------------------------------------------------------------------------
Require to use pledged arrangements when taking
collateral, except where title transfer arrangements are necessitated
by applicable law.\477\
---------------------------------------------------------------------------
\477\ See id.
---------------------------------------------------------------------------
The commenter also recommended that the Commission specify a
covered clearing agency's disclosure obligations with respect to its
collateral investment activities, including the extent of reuse of
participant collateral, eligible counterparties for collateral
rehypothecation, the covered clearing agency or participant's rights to
the collateral posted to it and the covered clearing agency's
investment policies, balances, and concentrations.\478\
---------------------------------------------------------------------------
\478\ See id.
---------------------------------------------------------------------------
Much of the clarification and guidance sought by the commenter, in
the Commission's view, would entail the imposition of prescriptive and
granular requirements on covered clearing agencies with respect to
their custody and investment risks. Such ex ante requirements would be
inconsistent with the Commission's principles-based approach to Rule
17Ad-22(e).\479\ Although it is possible that the commenter's
suggestions could be appropriate in certain circumstances, the
Commission believes that these comments do not take into account the
variation among covered clearing agencies with respect to the different
markets served, products cleared, and risk management needs.
Nevertheless, the Commission believes that Rule 17Ad-22(e)(16) already
encompasses the commenter's suggestions, and that many covered clearing
agencies already employ and can continue to consider these suggestions
when designing or revising policies and procedures under the rule. The
Commission therefore believes that no modifications to Rule 17Ad-
22(e)(16) are necessary.
---------------------------------------------------------------------------
\479\ See supra Part II.B.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(16) as proposed. Because
the Commission recognizes that there may be a number of ways to address
compliance with Rule 17Ad-22(e)(16), the Commission is providing the
following guidance that a covered clearing agency generally should
consider in establishing and maintaining policies and procedures that
address custody and investment risk:
Whether it holds its own and its participants' assets at
supervised and regulated entities that have robust accounting
practices, safekeeping procedures, and internal controls that fully
protect these assets;
whether it has prompt access to its assets and the assets
provided by participants, when required;
whether it evaluates and understands its exposures to its
custodian banks, taking into account the full scope of its
relationships with each;
whether its investment strategy is consistent with its
overall risk management strategy and fully disclosed to its
participants; and
whether its investments are secured by, or claims on,
high-quality obligors, allowing for quick liquidation with little, if
any, adverse price effect.
The Commission also notes that failure by a clearing agency to hold
assets in instruments with minimal credit, market, and liquidity risk
may limit the clearing agency's ability to access these assets
promptly. The Commission therefore believes that covered clearing
agencies, in seeking to satisfying the requirements of Rule 17Ad-
22(e)(16), generally should seek to minimize the risk of loss or delay
in access by holding assets that are highly liquid (e.g., cash, U.S.
Treasury securities, or securities issued by a U.S. government agency)
and by using only supervised and regulated entities such as banks to
act as custodians for the assets and to facilitate settlement. The
Commission further notes that the rule does not require that a covered
clearing agency invest its own and its participants' assets but that it
have policies and procedures for investing such assets in instruments
with minimal credit, market, and liquidity risks when it determines to
so invest.
17. Rule 17Ad-22(e)(17): Operational Risk Management
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(17) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to manage the covered clearing
agency's operational risk. In proposing Rule 17Ad-22(e)(17), the
Commission noted that operational risk involves, among other things,
the likelihood that deficiencies in information systems or internal
controls, human errors or misconduct, management failures, unauthorized
intrusions into corporate or production systems, or disruptions from
external events such as natural disasters, would adversely affect the
functioning of a clearing agency.\480\
---------------------------------------------------------------------------
\480\ See CCA Standards proposing release, supra note 5, at
29551.
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(17)(i) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify the plausible sources of
operational risk, both internal and external, and mitigate their impact
through the use of appropriate systems, policies, procedures, and
controls. Proposed Rule 17Ad-22(e)(17)(ii) would require a covered
clearing agency to establish, implement, maintain, and enforce written
policies and procedures reasonably designed to ensure that systems have
a high degree of security, resiliency, operational reliability, and
adequate, scalable capacity. Finally, proposed Rule 17Ad-22(e)(17)(iii)
would require a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to provide for a
[[Page 70838]]
business continuity plan that addresses events posing a significant
risk of disrupting operations.\481\
---------------------------------------------------------------------------
\481\ See id.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
The Commission received one comment that generally supported the
Commission's approach in Rule 17Ad-22(e)(17). The commenter expressed a
belief that most, if not all, businesses of the size and significance
of a covered clearing agency must commit to and undertake plans to
manage operations in the event of a disruption, including through the
adoption of a formal business continuity plan.\482\ The commenter also
argued that anything less risks major repercussions and the loss of
investor trust. In response, the Commission notes that Rule 17Ad-
22(e)(17) addresses the commenter's concerns by including requirements
for policies and procedures with respect to a business continuity plan.
---------------------------------------------------------------------------
\482\ See CFA Institute at 11.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(17) with one
modification: Because the text in Rule 17Ad-22(e)(17)(ii) for
``establishing and maintaining policies and procedures reasonably
designed'' is duplicative of the requirement under Rule 17Ad-22(e) to
have policies and procedures reasonably designed to establish,
maintain, implement, and enforce the requirements thereunder, the
Commission is removing the duplicative text. In addition, the
Commission notes that Rule 17Ad-22(e)(17) includes similar provisions
to Rule 17Ad-22(d)(4), and that, like Rule 17Ad-22(d)(4), Rule 17Ad-
22(e)(17) concerns operational risks that stem from deficiencies in
internal controls, human errors, and management failures.\483\ The
Commission also notes that Rule 17Ad-22(e)(17) includes requirements
related to operational risk management in addition to the requirements
in Regulation SCI, previously discussed in Part I.A.4. The Commission
therefore notes that a covered clearing agency, in seeking to address
the requirements of Rule 17Ad-22(e)(17), generally should remain
mindful of related requirements under other Commission rules and
regulation.
---------------------------------------------------------------------------
\483\ See CCA Standards proposing release, supra note 5, at
29551; see also infra Part IV.C.17 (also discussing the similar
provisions between Rules 17Ad-22(e)(17) and (d)(4)); Clearing Agency
Standards, supra note 5, at 66248 (discussing Rule 17Ad-22(d)(4)).
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(17), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address operational risk:
Whether it establishes a robust operational risk-
management framework with appropriate systems, policies, procedures,
and controls to identify, monitor, and manage operational risks;
whether its board of directors clearly define the roles
and responsibilities for addressing operational risk and whether it
endorses the covered clearing agency's operational risk-management
framework;
whether it clearly defines operational reliability
objectives and whether it has policies in place that are designed to
achieve its service-level objectives;
whether the covered clearing agency ensures that it has
scalable capacity adequate to handle increasing stress volumes and to
achieve its service-level objectives;
whether it has comprehensive physical and information
security policies that address all potential vulnerabilities and
threats;
whether it has a business continuity plan that addresses
events posing a significant risk of disrupting operations, including
events that could cause a wide-scale or major disruption; and
whether it identifies, monitors, and manages the risks
that key participants, other covered clearing agencies, and service and
utility providers might pose to its operations.
With respect to ``adequate, scalable capacity'' under Rule 17Ad-
22(e)(17)(ii), the Commission believes that a covered clearing agency
generally should have operational systems that can be extended or
expanded based on its anticipated business needs. Further, the
Commission believes that, to help limit disruptions that may impede the
proper functioning of a covered clearing agency, covered clearing
agencies generally should review their operations for potential
weaknesses and develop appropriate systems, controls, and procedures to
address weaknesses the rule seeks to mitigate.
18. Rule 17Ad-22(e)(18): Access and Participation Requirements
As proposed, Rule 17Ad-22(e)(18) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish objective, risk-based,
and publicly disclosed criteria for participation, which permit fair
and open access by direct and, where relevant, indirect participants
and other FMUs. Proposed Rule 17Ad-22(e)(18) also would require that a
covered clearing agency establish, implement, maintain and enforce
written policies and procedures reasonably designed to require
participants to have sufficient financial resources and robust
operational capacity to meet obligations arising from participation in
the clearing agency and to monitor compliance with participation
requirements on an ongoing basis.\484\
---------------------------------------------------------------------------
\484\ See CCA Standards proposing release, supra note 5, at
29551-52.
---------------------------------------------------------------------------
The Commission received one comment regarding Rule 17Ad-22(e)(18).
The commenter expressed support for the fair and open participation
requirements under the proposed rule, the public disclosure of such
participation criteria under the proposed rule, and the proposed
requirement that such criteria be risk-based.\485\
---------------------------------------------------------------------------
\485\ See CFA Institute at 11.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(18) as proposed.
Moreover, because the Commission recognizes that there may be a number
of ways to address compliance with Rule 17Ad-22(e)(18), the Commission
is providing the following guidance that a covered clearing agency
generally should consider in establishing and maintaining policies and
procedures that address access and participation requirements:
Whether it allows for fair and open access to its
services, including by direct and where relevant, indirect participants
and other covered clearing agencies, based on reasonable risk-related
participation requirements;
whether its participation requirements are justified in
terms of the safety and efficiency of the covered clearing agency and
the markets it serves, are tailored to and commensurate with its
specific risks, and are publicly disclosed; and
whether it monitors compliance with its participation
requirements on an ongoing basis and clearly defines and publicly
discloses procedures for facilitating the suspension and orderly exit
of a participant that breaches, or no longer meets, the participation
requirements.
The Commission also notes that, in contrast to other requirements
in Rule 17Ad-22(e) where the term ``transparent'' is used in the
context of facilitating disclosure ``where appropriate,'' the
requirement here for policies and procedures reasonably
[[Page 70839]]
designed to establish ``publicly disclosed'' criteria for participation
would necessarily require that the relevant policies and procedures be
reasonably designed to provide for disclosure of such criteria for
participation. The Commission also notes that membership standards at
covered clearing agencies generally should seek to limit the potential
for member defaults and, as a result, losses to non-defaulting members
in the event of a member default. Using risk-based criteria helps to
protect investors by limiting the participants of a covered clearing
agency to those for which the covered clearing agency has assessed the
likelihood of default.
19. Rule 17Ad-22(e)(19): Tiered Participation Arrangements
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(19) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage the
material risks to the covered clearing agency arising from arrangements
in which firms that are indirect participants in the covered clearing
agency rely on the services provided by direct participants in the
covered clearing agency to access the covered clearing agency's
payment, clearing, or settlement facilities (hereinafter ``tiered
participation arrangements''). In addition, proposed Rule 17Ad-
22(e)(19) would require that a covered clearing agency establish,
implement, maintain and enforce written policies and procedures
reasonably designed to regularly review the material risks to the
covered clearing agency arising from such tiered participation
arrangements.\486\
---------------------------------------------------------------------------
\486\ See CCA Standards proposing release, supra note 5, at
29553.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
The Commission received several comments regarding tiered
participation arrangements under Rule 17Ad-22(e)(19). One commenter
believed that regular reviews of tiered participation arrangements are
an important part of a covered clearing agency's ability to perform
prompt and accurate clearance and settlement, to protect investors, and
to safeguard securities and funds.\487\ However, some commenters
focused on particular aspects of the proposal in seeking to have the
Commission consider a specific approach or issue. Comments directed to
these particular substantive aspects of Rule 17Ad-22(e)(19) are
discussed below.
---------------------------------------------------------------------------
\487\ See CFA Institute at 11-12.
---------------------------------------------------------------------------
i. Need for Due Diligence of Indirect Participants
One commenter believed that the Commission did not provide
sufficient guidance regarding who would be indirect participants of a
covered clearing agency and, as a result, cannot ascertain whether it
is correctly reading the proposed rule.\488\ The commenter further
expressed the view that it is not appropriate for a covered clearing
agency to perform due diligence on the clients of its clearing members
for the following reasons:
---------------------------------------------------------------------------
\488\ See LCH at 5.
---------------------------------------------------------------------------
The covered clearing agency has no direct, contractual
relationship to these clients;
Performing due diligence on what may be a very large
number of clients could be very burdensome for the covered clearing
agency; and
Clients may object to due diligence inquiries from a
covered clearing agency and choose to move their business to another
CCP that is not required to perform such due diligence.\489\
---------------------------------------------------------------------------
\489\ See id.
---------------------------------------------------------------------------
Instead, the commenter expressed a view that a covered clearing
agency can reasonably rely on the due diligence that its clearing
members perform on their clients and should not have to perform its own
due diligence on these indirect participants.\490\
---------------------------------------------------------------------------
\490\ See id.
---------------------------------------------------------------------------
In response, the Commission first notes that the scope of Rule
17Ad-22(e)(19) does not only contemplate clients of clearing members.
Instead, the rule also contemplates situations where other parties may
enter into a contractual arrangement with a clearing member,
particularly arrangements that create credit exposures to the clearing
member, such as where a third party acts as guarantor to an obligation
on behalf of the clearing member, may be indirect participants in the
covered clearing agency. The Commission therefore believes that the
alternative approach suggested by the commenter above does not entirely
contemplate the scope of indirect participants addressed by the Rule
17Ad-22(e)(19).
The Commission acknowledges that there are limits on the extent to
which a covered clearing agency can, in practice, observe or influence
a direct participant's commercial or contractual relationships, and
that these limits will, in turn, affect the appropriateness of a
covered clearing agency performing due diligence on its indirect
participants. However, a clearing agency will often have access to
information, including through the due diligence that a member performs
on its clients as well as information on transactions undertaken on
behalf of indirect participants. A clearing agency can also set direct
participation requirements that may include criteria relating to how
direct participants manage relationships with their customers in-so-far
as these criteria are relevant for the safe, efficient, and effective
operation of the clearing agency. Accordingly, a covered clearing
agency generally should have the ability to identify the types of risk
that could arise from tiered participation and should monitor
concentrations of such risk. Further, the Commission notes that some
direct and indirect participants of the covered clearing agency will be
registered with the Commission as, for example, a broker-dealer, and
therefore be subject to their own requirements for reporting and
financial responsibility,\491\ which a covered clearing agency could
use in developing policies and procedures for tiered participation
arrangements. In light of the availability of the tools described
above, the Commission does not believe that the commenter's suggestion
for a covered clearing agency to rely on due diligence performed by its
clearing members is an appropriate alternative for the purposes of
addressing the requirements a covered clearing agency must satisfy
under Rule 17Ad-22(e)(19).
---------------------------------------------------------------------------
\491\ See, e.g., 17 CFR 240.15c3-1, 15.c3-3 (setting forth net
capital and customer protection requirements for broker-dealers); 17
CFR 240.17h-1T, 17h-2T (setting forth requirements that certain
broker-dealers maintain, preserve, and file a quarterly summary of
certain information regarding those affiliates, subsidiaries and
holding companies whose business activities are reasonably likely to
have a material impact on their own financial and operating
condition); 17 CFR 240.17a-3, 17a-4, 17a-5, 17a-11 (setting forth
requirements for broker-dealers to maintain books and records, file
periodic reports including quarterly and annual financial
statements, and report to the Commission and the appropriate SRO
regarding net capital, recordkeeping, and other operational
problems, within certain time periods).
---------------------------------------------------------------------------
ii. Need To Obtain Information From Clearing Members
One commenter expressed concern that proposed Rule 17Ad-22(e)(19)
could be interpreted as requiring a covered clearing agency to obtain
information from its clearing members identifying with specificity each
of the customers attached to each cleared transaction and to routinely
monitor customer-level risk with respect to each such customer.\492\
The commenter acknowledged that covered clearing agencies should have
the ability to gather certain information from its
[[Page 70840]]
direct participants and that some circumstances may require clearing
agencies to monitor the systemic risk created by one or more
significant indirect participants, but the commenter believed it is
inappropriate for a covered clearing agency to routinely police the
systemic risks created by each indirect participant.\493\ In response,
the Commission notes that Rule 17Ad-22(e)(19) requires a covered
clearing agency to have policies and procedures governing risk
management that considers a clearing member's customer relationships,
but it does not require a covered clearing agency to actively risk
manage those customer relationships on behalf of each clearing member.
Instead, Rule 17Ad-22(e)(19) requires policies and procedures that
identify, monitor, and manage the material risks to the covered
clearing agency arising from tiered participation arrangements. Such
policies and procedures would require a covered clearing agency to
account for the range of risks stemming from each clearing member,
which necessarily includes risks resulting from the clearing member's
relationships with its customers, as previously described above. To
engage in effective risk management of a clearing member, the covered
clearing agency would need a complete picture of cleared transactions
attributed to each clearing member, but it may require less specific
information from the clearing member with respect to customers so long
as the information it does receive provides the covered clearing agency
with a comprehensive understanding of the material risks posed to the
covered clearing agency by each clearing member.\494\
---------------------------------------------------------------------------
\492\ See OCC at 15.
\493\ See id.
\494\ See supra note 491 (describing examples of such
information that is available for certain participants that are
separately registered with the Commission).
---------------------------------------------------------------------------
iii. Recommendation for a Risk-Based Approach
One commenter expressed the belief that covered clearing agencies
should use a risk-based approach when developing policies and
procedures to implement the requirement that a covered clearing agency
have policies and procedures reasonably designed to identify, monitor,
and manage the risks to the clearing agency arising from indirect
participants.\495\ The commenter expressed the belief that a covered
clearing agency should provide direct participants with information
relevant to their activities (both direct and indirect) that is
available to the clearing agency, thus enabling direct participants to
use such information to evaluate and manage its correspondent customer
relationships.\496\ The commenter also expressed a view that a covered
clearing agency should evaluate the risks presented to it by indirect
relationships in the context of a direct participant's overall risk
management policies and procedures.\497\ The commenter expressed the
belief that such policies will need to take into account the level of
information available to the covered clearing agency and that there
needs to be a distinction between the supervisory oversight of the
direct participant by its primary supervisor and the type of oversight
that a clearing agency can be expected to provide.
---------------------------------------------------------------------------
\495\ See DTCC at 11.
\496\ See id.
\497\ See id.
---------------------------------------------------------------------------
The Commission agrees that such a risk-based approach could be one
approach to achieving compliance with Rule 17Ad-22(e)(19), but believes
that each covered clearing agency should determine the appropriate
approach for determining compliance with Rule 17Ad-22(e)(19) in light
of the composition of its members and the products they clear, as well
as its risk management framework. Policies and procedures at a covered
clearing agency for managing risks from indirect participants will
necessarily be constrained to some degree by the lack of a direct
contractual agreement between the covered clearing agency itself and
the indirect participant. The Commission notes, however, that
evaluating and managing the risk from direct participants, pursuant to
Rule 17Ad-22(e)(19), would require policies and procedures consistent
with the Commission's statements in Parts II.C.19.b.i and ii above. As
noted there, the Commission acknowledges that direct and indirect
participants in a covered clearing agency may be regulated entities
themselves subject to reporting and other requirements that may help
facilitate the covered clearing agency's management of risk from tiered
participation arrangements.\498\
---------------------------------------------------------------------------
\498\ See supra notes 491, 494, and accompanying text.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(19) as proposed. Because
the Commission recognizes that there may be a number of ways to address
compliance with Rule 17Ad-22(e)(19), the Commission is providing the
following guidance that a covered clearing agency generally should
consider in establishing and maintaining policies and procedures that
address tiered participation arrangements:
Whether a covered clearing agency ensures that its rules,
procedures, and agreements allow it to gather sufficient information
about indirect participation to identify, monitor, and manage any
material risks to the covered clearing agency arising from such tiered
participation arrangements;
whether it identifies material dependencies between direct
and indirect participants that might affect the covered clearing
agency;
whether it identifies indirect participants responsible
for a significant proportion of transactions processed by the covered
clearing agency and indirect participants whose transaction volumes or
values are large relative to the capacity of the direct participants
through which they access the covered clearing agency to manage the
risks arising from these transactions; and
whether it regularly reviews risks arising from tiered
participation arrangements and takes mitigation action when
appropriate.
In addition to the guidance above, the Commission notes that, when
addressing its compliance with Rule 17Ad-22(e)(19), a covered clearing
agency could consider whether its rules, policies, procedures, and
agreements with direct participants allow it to gather basic
information about indirect participants to identify, monitor, and
manage any material risks to the covered clearing agency arising from
such tiered participation arrangements. This information should help
enable the covered clearing agency to identify (i) the proportion of
activity that direct participants conduct on behalf of indirect
participants, (ii) direct participants that act on behalf of a material
number of indirect participants, (iii) indirect participants with
significant volumes or values of transactions in the system, and (iv)
indirect participants whose transaction volumes or values are large
relative to those of the direct participants through which they access
the covered clearing agency. In this vein, a covered clearing agency
could consider an indirect participant's status as a designated market
maker or supplemental liquidity provider in identifying material risks
to the covered clearing agency. A covered clearing agency could also
consider different trading strategies or changes in trading strategies
used by indirect participants in identifying, monitoring, and managing
material risks to the covered clearing agency.
The Commission also notes that Rule 17Ad-22(e)(19) is intended to
promote the ongoing management of risks associated with tiered
participation arrangements stemming from the
[[Page 70841]]
dependencies and risk exposures that such arrangements can create.
However, because proposed Rule 17Ad-22(e)(19) only addresses the
situation where indirect participants in the covered clearing agency
rely on direct participants, the Commission notes that Rule 17Ad-
22(e)(19) would not apply in the circumstance where a covered clearing
agency providing CSD services has members that are broker-dealers
maintaining accounts for retail customers.
20. Rule 17Ad-22(e)(20): Links
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(20) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage
risks related to any link with one or more other clearing agencies,
FMUs, or trading markets.\499\ In proposing the rule, the Commission
proposed to define ``link'' in Rule 17Ad-22(a)(10) to mean any set of
contractual and operational arrangements between a covered clearing
agency and one or more other clearing agencies, FMUs, or trading venues
that connect them directly or indirectly for the purposes of
participating in settlement, cross margining, expanding its services to
additional instruments and participants, or for any other purposes
material to their business.\500\
---------------------------------------------------------------------------
\499\ See CCA Standards proposing release, supra note 5, at
29553.
\500\ See id. at 29554. The Commission received no comments
regarding the definition of ``link'' and is adopting it with one
modification, as discussed in Part II.C.20.c. Because of other
modifications to Rule 17Ad-22(a), the definition of ``link'' is also
being moved to Rule 17Ad-22(a)(8). See infra Part VI.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
The Commission received no comments regarding the substance of the
proposed rule. One comment requested that the Commission phase-in
implementation of Rule 17Ad-22(e)(20),\501\ and that comment is
addressed in Part II.G below.
---------------------------------------------------------------------------
\501\ See DTCC at 13-14 & n.46.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(20) as proposed.\502\
The Commission is adopting the definition of ``link'' with one
modification and moving it to Rule 17Ad-22(a)(8), as previously
discussed.\503\ Specifically, in the definition of ``link,'' the
Commission is replacing the word ``venues'' with ``markets'' to improve
consistency with Rule 17Ad-22(e)(20).\504\
---------------------------------------------------------------------------
\502\ See Rule 17Ad-22(e)(20), infra Part VI.
\503\ See supra note 500.
\504\ See Rule 17Ad-22(a)(8), infra Part VI.
---------------------------------------------------------------------------
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(20), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address links:
Whether it identifies, monitors, and manages all potential
sources of risk arising from the link arrangement, before entering into
a link arrangement and on an ongoing basis once the link is
established;
whether a link has a well-founded legal basis, in all
relevant jurisdictions, that support its design and provides adequate
protection to the covered clearing agencies involved in the link;
whether linked CSDs measure, monitor, and manage the
credit and liquidity risk arising from each other;
whether provisional transfers of securities between linked
CSDs are prohibited or, at a minimum, the retransfer of provisionally
transferred securities are prohibited prior to the transfer becoming
final.
whether an investor CSD can only establish a link with an
issuer CSD if the arrangement provides a high level of protection for
the rights of the investor CSD's participants;
whether an investor CSD that uses an intermediary to
operate a link with an issuer CSD measures, monitors, and manages the
additional risks arising from the use of the intermediary.
before entering into a link with a CCP, whether it
identifies and manages the potential spill-over effects from the
default of the linked CCP; and
when in a CCP link arrangement, whether it is able to
cover, at least on a daily basis, its current and potential future
exposures to the linked CCP and its participants, if any, fully with a
high degree of confidence without reducing the covered clearing
agency's ability to fulfill its obligations to its own participants at
any time.
In addition, the Commission reiterates that the requirements for
policies and procedures for linkages must be addressed by each covered
clearing agency at the level of the covered clearing agency.\505\
Therefore, each covered clearing agency under Rule 17Ad-22(e) would
itself need to adopt or ratify policies and procedures for linkages
with respect to its own business, even if it is a member of a group or
under a holding company that has group-level policies and procedures.
---------------------------------------------------------------------------
\505\ See supra Part II.B.3.c.
---------------------------------------------------------------------------
21. Rule 17Ad-22(e)(21): Efficiency and Effectiveness
As proposed, Rule 17Ad-22(e)(21) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it is efficient and
effective in meeting the requirements of its participants and the
markets it serves. Proposed Rule 17Ad-22(e)(21)(i) through (iv) would
require a covered clearing agency's management to regularly review the
efficiency and effectiveness of its (i) clearing and settlement
arrangements; (ii) operating structure, including risk management
policies, procedures, and systems; (iii) scope of products cleared,
settled, or recorded; and (iv) use of technology and communication
procedures.\506\
---------------------------------------------------------------------------
\506\ See CCA Standards proposing release, supra note 5, at
29554.
---------------------------------------------------------------------------
The Commission received one comment in support of the proposed
approach. The commenter expressed support for the requirement that a
covered clearing agency review its efficiency and effectiveness in
meeting the requirements of its participants and the markets it serves
and for the specific areas to be reviewed as set forth in proposed Rule
17Ad-22(e)(21).\507\
---------------------------------------------------------------------------
\507\ See CFA Institute at 12.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(21) with one
modification: The Commission is removing reference to ``recorded''
products under Rule 17Ad-22(e)(21)(iii) because recording products is
not a function of covered clearing agencies. In addition, because the
Commission recognizes that there may be a number of ways to address
compliance with Rule 17Ad-22(e)(21), the Commission is providing the
following guidance that a covered clearing agency generally should
consider in establishing and maintaining policies and procedures that
address efficiency and effectiveness:
Whether its design meets the needs of its participants and
the markets it serves, particularly with regard to choice of a
clearance and settlement arrangement, operating structure, scope of
products cleared, settled, or recorded, and use of technology and
procedures;
whether it clearly defines goals and objectives that are
measurable and achievable, such as in the areas of minimum service
levels, risk-management expectations, and business priorities; and
[[Page 70842]]
whether it establishes mechanisms for the regular review
of its efficiency and effectiveness.
22. Rule 17Ad-22(e)(22): Communication Procedures and Standards
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(22) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it uses, or at a
minimum accommodates, relevant internationally accepted communication
procedures and standards in order to facilitate efficient payment,
clearing, and settlement.
b. Comments Received and Commission Response
Two commenters expressed views regarding Rule 17Ad-22(e)(22). The
first commenter supported the Commission's proposed rules requiring the
use of internationally accepted communication procedures and standards.
The commenter expressed the belief that such a requirement will result
in more effective communication with direct and indirect participants
and will result in a more prompt and accurate process.\508\
---------------------------------------------------------------------------
\508\ See CFA Institute at 12.
---------------------------------------------------------------------------
The second commenter noted that users of its systems that process
transactions only in a particular market typically rely on long-
standing, highly automated communications methods and messaging formats
that are viewed as industry-standard, regardless of international
standards. The commenter urged that these users not be required to
retool their communication systems in such a market to comply with
international communication standards and that such a requirement may
impose substantial costs devoid of any material benefits. The commenter
noted that the proposed rule permits a covered clearing agency to
accommodate international standards as an equally appropriate means of
satisfying the requirement as is the exclusive use of a standard (e.g.,
a clearing agency providing such an accommodation can permit users who
wish to use international standards exclusively to do so, without
forcing those users who do not wish (and have no need to) use the
international standards to convert to them). Additionally, the
commenter read the proposed provision as intending to provide
sufficient flexibility to enable a covered clearing agency, when
evaluating systems upgrades or new services, to take into account
several factors to select the protocol that it deems most appropriate
for the circumstances.\509\
---------------------------------------------------------------------------
\509\ See DTCC at 11-12.
---------------------------------------------------------------------------
In response to the second commenter, the Commission notes that Rule
17Ad-22(e)(22) requires policies and procedures that at a minimum
accommodate international standards. A covered clearing agency that
does not rely on existing international standards as part of its own
communication protocols could comply with Rule 17Ad-22(e)(22) by having
policies and procedures that require its systems to be able to receive
communications from and transmit communications to a system that uses
the international standards. However, the Commission also believes that
accommodating international standards does not require implementing
international standards as the only or primary communication protocol,
particularly if other automated messaging formats exist that are widely
used and considered industry standard in the United States.
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(22) as proposed.\510\
The Commission notes that the ability of participants to communicate
with a covered clearing agency in a timely, reliable, and accurate
manner is important to achieving prompt and accurate clearance and
settlement.
---------------------------------------------------------------------------
\510\ Relevant internationally accepted communication procedures
and standards could include messaging standards such as SWIFT, FIX,
and FpML.
---------------------------------------------------------------------------
23. Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures, and
Market Data
a. Proposed Rule
As proposed, Rule 17Ad-22(e)(23) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for the specific disclosures
enumerated in the rule, as discussed below. Proposed Rule 17Ad-
22(e)(23)(i)-(iii) would require such policies and procedures to
specifically require a covered clearing agency to (i) publicly disclose
all relevant rules and material procedures, including key aspects of
its default rules and procedures; (ii) provide sufficient information
to enable participants to identify and evaluate the risks, fees, and
other material costs they incur by participating in the covered
clearing agency; and (iii) publicly disclose relevant basic data on
transaction volume and values.
Proposed Rule 17Ad-22(e)(23)(iv) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for a comprehensive public disclosure
of its material rules, policies, and procedures regarding governance
arrangements and legal, financial, and operational risk management,
accurate in all material respects at the time of publication, including
(i) a general background of the covered clearing agency, including its
function and the market it serves, basic data and performance
statistics on its services and operations, such as basic volume and
value statistics by product type, average aggregate intraday exposures
to its participants, and statistics on the covered clearing agency's
operational reliability, and a description of its general organization,
legal and regulatory framework, and system design and operations; (ii)
a standard-by-standard summary narrative for each applicable standard
set forth in proposed Rules 17Ad-22(e)(1) through (22) with sufficient
detail and context to enable the reader to understand its approach to
controlling the risks and addressing the requirements in each standard;
(iii) a summary of material changes since the last update of the
disclosure; and (iv) an executive summary of the key points regarding
each.\511\ Proposed Rule 17Ad-22(e)(23)(v) would also require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure the comprehensive
public disclosure required under proposed Rule 17Ad-22(e)(23)(iv) is
updated not less than every two years, or more frequently following
changes to its system or the environment in which it operates to the
extent necessary, to ensure statements previously provided remain
accurate in all material respects.\512\
---------------------------------------------------------------------------
\511\ See id. at 29556.
\512\ See id. at 29557.
---------------------------------------------------------------------------
b. Comments Received and Commission Response
One commenter expressed support for the Commission's proposed
requirements regarding the disclosures set forth in proposed Rule 17Ad-
22(e)(23). The commenter expressed the belief that such disclosures are
necessary to enhance transparency and allow investors and other
participants to obtain the information necessary to evaluate covered
clearing agencies and also believes that such an approach may
[[Page 70843]]
add to market discipline.\513\ A second commenter expressed support for
strong and effective transparency requirements for covered clearing
agencies.\514\ However, a number of commenters requested that the
Commission consider amending the rule to incorporate more granular or
prescriptive guidance and requirements, with a particular focus on
achieving consistency with international standards and enhanced
disclosures regarding emergency actions by covered clearing agencies.
The Commission discusses these particular comments below.
---------------------------------------------------------------------------
\513\ See CFA Institute at 13.
\514\ See The Clearing House at 15.
---------------------------------------------------------------------------
i. Comprehensive Public Disclosure
One commenter read the leading language in proposed Rule 17Ad-
22(e)(23)(iv) to imply a requirement to create a comprehensive document
that should address how the clearing agency's governance arrangements,
legal structure, approach to risk management, and financial
arrangements operate, as opposed to implying a separate obligation to
publicly disclose all such policies and procedures, irrespective of
whether they relate to internal operational policies or are otherwise
comprehended within the requirements of 17Ad-22(e)(23)(i).\515\ The
Commission believes that the commenter's interpretation of the leading
language in proposed Rule 17Ad-22(e)(23)(iv) is consistent with the
requirements of the rule.
---------------------------------------------------------------------------
\515\ See DTCC at 13.
---------------------------------------------------------------------------
In the CCA Standards proposing release, the Commission made several
statements regarding the requirements under Rule 17Ad-22(e)(23):
With respect to the basic data and performance statistics
envisioned by the rule, the Commission identified, as relevant to the
requirement, statistics on the covered clearing agency's operational
reliability so that the relevant stakeholders and the general public
have data regarding, for example, performance targets for systems and
the actual performance thereof over specified periods, as well as
targets for recovery.
With respect to the standard-by-standard summary
narrative, the Commission sought to elicit a summary discussion of the
covered clearing agency's implementation of policies and procedures
that would need to be established, implemented, maintained and enforced
by a covered clearing agency in response to proposed Rules 17Ad-
22(e)(1) through (22).
With respect to material changes to the disclosure, the
Commission stated that it would expect a covered clearing agency to
consider its particular circumstances, such as, for example, changes in
the scope of services provided by the covered clearing agency, in
satisfying this requirement.\516\
---------------------------------------------------------------------------
\516\ See CCA Standards proposing release, supra note 5, at
29557.
---------------------------------------------------------------------------
The Commission further notes that the comprehensive public
disclosure is intended to elicit all material information that would
address compliance with each of the requirements in Rule 17Ad-22(e),
along with information such as its function and the markets it serves
and basic data and performance statistics. Moreover, in proposing Rule
17Ad-22(e)(23), the Commission also stated that two purposes of Rule
17Ad-22(e)(23) were to (i) provide participants with the information
necessary to, at a minimum, identify and evaluate the risks and costs
associated with the use of a covered clearing agency, thereby promoting
transparency and enhancing competition and market discipline, and (ii)
provide other stakeholders, including regulators and the public, with
information that facilitates informed oversight and decision-making
regarding each covered clearing agency.
The Commission is modifying Rule 17Ad-22(e)(23)(iv) so that the
language more closely tracks the categories of requirements in Rule
17Ad-22(e) and the statements immediately above. The purpose of this
modification is to make clear that the comprehensive public disclosure
is intended to describe the material rules, policies and procedures of
the covered clearing agency related to compliance with Rule 17Ad-22(e),
rather than require a complete disclosure of all rules, policies, and
procedures. As adopted, the leading language of Rule 17Ad-22(e)(23)(iv)
will require policies and procedures providing for a comprehensive
public disclosure that describes the covered clearing agency's material
rules, policies, and procedures regarding its legal, governance, risk
management, and operating framework, accurate in all material respects
at the time of publication.
ii. Consistency With International Standards
One commenter recommended that the Commission provide guidance that
it will interpret and administer Rule 17Ad-22(e)(23) as being
consistent with PFMI disclosure framework to ensure that clearing
participants have sufficient information to conduct diligence and
assess the risks of exposure to a covered clearing agency and to
maintain consistency with evolving international standards.\517\ In
response, and as previously noted, the Commission intends to interpret
and administer Rule 17Ad-22(e)(23) consistent with Section 17A of the
Exchange Act and, to the extent consistent with Section 17A, with
relevant international standards such as the PFMI and the PFMI
disclosure framework.\518\ Additionally, the Commission notes that a
covered clearing agency could consider the PFMI quantitative
disclosures to develop its policies and procedures in compliance with
Rule 17Ad-22(e)(23).\519\ The Commission believes that the PFMI, the
PFMI disclosure framework, and the PFMI quantitative disclosures can be
useful tools to help a covered clearing agency consider how to disclose
information to its participants, other relevant stakeholders, or the
public. However, the Commission also notes that publishing the PFMI
disclosure framework or the PFMI quantitative disclosures does not, in
and of itself, constitute compliance with Rule 17Ad-22(e)(23).\520\ As
previously discussed, Rule 17Ad-22(e)(23) requires that a covered
clearing agency (i) publicly disclose all relevant rules and material
procedures, including key aspects of its default rules and procedures;
(ii) provide sufficient information to enable participants to identify
and evaluate the risks, fees, and other material costs they incur by
participating in the covered clearing agency; and (iii) publicly
disclose relevant basic data on transaction volume and values. It also
requires, as discussed in Part II.C.23.b.i, a comprehensive public
disclosure consistent with Rule 17Ad-22(e)(23)(iv). The Commission
believes that covered clearing agencies may use a number of different
approaches to make disclosures under Rule 17Ad-22(e)(23), and the
Commission notes that policies and procedures for such disclosures must
be in compliance with Rule 17Ad-22(e)(23).
---------------------------------------------------------------------------
\517\ See ISDA at 6; see also supra note 41 (providing a
citation for the PFMI disclosure framework).
\518\ See supra Part I.A.5. (discussing the relevant
international standards).
\519\ See supra note 41 (providing a citation for the PFMI
quantitative disclosures).
\520\ A covered clearing agency independently prepares and
publishes these disclosure documents, and the Commission does not
review, opine on, or approve them.
---------------------------------------------------------------------------
iii. Disclosures Regarding Emergency Actions
One commenter stated that, when taking emergency actions, CCPs must
consider the interests of members and
[[Page 70844]]
market stability in addition to those of CCP owners.\521\ The commenter
identified the following concerns:
---------------------------------------------------------------------------
\521\ See The Clearing House, annex, at 24.
---------------------------------------------------------------------------
Changes to CCP rules and procedures and other actions
taken during emergencies can affect the economic position of members,
imposing unexpected losses and liquidity demands, and can thus have
spillover effects in the broader market.\522\
---------------------------------------------------------------------------
\522\ See id.
---------------------------------------------------------------------------
Unchecked and unbounded discretion could permit a CCP to
alter the fundamental economic relationship between it and its members
without notice or a chance for members to evaluate the consequences of
such changes.\523\
---------------------------------------------------------------------------
\523\ See id. at 25.
---------------------------------------------------------------------------
In response, the Commission notes that the above comments are most
directly relevant to the Commission's discussion of crisis and
emergency decision-making with respect to Rule 17Ad-22(e)(2). The
Commission has previously addressed comments regarding crisis or
emergency decision-making in Part II.C.2.b.v.
iv. Disclosures Regarding Participant-Default Rules and Procedures
One commenter recommended that the Commission make some
clarifications to the requirement in proposed Rule 17Ad-22(e)(23)(ii)
that a covered clearing agency provide sufficient detail to enable
participants to identify and evaluate the risks they incur by
participating in the covered clearing agency. Specifically, the
commenter recommended that the Commission require the covered clearing
agency to disclose (i) to its participants the policies and procedures
established by the covered clearing agency pursuant to proposed Rule
17Ad-22(e)(13), and (ii) to its participants and their customers, the
financial risks to which they would be subject in a scenario in which
the covered clearing agency's credit losses upon the default of one or
more participants exceed the resources designated to absorb such
losses.\524\ As discussed above in connection with the requirements for
the comprehensive public disclosure, the two purposes of proposing Rule
17Ad-22(e)(23) were to (i) provide participants with the information
necessary to, at a minimum, identify and evaluate the risks and costs
associated with the use of a covered clearing agency, and (ii) provide
other stakeholders, including regulators and the public, with
information that facilitates informed oversight and decision-making
regarding each covered clearing agency.\525\ Pursuant to Rule 17Ad-
22(e)(23)(iv), the comprehensive public disclosure is intended to
provide participants with the information necessary to, at a minimum,
identify and evaluate the risks and costs associated with the use of a
covered clearing agency. In addition, a covered clearing agency's
recovery and wind-down plans consistent with Rule 17Ad-22(e)(3) would
also provide further insight into the financial risks to which
participants and their customers may be subject in a scenario in which
the covered clearing agency's credit losses exceed the resources
designated to absorb such losses. Accordingly, the Commission believes
that the required public disclosure will encompass the information that
the commenter seeks.
---------------------------------------------------------------------------
\524\ See The Clearing House at 7.
\525\ See supra Part II.C.23.b.i.
---------------------------------------------------------------------------
The same commenter also recommended that the Commission clarify
that a covered clearing agency may not, pursuant to emergency authority
or otherwise, modify its rules, policies, or procedures in a manner
that would materially increase a non-defaulting participant's exposure
to loss or the extent of the covered clearing agency's recourse to a
non-defaulting participant's assets, or redefine the economic terms of
outstanding cleared contracts, without a reasonable prior notice and
transition period prior to effectiveness.\526\ The commenter further
stated that a reasonable prior notice period for such a modification
would be one that is sufficient to enable a non-defaulting participant
to complete the process of withdrawal from participant status, in
accordance with the rules of the covered clearing agency, under
reasonable assumptions that take into account the demonstrated
liquidity of the relevant product or asset type.\527\ In addition, the
commenter stated that any such modification that takes place following
the occurrence of a default or series of defaults involving one or more
participants and prior to expiration of the covered clearing agency's
``cooling-off period'' should not take effect until after the
expiration of that period.\528\ For the commenter's purposes, the term
``cooling-off period'' referred to the period following the default of
one or more participants during which losses accrued by the covered
clearing agency may be satisfied by recourse to the clearing or
guaranty fund contributions of non-defaulting participants,
notwithstanding the intervening withdrawal from participant status of
one or more such participants.\529\ The commenter's recommendations
contemplated that cooling-off periods will continue to be specified in
the rules of a covered clearing agency, subject to Commission review.
According to the commenter, although appropriate cooling-off periods
may vary by product or asset type, the commenter believed that the
Commission should, in reviewing a covered clearing agency's rules,
ensure that its cooling-off period(s) are of sufficient duration
following a participant default (or the last in a series of
substantially contemporaneous participant defaults) to allow the
relevant market to return to stability under reasonable
assumptions.\530\ In response, the Commission notes that the above
comments are beyond the scope of Rule 17Ad-22(e)(23), which pertains to
disclosures, but instead are relevant to crisis and emergency decision-
making, which are discussed above in Part II.C.2.b.v.
---------------------------------------------------------------------------
\526\ See The Clearing House at 7.
\527\ See id. at 7 n.16.
\528\ See id.
\529\ See id.
\530\ See id.
---------------------------------------------------------------------------
v. Additional Disclosures
One commenter believed that, to enhance participants' ability to
evaluate their risks, the Commission should require a covered clearing
agency to provide their participants with additional, more specific
disclosures regarding its default rules and procedures, custody and
collateral investment activities, methodologies for determining initial
margin requirements and clearing or guaranty fund contributions, stress
testing methodologies, and the covered clearing agency's treatment of
participant initial margin and clearing or guaranty fund
contributions.\531\ The Commission notes that each of these topic areas
are addressed by requirements under Rule 17Ad-22(e),\532\ and therefore
these topic
[[Page 70845]]
areas are also the types of material information that would constitute
elements of the comprehensive public disclosure required under Rule
17Ad-22(e)(23)(iv).\533\
---------------------------------------------------------------------------
\531\ See The Clearing House at 3, 15. The commenter further
stated that, based on current disclosure practices, members are
unable to effectively measure or manage their risk exposure to CCPs,
and that disclosure to a CCP's risk committee is generally
insufficient due to confidentiality restrictions, which prevents the
risk committee from being able to share relevant information with
their employer clearing member (and, further, not all clearing
members even have employees on the CCP's risk committee). See id.,
annex at 26, 27.
\532\ See supra Parts II.C.4 (discussing requirements for
guaranty fund contributions, allocation of losses pursuant to the
default waterfall, and stress testing for credit risk under Rule
17Ad-22(e)(4)), II.C.5 (discussing requirements for collateral under
Rule 17Ad-22(e)(5)), II.C.6 (discussing requirements for margin
under Rule 17Ad-22(e)(6)), II.C.7 (discussing requirements for
stress testing for liquidity risk under Rule 17Ad-22(e)(7)), II.C.13
(discussing requirements for participant-default rules and
procedures under Rule 17Ad-22(e)(13)), and II.C.16 (discussing
requirements for custody and investment policies under Rule 17Ad-
22(e)(16)).
\533\ See supra Part II.C.23.b.i.
---------------------------------------------------------------------------
To facilitate sufficient disclosure, the commenter recommended that
the Commission adopt the recommendations developed by the FRB of New
York's Payments Risk Committee for participant due diligence of CCPs in
these and other areas.\534\ The commenter stated that obtaining
information in these areas is necessary for participants to adequately
identify and evaluate the risks they incur by participating in a CCP.
Like the PFMI disclosure framework and the PFMI quantitative
disclosures, the framework set forth by the FRB Payments Risk Committee
may be another useful tool to help a covered clearing agency consider
how best to disclose information to its participants, other relevant
stakeholders, or the public, but, as noted above, should not be viewed
as a substitute for compliance with Rule 17Ad-22(e)(23) and the
requirements of Section 17A of the Exchange Act. The Commission further
notes that the disclosure required by Rule 17Ad-22(e)(23) marks a
significant increase in the level and detail of disclosure that a
covered clearing agency will be required to provide to its participants
and the public, and that such disclosure will also encompass much of
the information covered in the framework established by the FRB
Payments Risk Committee. Therefore, the Commission declines to further
modify Rule 17Ad-22(e)(23).
---------------------------------------------------------------------------
\534\ See The Clearing House at 15; see also Payments Risk
Committee, Recommendations for Supporting Participant Due Diligence
of Central Counterparties (Feb. 5, 2013).
---------------------------------------------------------------------------
The commenter further stated that because a CCP's internal models
are not usually disclosed at a sufficient level of detail, participants
are often unable to predict initial margin requirements, clearing or
guaranty fund contributions, or possible loss allocations accurately
and, as a result, cannot anticipate exposures or hedge resulting
risks.\535\ The commenter also stated that participants typically do
not have sufficient insight into the stress framework and stress
scenarios that are intended to ensure sufficiency of total financial
resources and as such are unable to determine the CCP's ability to
withstand multiple participants' failures or market stress.\536\ As
noted above, the disclosure required by policies and procedures under
Rule 17Ad-22(e)(23) marks a significant increase in the level and
detail of disclosure that a covered clearing agency will be required to
provide to its participants and the public and addresses in significant
portion the commenter's concerns.
---------------------------------------------------------------------------
\535\ See The Clearing House at 15.
\536\ See id.
---------------------------------------------------------------------------
In addition, to promote participants' ability to identify and
evaluate their risks, the commenter recommended that the Commission
clarify that a covered clearing agency must provide to its participants
each fiscal quarter, or at any time upon request, the following minimum
information:
The methodologies for determining initial margin
requirements and clearing or guaranty fund contributions, at a level of
detail adequate to enable participants to replicate the covered
clearing agency's calculations; \537\
---------------------------------------------------------------------------
\537\ See The Clearing House at 16.
---------------------------------------------------------------------------
The methodologies for stress testing the adequacy of the
clearing or guaranty fund, including the assumptions and scenarios that
formed the basis of the stress test and the results of the stress test,
which shall include but not be limited to an analysis of the adequacy
of the defaulting participant's resources available to cover losses
arising from the liquidation, transfer or termination of the positions
in its portfolio; \538\ and
---------------------------------------------------------------------------
\538\ See id. The commenter stated that stress frameworks
mandated by the Commission should form the baseline set of
assumptions/scenarios for a covered clearing agency, and those
frameworks should be based on sufficiently severe stressed
macroeconomic conditions to provide a consistent initial baseline
from which covered clearing agencies can begin to estimate the
extent of their need for loss-absorbing resources. These baseline
assumptions/scenarios should be bolstered by specific scenarios
unique to the particular asset class and should include
idiosyncratic stresses on basis and higher order risk exposures
embedded in the covered clearing agency's portfolio. See id. at 16
n.44.
---------------------------------------------------------------------------
The covered clearing agency's treatment and segregation of
participant initial margin and clearing or guaranty fund
contributions.\539\
---------------------------------------------------------------------------
\539\ See The Clearing House at 16.
---------------------------------------------------------------------------
In suggesting that such information be required to be disclosed,
the commenter suggested that members of CCPs should also be able to
accurately predict the fees, margin requirements and guaranty fund
contribution requirements associated with participation in the CCP and
changes to the member's portfolio or clearing activity.
Where the above disclosure is not possible, the commenter stated
that the Commission should instead require a covered clearing agency to
develop computational solutions that provide its participants with the
ability to determine the costs, initial margin, clearing or guaranty
fund contributions, clearing or guaranty fund performance and loss
allocations associated with changes to each respective participant's
portfolio or hypothetical portfolio, participant defaults and other
relevant information.\540\ Mandating disclosure of this frequency and
granularity would be inconsistent with the principles-based approach
the Commission is taking in Rule 17Ad-22(e), and Rule 17Ad-22(e)(23)
addresses in significant portion the commenter's concerns.
---------------------------------------------------------------------------
\540\ See The Clearing House at 16.
---------------------------------------------------------------------------
The commenter also stated that CCPs should be required to provide
advance notice to members of any proposed changes to policies,
procedures, models, or other elements of the CCPs' operations that
could have a material adverse economic effect on members. According to
the commenter, such advance notice is necessary to protect members'
ability to manage their risk by withdrawal from the CCP if necessary,
and further CCPs should seek member input on any such changes through a
formal consultation process to the extent possible.\541\ The Commission
believes that the rule filing process under Section 19(b) of the
Exchange Act and Rule 19b-4 thereunder, as well as the process for
advance notices under Section 806(e) of the Clearing Supervision Act,
address this comment, including by providing the opportunity for member
input upon the proposed rule change.
---------------------------------------------------------------------------
\541\ See id.
---------------------------------------------------------------------------
c. Final Rule
The Commission is adopting Rule 17Ad-22(e)(23) with modifications.
First, the Commission is striking the language ``maintain clear and
comprehensive rules and procedures'' under Rule 17Ad-22(e)(23) because
Rule 17Ad-22(e) already requires that a covered clearing agency have
written policies and procedures reasonably designed to establish,
implement, maintain and enforce the requirements thereunder. Consistent
with this change, the Commission is also striking ``providing'' from
Rule 17Ad-22(e)(23)(iv). Second, the Commission is modifying paragraph
(iv) as described in Part II.C.23.b.i. Third, the Commission is also
modifying paragraph (iv)(D) to correct technical errors in the proposed
rule text so that it refers to the standards set forth in paragraphs
(e)(1) through (23) (rather than (e)(1) through (22)). The Commission
believes that providing a summary narrative for Rule 17Ad-22(e)(23) is
appropriate because Rule 17Ad-22(e)(23) requires policies and
[[Page 70846]]
procedures to (i) publicly disclose all relevant rules and material
procedures, including key aspects of its default rules and procedures;
(ii) provide sufficient information to enable participants to identify
and evaluate the risks, fees, and other material costs they incur by
participating in the covered clearing agency; and (iii) publicly
disclose relevant basic data on transaction volume and values, in
addition to requiring the standard-by-standard summary narrative
required by Rule 17Ad-22(e)(23)(iv)(D). A summary narrative for Rule
17Ad-22(e)(23) would allow for a better understanding of a covered
clearing agency's policies and procedures for compliance with this
rule.
Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(23), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address disclosure of rules, key
procedures, and market data:
Whether it adopts clear and comprehensive rules and
procedures that are fully disclosed to participants;
whether it discloses clear descriptions of the system's
design and operations, as well as its and participants' rights and
obligations, so that participants can assess the risks they would incur
by participating in the covered clearing agency;
whether it provides all necessary and appropriate
documentation and training to facilitate participants' understanding of
the covered clearing agency's rules and procedures and the risks they
face from participating in the covered clearing agency;
whether it publicly discloses its fees at the level of
individual service it offers as well as its policies on any available
discounts; and
whether it completes regularly and discloses publicly
responses to the PFMI disclosure framework.
In addition, the Commission notes that, as with public disclosures
contemplated in conjunction with Rule 17Ad-22(e)(23), a covered
clearing agency could comply with the proposed requirement by posting
the relevant documentation to its Web site.
D. Rule 17Ab2-2
1. Proposed Rule
The Commission proposed Rule 17Ab2-2 to establish procedures for
the Commission to make determinations affecting covered clearing
agencies. Under the proposed rule, the Commission would make
determinations in three cases, as discussed below. In each case, under
proposed Rule 17Ab2-2(d), the Commission would publish notice of its
intention to consider such determinations, together with a brief
statement of the grounds under consideration, and provide at least a
30-day public comment period prior to any determination. The Commission
may provide the clearing agency subject to the proposed determination
opportunity for hearing regarding the proposed determination. Under
proposed Rule 17Ab2-2(e), notice of determinations in each case would
be given by prompt publication thereof, together with a statement of
written reasons supporting the determination. In proposing Rule 17Ab2-
2, the Commission noted that determinations could be made as part of
the registration process upon receiving an application for registration
as a clearing agency or at some point after registration, if the
Commission determines that a clearing agency does not meet the
definition of a covered clearing agency upon registration but does so
at a later date, as either market conditions or the characteristics of
the clearing agency itself change.\542\
---------------------------------------------------------------------------
\542\ See CCA Standards proposing release, supra note 5, at
29557-58.
---------------------------------------------------------------------------
As proposed, Rule 17Ab2-2 provides the Commission with procedures
for making determinations in the following three cases:
Pursuant to Rule 17Ab2-2(a), the Commission may, if it
deems appropriate, upon application by any registered clearing agency
or member thereof or on its own initiative, determine whether a
registered clearing agency should be considered a covered clearing
agency. In determining whether a registered clearing agency should be
considered a covered clearing agency, the Commission may consider
characteristics such as the clearing of financial instruments that are
characterized by discrete jump-to-default price changes or that are
highly correlated with potential participant defaults or other such
factors as it deems appropriate in the circumstances.\543\
---------------------------------------------------------------------------
\543\ See id. at 29558.
---------------------------------------------------------------------------
Pursuant to Rule 17Ab2-2(b), the Commission may, if it
deems appropriate, upon application by any clearing agency or member
thereof, or on its own initiative, determine whether a covered clearing
agency meets the definition of ``systemically important in multiple
jurisdictions.'' In determining whether a covered clearing agency is
systemically important in multiple jurisdictions, the Commission may
consider (i) whether the covered clearing agency is a designated
clearing agency; (ii) whether the clearing agency has been determined
to be systemically important by one or more jurisdictions other than
the United States through a process that includes consideration of
whether the foreseeable effects of a failure or disruption of the
designated clearing agency could threaten the stability of each
relevant jurisdiction's financial system; \544\ or (iii) such other
factors as the Commission may deem appropriate in the circumstances.
The Commission also noted that analysis of other factors could include
whether foreign regulatory authorities have designated the covered
clearing agency as systemically important and whether any findings were
made in anticipation of that designation.\545\
---------------------------------------------------------------------------
\544\ The Commission notes that this provision of proposed Rule
17Ab2-2(b) parallels the definition of systemic importance in
Section 803(9) of the Clearing Supervision Act, which states that
systemic importance means a situation where the failure of or a
disruption to the functioning of an FMU could create, or increase,
the risk of significant liquidity or credit problems spreading among
financial institutions or markets and thereby threaten the stability
of the financial system of the United States. See 12 U.S.C. 5462(9).
\545\ See CCA Standards proposing release, supra note 5, at
29558.
---------------------------------------------------------------------------
Pursuant to Rule 17Ab2-2(c), the Commission may, if it
deems appropriate, determine whether any of the activities of a
clearing agency providing CCP services, in addition to clearing
agencies registered with the Commission for the purpose of clearing
security-based swaps, have a more complex risk profile. In determining
whether a clearing agency's activity has a more complex risk profile,
the Commission may consider (i) characteristics such as the clearing of
financial instruments that are characterized by discrete jump-to-
default price changes or that are highly correlated with potential
participant defaults; or (ii) such other characteristics as it deems
appropriate in the circumstances. \546\
---------------------------------------------------------------------------
\546\ See id. at 29559.
---------------------------------------------------------------------------
2. Comments Received and Commission Response
The Commission received two comments that generally supported the
Commission's approach in Rule 17Ab2-2 \547\ However, a number of
commenters also raised concerns about particular procedural and
substantive aspects of the Rule 17Ab2-2, and the Commission discusses
each of these in turn below.
---------------------------------------------------------------------------
\547\ See CFA Institute at 5, 14; OSEC at 2.
---------------------------------------------------------------------------
[[Page 70847]]
a. Determinations Regarding ``Covered Clearing Agency'' Status
Generally
One commenter argued that Rule 17Ab2-2 lacks clear standards for
determining when and according to which standards a registered clearing
agency would be found to be a covered clearing agency, and further
stated that such determinations are based upon factors that may be
entirely defined by the Commission during the determinations process
itself.\548\ In response to this comment, and in light of the
Commission's separate proposal to amend the definition of ``covered
clearing agency,'' \549\ the Commission has determined not to adopt
Rule 17Ab2-2(a). Because the Commission had determined not to adopt
Rule 17Ab2-2(a), the subsequent paragraphs in Rule 17Ab2-2 will be
renumbered accordingly.
---------------------------------------------------------------------------
\548\ See CME at 3.
\549\ See CCA Definition proposing release, supra note 82, at
25-26.
---------------------------------------------------------------------------
b. Determinations Regarding ``Covered Clearing Agency'' Status for
Dually Registered Entities
In another commenter's view, any decision to apply the enhanced
standards for covered clearing agencies should take into account
whether, and the extent to which, the clearing agency is already
subject to similar or comparable standards under other regulation.\550\
The commenter noted that the proposed rules take this approach with
respect to dually registered SIDCOs for which the CFTC is the
supervisory agency under the Clearing Supervision Act and believed a
similar exclusion would be appropriate for clearing agencies subject to
other regulatory frameworks.\551\ The commenter cited as examples
regulation by the Bank of England under existing U.K. legislation and,
for those clearing agencies that have been granted authorization as a
CCP under EMIR, the regulations under EMIR.\552\
---------------------------------------------------------------------------
\550\ See ICEEU at 4-5.
\551\ See id. at 5.
\552\ See id.
---------------------------------------------------------------------------
Because the Commission has determined not to adopt Rule 17Ab2-2(a),
the commenter's concerns regarding determinations under Rule 17Ab2-2(a)
for dually registered clearing agencies have been addressed.
c. Determinations Regarding ``Complex Risk Profile''
One commenter expressed concern about the proposed criteria for
determining whether a clearing agency is involved in activities with a
more complex risk profile under proposed Rule 17Ab2-2(c), which
triggers enhanced requirements for policies and procedures related to
credit and liquidity risk management.\553\ The commenter believed that
it is necessary to consider additional factors, including the
proportion of the covered clearing agency's clearing activities
involving higher risk products as well as the manner in which it
manages those risks. In the absence of considering such additional
factors, the commenter expressed concern that a trivial amount of
clearing of credit default options, in comparison to more standardized
options, could trigger a cover two requirement, when a clearing agency
may have other means to address the added risk, such as through an
enhanced margin system.\554\ The commenter suggested that the
Commission clarify that it is not its intention to interpret the rules
in such a manner.\555\ A second commenter believed that the proposed
wording of paragraphs (1) and (2) under proposed Rule 17Ab2-2(c) is
vague.\556\ The commenter believed it is unclear whether
``characteristics such as the clearing of financial instruments that
are characterized by discrete jump-to-default price changes or that are
highly correlated with potential participant defaults'' and ``such
other characteristics as it deems appropriate in the circumstances''
are independent analyses by which a clearing agency may be judged or
whether they should be considered jointly.
---------------------------------------------------------------------------
\553\ See OCC at 7.
\554\ See id.
\555\ See id. at 8.
\556\ See Joyce.
---------------------------------------------------------------------------
In response to these comments, the Commission is modifying the
proposed criteria to be considered in determining whether any of the
activities of a clearing agency providing CCP services have a more
complex risk profile in Rule 17Ab2-2 to remove the reference to
``[s]uch other characteristics as it may deem appropriate in the
circumstances, as factors supporting a finding of a more complex risk
profile.'' \557\ Further, the Commission notes that it could, as part
of its analysis under the rule, also consider the extent to which a
clearing agency clears financial instruments that are characterized by
discrete jump-to-default price changes or that are highly correlated
with potential participant defaults. The Commission believes that this
approach mitigates the concern raised by the commenter that a clearing
agency clearing only a trivial amount of credit default options could
be subject to the ``cover two'' requirement in Rule 17Ad-22(e)(4).
---------------------------------------------------------------------------
\557\ In addition, as noted in Part II.D.2.a, the Commission has
determined not to adopt proposed Rule 17Ab2-2(a). The Commission is
therefore renumbering Rule 17Ab2-2 so that proposed Rule 17Ab2-2(c)
is being moved to Rule 17Ab2-2(b). See infra Part VI.
---------------------------------------------------------------------------
In addition, in light of the concerns regarding the scope of such
other characteristics as the Commission may deem appropriate in the
circumstances, the Commission is also removing the similar criteria--
``such other factors as it may deem appropriate in the
circumstances''--from proposed Rule 17Ab2-2(b).\558\
---------------------------------------------------------------------------
\558\ As discussed in Part II.D.2.a above, the Commission has
determined not to adopt proposed Rule 17Ab2-2(a), and therefore, in
adopting proposed Rule 17Ab2-2(b), the Commission is moving it to
Rule 17Ab2-2(a). See infra Part VI.
---------------------------------------------------------------------------
d. Sufficiency of Procedures Generally
One commenter stated that proposed Rule 17Ab2-2 does not provide
the subjected clearing agency with an opportunity for a hearing.\559\
The commenter further stated that it is not apparent under the proposed
framework that a registered clearing agency would be able to
meaningfully impact any proceeding in which the Commission seeks to
determine that it should be subject to the requirements for covered
clearing agencies, exacerbating regulatory uncertainty.\560\
---------------------------------------------------------------------------
\559\ See CME at 3.
\560\ See id.
---------------------------------------------------------------------------
As discussed above, the Commission has determined not to adopt Rule
17Ab2-2(a), and therefore no process would exist under Rule 17Ab2-2 by
which the Commission could designate a registered clearing agency as a
covered clearing agency. The Commission notes, nonetheless, that the
procedures set forth in Rule 17Ab2-2, as previously discussed, include
provisions for publishing notice of the Commission's intention to
consider determinations under Rule 17Ab2-2, including a brief statement
of the grounds under consideration, and for providing at least a 30-day
public comment period. The Commission believes that this should provide
a clearing agency with ample opportunity to present data, views, and
arguments supporting why it should not be subject to the requirements
for covered clearing agencies. Nevertheless, the rule also provides
that the clearing agency subject to the proposed determination may be
provided an opportunity for hearing, which provides the possibility of
an opportunity for additional input.
e. Procedures for Removing ``Covered Clearing Agency'' Status
One commenter believed that the Commission should establish a
process,
[[Page 70848]]
including a public comment period, for determinations regarding covered
clearing agency status and recommends that a process for removing that
status (due to, for example, a change in circumstances such that the
clearing agency no longer meets the criteria for designation) also be
established. The commenter stated that it should include a public
comment period and advance notice to clearing members of at least 180
days prior to the effectiveness of such change in status.\561\ The
Commission believes that such procedures will ensure that each clearing
agency is subject to the appropriate rule set on an ongoing basis. In
response to this comment, the Commission is adding new paragraph (d) to
Rule 17Ab2-2 to provide for a process to rescind any determination made
pursuant to Rule 17Ab2-2(a), (b), or (c). This new rule includes the
same procedural elements as for determinations under Rules 17Ab2-2(b)
and (c), including publication with a 30-day comment period. The
commenter requested that clearing members be provided notice at least
180 days prior to the effectiveness of a change in status. The
Commission believes that the effective date for any such determination
should be based on the facts and circumstances of the clearing agency
for which removal of covered clearing agency status is being
considered.
---------------------------------------------------------------------------
\561\ See ISDA at 2.
---------------------------------------------------------------------------
3. Final Rule
The Commission has determined not to adopt proposed Rule 17Ab2-
2(a), as discussed above. The Commission is adopting proposed Rules
17Ab2-2(b) through (g) with the modifications described above. Because
the Commission is not adopting proposed Rule 17Ab2-2(a), the Commission
is renumbering the remaining paragraphs under Rule 17Ab2-2 accordingly.
E. Rule 17Ad-22(f)
As proposed, Rule 17Ad-22(f) would codify the Commission's special
enforcement authority over designated clearing agencies for which the
Commission acts as the supervisory agency, pursuant to the Clearing
Supervision Act. Under Section 807(c) of the Clearing Supervision Act,
for purposes of enforcing the provisions of the Clearing Supervision
Act, a designated clearing agency is subject to, and the Commission has
authority under, the provisions of subsections (b) through (n) of
Section 8 of the Federal Deposit Insurance Act in the same manner and
to the same extent as if a designated clearing agency were an insured
depository institution and the Commission were the appropriate Federal
banking agency for such insured depository institution.\562\ The
Commission received no comments regarding the proposed rule and is
adopting Rule 17Ad-22(f) as proposed.
---------------------------------------------------------------------------
\562\ See 12 U.S.C. 5466(c); see also 12 U.S.C. 1818 (relevant
provisions under the Federal Deposit Insurance Act).
---------------------------------------------------------------------------
F. Amendment to Rule 17Ad-22(d)
To facilitate consistency between existing Rule 17Ad-22(d) and
proposed Rule 17Ad-22(e), the Commission proposed to amend the first
paragraph of Rule 17Ad-22(d) so that it would not apply to covered
clearing agencies. Rule 17Ad-22(d) provides that a registered clearing
agency shall establish, implement, maintain and enforce written
policies and procedures reasonably designed to fulfill the requirements
of Rules 17Ad-22(d)(1) through (15), as applicable. As proposed, the
amended Rule 17Ad-22(d) would instead apply only to a registered
clearing agency other than a covered clearing agency.
The Commission received general comments regarding the overall
structure and application of Rule 17Ad-22 in light of proposed Rule
17Ad-22(e) and the existing requirements under Rule 17Ad-22(d), and has
addressed those comments in Part I.C.2. The Commission did not receive
any comments addressed to the proposed amendment to the first paragraph
of Rule 17Ad-22(d), and the Commission is adopting the amendment as
proposed.
G. Effective and Compliance Dates
One commenter believed that a phase-in of Rule 17Ad-22(e) is
necessary and appropriate.\563\ The commenter suggested that the
implementation phase-in extend to at least one year following
publication of Rule 17Ad-22(e), citing in particular the requirements
related to linkages in Rule 17Ad-22(e)(20) and views that compliance
with such rules will require extensive cooperation and coordination
among the relevant entities.\564\ Another commenter specifically
requested sufficient time for covered clearing agencies to implement
the requirements with respect to equity capital funding pursuant to
proposed Rule 17Ad-22(e)(15).\565\
---------------------------------------------------------------------------
\563\ See DTCC at 13.
\564\ See id. at 13-14 & n.46.
\565\ See OCC at 15. The Commission has since issued an order
approving a proposed rule change by OCC concerning a proposed
capital plan. See Exchange Act Release No. 34-74452 (Mar. 6, 2015),
80 FR 13058 (Mar. 12, 2015) (order approving proposed rule change by
OCC concerning a proposed capital plan for raising additional
capital that would support its function as a SIFMU).
---------------------------------------------------------------------------
The amendments to Rule 17Ad-22 and new Rule 17Ab2-2 will become
effective 60 days after publication in the Federal Register
(``effective date''). As proposed, a covered clearing agency would have
been required to meet the requirements of Rule 17Ad-22(e) on the
effective date. However, after consideration of the views of the
commenters, the Commission has determined to adopt a compliance date of
120 days after the effective date (``compliance date''). The Commission
believes it is important to establish enhanced requirements for covered
clearing agencies given the potentially significant risks posed by
their size, systemic importance, global reach, and/or the risks
inherent in the products they clear, and therefore continues to believe
that implementation of the requirements in Rule 17Ad-22(e) should be
prompt. The Commission notes that one commenter requesting a phase-in
approach for Rule 17Ad-22(e)(15) stated it would be in compliance with
the proposed requirements no later than January 1, 2015,\566\ which has
already passed. The other commenter raised several concerns regarding
the need to review existing policies and procedures, develop and draft
new policies and procedures, submit, where appropriate, proposed rule
changes and advance notices for Commission review, raise additional
capital or qualifying liquid resources, and hire and train additional
personnel.\567\ The Commission believes that the additional time it is
providing with the compliance date of 120 days after the effective date
addresses this concern.
---------------------------------------------------------------------------
\566\ See supra note 565.
\567\ See DTCC at 14.
---------------------------------------------------------------------------
In addition, one commenter requested that the Commission clarify
how it intends to apply the rules to applications for registration as a
clearing agency that are pending when the rules are finalized.\568\ The
Commission intends to review any application for registration as a
clearing agency pursuant to the requirements of Section 17A of the
Exchange Act and the rules and regulations thereunder, including Rule
17Ad-22 and any amendments thereto, and notes that the compliance date
would apply to all covered clearing agencies, including an applicant
for registration as a clearing agency whose application is pending upon
the compliance date that would, if registered, meet the definition of a
[[Page 70849]]
covered clearing agency. In reviewing such an application, Section
17A(b)(3) of the Exchange Act requires that a clearing agency shall not
be registered unless the Commission determines that an applicant's
rules and operations satisfy each of the requirements set forth in
Section 17A(b)(3).\569\ Following registration, any registered clearing
agency that falls within the definition of a covered clearing agency
would need to address compliance with each of the requirements in Rule
17Ad-22(e) no later than the compliance date.
---------------------------------------------------------------------------
\568\ See LCH at 3.
\569\ See 15 U.S.C. 78q-1(b)(3).
---------------------------------------------------------------------------
The Commission also notes that the staff regularly conducts
examinations, including those required under Section 807 of the
Clearing Supervision Act,\570\ and supervisory reviews of registered
clearing agencies that are covered clearing agencies.\571\ Accordingly,
the staff will periodically evaluate the results of these reviews and
examinations of covered clearing agencies to evaluate the extent to
which covered clearing agencies have achieved and maintained compliance
with Rule 17Ad-22(e); the various outcomes observed in how the covered
clearing agencies seek to implement the requirements of Rule 17Ad-
22(e), and possible reasons for such variations; and any other
observations relevant to implementation of Rule 17Ad-22(e).
---------------------------------------------------------------------------
\570\ Section 807 annual examinations of designated clearing
agencies are conducted in order to determine: (1) The nature of the
operations of, and the risks borne by, the designated financial
market utility; (2) the financial and operational risks presented by
the designated market utility to financial institutions, critical
markets, or the broader financial system; (3) the resources and
capabilities of the designated financial market utility to monitor
and control such risks; (4) the safety and soundness of the
designated financial market utility; and (5) the designated
financial market utility's compliance with the Clearing Supervision
Act and the rules and orders prescribed under the Clearing
Supervision Act. See 12 U.S.C. 5466(a).
\571\ See supra Part I.A.1.
---------------------------------------------------------------------------
III. Economic Analysis
As noted above, registered clearing agencies have become an
essential part of the infrastructure of the U.S. securities markets.
Many securities transactions are centrally cleared by clearing
agencies, and central clearing has become more prevalent in the market
for security-based swaps.\572\ For example, in the cash markets, DTCC
processed $1.508 quadrillion in financial transactions in 2015. Within
DTCC, NSCC processed an average daily value of $976.6 billion in equity
securities, FICC cleared $917.1 trillion of transactions in government
securities and $48.2 trillion of transactions in agency mortgage-backed
securities, and DTC settled $112.3 trillion of securities and held
securities valued at $45.4 trillion.\573\ In the listed options
markets, OCC cleared more than 4.1 billion contracts and held margin of
$98.3 billion at the end of 2015.\574\
---------------------------------------------------------------------------
\572\ The Commission is using ``central clearing'' here and
below to refer to both the clearance and settlement of securities
transactions. In this regard, ``clearing'' is performed by a CCP,
and ``settlement'' is performed for certain securities transactions
by a CSD, which then holds those securities in its role as the
central depository. Because clearing agencies can provide either CCP
or CSD services, the Commission uses ``clearing agencies'' here and
below to refer to CCPs and CSDs collectively. ``Registered clearing
agencies'' are those CCPs and CSDs that are registered with the
Commission.
\573\ See DTCC, 2015 Annual Report, available at http://www.dtcc.com/annuals/2015/index.php.
\574\ See OCC, 2015 Annual Report, available at http://www.theocc.com/components/docs/about/annual-reports/occ-2015-annual-report.pdf.
---------------------------------------------------------------------------
While central clearing generally benefits the markets in which it
is available, clearing agencies can pose substantial risk to the
financial system as a whole, due in part to the fact that central
clearing concentrates risk in the clearing agency. Disruption to a
clearing agency's operations, or failure on the part of a clearing
agency to meet its obligations, could therefore serve as a potential
source of contagion, resulting in significant costs not only to the
clearing agency itself or its members but also to other market
participants or the broader U.S. financial system.\575\ As a result,
proper management of the risks associated with central clearing is
necessary to ensure the stability of the U.S. securities markets and
the broader U.S. financial system. The mandate in Title VII of the
Dodd-Frank Act for central clearing of security-based swaps, wherever
possible and appropriate, further reinforces this need.\576\ When a
clearing agency provides CCP services, central clearing replaces
bilateral counterparty exposures with exposures against the clearing
agency. Consequently, a move from voluntary clearing to mandatory
clearing of security-based swaps, holding the volume of security-based
swap transactions constant, would increase economic exposures against
clearing agencies that centrally clear security-based swaps. Increased
exposures in turn raise the possibility that these clearing agencies
may serve as a transmission mechanism for systemic events.
---------------------------------------------------------------------------
\575\ See generally Dietrich Domanski, Leonardo Gambacorta, and
Cristina Picillo, Central Clearing: Trends and Current Issues, BIS
Quarterly Review (Dec. 2015), available at https://www.bis.org/publ/qtrpdf/r_qt1512g.pdf (describing links between CCP financial risk
management and systemic risk); Darrell Duffie, Ada Li & Theo Lubke,
Policy Perspectives on OTC Derivatives Market Infrastructure, at 9
(Fed. Reserve Bank N.Y. Staff Reps., Mar. 2010), available at http://www.newyorkfed.org/research/staff_reports/sr424.pdf (``If a CCP is
successful in clearing a large quantity of derivatives trades, the
CCP is itself a systemically important financial institution. The
failure of a CCP could suddenly expose many major market
participants to losses. Any such failure, moreover, is likely to
have been triggered by the failure of one or more large clearing
members, and therefore to occur during a period of extreme market
fragility.''); Pirrong, The Inefficiency of Clearing Mandates,
Policy Analysis, No. 655, at 11-14, 16-17, 24-26 (2010), available
at http://www.cato.org/pubs/pas/PA665.pdf, at 11-14, 16-17, 24-26
(stating, among other things, that ``CCPs are concentrated points of
potential failure that can create their own systemic risks,'' that
``[a]t most, creation of CCPs changes the topology of the network of
connections among firms, but it does not eliminate these
connections,'' that clearing may lead speculators and hedgers to
take larger positions, that a CCP's failure to effectively price
counterparty risks may lead to moral hazard and adverse selection
problems, that the main effect of clearing would be to
``redistribute losses consequent to a bankruptcy or run,'' and that
clearing entities have failed or come close to failing in the past,
including in connection with the 1987 market break); Froukelien
Wendt, Central Counterparties: Addressing Their Too Important to
Fail Nature (IMF Working Paper, Jan. 2015), available at http://papers.ssrn.com/sol3/Delivery.cfm/wp1521.pdf (assessing the
potential channels for contagion arising from CCP
interconnectedness); Manmohan Singh, Making OTC Derivatives Safe--A
Fresh Look, at 5-11 (IMF Working Paper, Mar. 2011), available at
http://www.imf.org/external/pubs/ft/wp/2011/wp1166.pdf (addressing
factors that could lead central counterparties to be ``risk nodes''
that may threaten systemic disruption).
\576\ See supra Part I.A.2.
---------------------------------------------------------------------------
Clearing agencies have incentives to implement a risk management
framework that can effectively manage the risks posed by central
clearing. First, the ongoing viability of a clearing agency depends on
its reputation and the confidence that market participants have in its
services. Clearing agencies therefore have an incentive to reduce the
likelihood that a member default or operational outage would disrupt
settlement of a particular transaction or set of transactions. Second,
some clearing agencies operate as member-owned utilities and mutualize
default risk across their members, and thus non-defaulting participants
are subject to losses that occur above the defaulter's margin and
clearing fund. Clearing agencies that operate under such models thus
have an economic interest in sound risk management to reduce the
expected level of losses that must be mutualized. Other clearing
agencies are publicly traded and therefore could have different
incentives because non-member-owners may have a lower economic stake in
the clearing agency than member-owners under a mutualized structure.
Such an ownership structure could increase the incentive for owners,
particularly those that are non-members, to take risks, though these
incentives may be tempered by rules of the clearing agency
[[Page 70850]]
that are consistent with Section 17A(b)(3)(C) of the Exchange Act,
which requires that the clearing agency's rules assure fair
representation of its shareholders and participants in the selection of
the clearing agency's directors and administration of its affairs.\577\
---------------------------------------------------------------------------
\577\ See 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------
Further, Section 17A of the Exchange Act requires that the rules of
a clearing agency protect investors and the public interest.\578\
Nevertheless, incentives for sound risk management may be tempered by
pressures to reduce costs and maximize profits that are distinct from
goals set forth in governing statutes.\579\ This tension may result in
a clearing agency making decisions that result in tradeoffs between the
costs and benefits of risk management that are not socially efficient
because a clearing agency's decision-making process may not fully
reflect the costs and benefits that accrue to other financial market
participants as a result of its decisions. Further, even if clearing
agencies do internalize costs that they impose on their clearing
members, they may fail to internalize the consequences of their risk
management decisions on other entities within the financial system that
are connected to them through relationships with their clearing
members.\580\ Such a failure represents a financial network externality
imposed by clearing agencies on the broader financial system and
suggests that financial stability, as a public good, may be under-
produced in equilibrium.
---------------------------------------------------------------------------
\578\ See 15 U.S.C. 78q-1(b)(3)(F).
\579\ See supra Parts I.A.1 and 2 (describing the requirements
under the Exchange Act and the Clearing Supervision Act).
\580\ See Daron Acemoglu, Asuman Ozdaglar & Alireza Tahbaz-
Salehi, Systemic Risk and Stability in Financial Networks (NBER
Working Paper No. 18727, Jan. 2013), available at http://www.nber.org/papers/w18727.
---------------------------------------------------------------------------
As discussed in more detail below, the amendments to Rule 17Ad-22
and Rule 17Ab2-2 represent a strengthening of the Commission's
regulation of registered clearing agencies. In particular, Rule 17Ad-
22(e) establishes requirements for the operation and governance of
registered clearing agencies that meet the definition of ``covered
clearing agency.'' The Commission believes that the more specific
requirements imposed by Rule 17Ad-22(e) will further mitigate the
potential for moral hazard associated with risk management at a covered
clearing agency. For instance, in the absence of policies and
procedures that require periodic stress-testing and validation of
credit and liquidity risk models, a covered clearing agency could
potentially choose to recalibrate models in periods of low volatility
and avoid recalibration in periods of high volatility, causing it to
underestimate the risks that it faces during periods of market stress.
The Commission believes that the specific requirements in Rule 17Ad-
22(e) with respect to stress testing and validation of credit and
liquidity models would be more effective at mitigating these particular
manifestations of incentive misalignments than the requirements in
Rules 17Ad-22(b) or (d).
The Commission believes, as a result, that Rule 17Ad-22(e) provides
a general benefit of reducing the likelihood of a clearing agency
failure. This general benefit accrues to the extent that clearing
agencies do not already conform to the requirements in Rule 17Ad-22(e).
Despite the potential incentive problems noted above, and perhaps in
anticipation of regulatory efforts, some registered clearing agencies
have already taken steps to update their policies and procedures in
manners that may be consistent with the requirements in Rule 17Ad-
22(e). The Commission also notes that, in some instances, the practices
that Rule 17Ad-22(e) codifies as minimum requirements are current
practices at some registered clearing agencies. In these cases, the
Commission believes that imposing these requirements on covered
clearing agencies will have the effect of imposing consistent, higher
minimum risk management standards across all covered clearing agencies.
In adopting these rules, the Commission is also mindful of the benefits
that would accrue by adopting regulatory approaches that are generally
consistent with those of the CFTC and FRB.
The Commission is sensitive to the economic consequences and
effects of the amendments to Rule 17Ad-22 and Rule 17Ab2-2, including
their benefits and costs. The Commission acknowledges that, since many
of these rules require a covered clearing agency to adopt new policies
and procedures, the economic effects and consequences of these rules
include those flowing from the substantive results of those new
policies and procedures. Under Section 3(f) of the Exchange Act,
whenever the Commission engages in rulemaking under the Exchange Act
and is required to consider or determine whether an action is necessary
or appropriate in the public interest, it must consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation.\581\ Further, as noted
above, Section 17A of the Exchange Act directs the Commission to have
due regard for the public interest, the protection of investors, the
safeguarding of securities and funds, and maintenance of fair
competition among brokers and dealers, clearing agencies, and transfer
agents when using its authority to facilitate the establishment of a
national system for clearance and settlement transactions in
securities.\582\ Section 23(a)(2) of the Exchange Act also prohibits
the Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.\583\
---------------------------------------------------------------------------
\581\ See 15 U.S.C. 78c(f).
\582\ See supra Part I.A.1.
\583\ See 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The Commission has attempted to quantify the benefits and costs
anticipated to flow from the amendments to Rule 17Ad-22 and Rule 17Ab2-
2. In the CCA Standards proposing release, the Commission requested
comment on all aspects of the economic analysis of the proposed rules,
including their benefits and costs, as well as any effect the proposed
rules may have on competition, efficiency, and capital formation, and
encouraged commenters to provide data and analysis to help further
quantify or estimate the potential benefits and costs of the proposed
rules. Although it did not receive comments specifically directed at
the economic analysis, the Commission has considered the comments, and,
as in some cases indicated below, certain data needed to quantify the
costs and benefits associated with the rules remains unavailable. For
example, implementing policies and procedures that require stress
testing of financial resources available to a covered clearing agency
at least once each day may require additional investment in
infrastructure, but the particular infrastructure requirements will
depend on existing systems and a covered clearing agency's choice of
modeling techniques.
As discussed above,\584\ the Commission believes that Rule 17Ad-
22(e), in requiring reasonably designed policies and procedures strikes
an appropriate balance between directing covered clearing agencies to
engage in specific conduct or practices and allowing each covered
clearing agency to design its own policies and procedures without any
framework. In adopting Rule 17Ad-22(e), the Commission is providing
guidance to help covered clearing agencies identify and develop
reasonable policies and
[[Page 70851]]
procedures. The guidance outlines key issues and building blocks that a
covered clearing agency generally should consider as it develops
policies and procedures in compliance with Rule 17Ad-22(e). While this
guidance provides covered clearing agencies with additional information
about the types of considerations that may be relevant to meeting
requirements under Rule 17Ad-22(e), the Commission does not believe
that considering these issues will entail substantial costs beyond the
estimates presented below.
---------------------------------------------------------------------------
\584\ See Part II.B.
---------------------------------------------------------------------------
Overall, the Commission believes that the amendments to Rule 17Ad-
22 and Rule 17Ab2-2 should result in improvements in risk management
with respect to systemic risk, as well as with respect to legal,
credit, liquidity, general business, custody, investment, and
operational risk. Further, the Commission believes that the amendments
to Rule 17Ad-22 should result in an increase in financial stability
insofar as they result in minimum standards at covered clearing
agencies that are higher than those standards implied by current
practices at covered clearing agencies. In particular cases, such as
requirements for the management of liquidity risk and general business
risk, an increase in financial stability may occur as a result of
higher risk management standards at covered clearing agencies that
lower the probability that either covered clearing agencies or their
members default. As explained in Part III.B.2, reduced default
probabilities for covered clearing agencies may, in turn, improve
efficiency and capital formation.
A. Economic Baseline
To consider the effect of the amendments to Rule 17Ad-22 and Rule
17Ab2-2 on market activity, including possible effects on efficiency,
competition, and capital formation, the Commission is using an economic
baseline that considers the current market for central clearing,
including the number of registered clearing agencies, the distribution
of members across these clearing agencies, and the volume of
transactions these clearing agencies process. As noted above, there are
currently five registered clearing agencies that provide CCP services
and one that provides CSD services, and these entities processed and
cleared a large number of contracts and securities. For example, for
2015 DTCC reported processing over $1.5 quadrillion in financial market
transactions, DTCC cleared over 4.1 billion in contract volume, and ICE
cleared over 6 million futures and OTC contracts each day.\585\
---------------------------------------------------------------------------
\585\ See supra notes 573-574 and accompanying text.
---------------------------------------------------------------------------
With respect to the distribution of members across clearing
agencies, Table 1 shows that membership rates vary.
---------------------------------------------------------------------------
\586\ Membership statistics are taken from the Web sites of each
of the listed clearing agencies as of March 2016. See DTCC, DTC
Member Directories, available at http://www.dtcc.com/client-center/dtc-directories; DTCC, FICC-GOV Member Directories, available at
http://www.dtcc.com/client-center/ficc-gov-directories; DTCC, FICC-
MBS Member Directories, available at http://www.dtcc.com/client-center/ficc-mbs-directories; DTCC, NSCC Member Directories,
available at http://www.dtcc.com/client-center/nscc-directories;
ICE, ICE Clear Credit Participants, available at https://www.theice.com/clear-credit/participants; ICE, ICE Clear Europe
Membership, available at https://www.theice.com/clear-europe/membership; OCC, Member Directory, http://www.optionsclearing.com/membership/member-information.
Table 1--Membership Statistics for Registered Clearing Agencies 586
------------------------------------------------------------------------
Number
------------------------------------------------------------------------
DTC................................ Full Service Members.. 255
FICC............................... GSD Members........... 106
MBSD Members.......... 77
ICE................................ Clear Credit Members.. 30
Clear Europe Members.. 80
--Clear Europe Members 21
that clear CDS.
NSCC............................... Full Service Members.. 163
OCC................................ Total Members......... 114
------------------------------------------------------------------------
The Commission notes that registered clearing agencies are
currently characterized by specialization and limited competition.
Central clearing exhibits high barriers to entry and economies of
scale. These features of the existing market, and the resulting
concentration of central clearing within a handful of entities, informs
the Commission's examination of the effects of the amendments to Rule
17Ad-22 and Rule 17Ab2-2 on competition, efficiency, and capital
formation, as discussed further below.\587\
---------------------------------------------------------------------------
\587\ See infra Part III.B.2 (discussing the effect of the
adopted rules on competition, efficiency, and capital formation).
---------------------------------------------------------------------------
To further assess the economic effects of the amendments to Rule
17Ad-22 and Rule 17Ab2-2, including possible effects on efficiency,
competition, and capital formation, the Commission is also considering
as part of the baseline (i) the current regulatory framework for
registered clearing agencies, and (ii) the current practices of
registered clearing agencies that relate to Rule 17Ad-22(e). Each is
discussed further below.
1. Regulatory Framework for Registered Clearing Agencies
As previously discussed, the current regulatory framework for
registered clearing agencies begins with Section 17A of the Exchange
Act, which directs the Commission to facilitate the establishment of
(i) a national system for the prompt and accurate clearance and
settlement of securities transactions and (ii) linked or coordinated
facilities for clearance and settlement of securities transactions.
Further, Section 17A and Rule 17Ab2-1 require an entity that meets the
definition of a clearing agency to register with the Commission or
obtain from the Commission an exemption from registration prior to
performing the functions of a clearing agency.\588\ After registration,
the Commission supervises registered clearing agencies using various
tools, including (i) the rule filing process for SROs set forth in
Section 19(b) of the Exchange Act and rules thereunder, (ii)
examinations of clearing agencies, and (iii) other provisions of the
Exchange Act.\589\ Titles VII and VIII of the Dodd-Frank Act have
expanded the Commission's role with respect to the regulation of
clearing agencies. Specifically, Title VII amended Section 17A of the
Exchange Act by adding, among other provisions, new paragraphs (g)
through (j), which provide the Commission with authority to adopt rules
governing security-based swap clearing agencies.\590\ The Clearing
Supervision Act, adopted in Title VIII, provides for enhanced
regulation of SIFMUs and, more generally, for enhanced coordination
between the Commission and FRB by facilitating regulator on-site
examinations and information sharing. It further provides that the
Commission and CFTC shall coordinate with the FRB to jointly develop
risk management supervision programs for SIFMUs and that the Commission
and CFTC can each prescribe risk management standards governing the
operations related to the PCS activities of SIFMUs for which each is
the supervisory agency, in consultation with the FSOC and FRB and
taking into consideration relevant international standards and existing
prudential requirements.\591\
---------------------------------------------------------------------------
\588\ See supra Part I.A.1.
\589\ See supra notes 11-16 and accompanying text.
\590\ See supra note 17 and accompanying text.
\591\ See supra notes 18-25 and accompanying text.
---------------------------------------------------------------------------
In 2012, the Commission adopted Rule 17Ad-22 under the Exchange Act
to strengthen the substantive regulation
[[Page 70852]]
of registered clearing agencies, promote the safe and reliable
operation of registered clearing agencies, and improve efficiency,
transparency, and access to registered clearing agencies.\592\ In its
economic analysis of the Clearing Agency Standards release, the
Commission noted that the economic characteristics of clearing
agencies, including economies of scale, barriers to entry, and the
particulars of their legal mandates, may limit competition and confer
market power on such clearing agencies, which may lead to lower levels
of service, higher prices, or under-investment in risk management
systems.\593\ The requirements in Rule 17Ad-22 establish an enhanced
regulatory framework for clearing agencies that raise systemic risk
concerns due to, among other things, their size, systemic importance,
global reach, or the risks inherent in the products they clear.\594\
---------------------------------------------------------------------------
\592\ See supra note 26 and accompanying text.
\593\ See CCA Standards proposing release, supra note 5, at
29579.
\594\ See supra note 29 and accompanying text.
---------------------------------------------------------------------------
a. Determinations by the Commission
Among other things, the Commission makes determinations regarding
the registration of clearing agencies and proposed rule changes. Rule
17Ad-22(d) has applied to registered clearing agencies since January
2013, and no mechanism exists under Rule 17Ad-22 for the Commission to
make determinations of the type that appear in Rule 17Ab2-2.\595\
---------------------------------------------------------------------------
\595\ See supra Part II.D.
---------------------------------------------------------------------------
b. BCBS Capital Framework
In addition to requirements under the Exchange Act, the Dodd-Frank
Act, and Rule 17Ad-22, other regulatory efforts are relevant to the
Commission's analysis of the economic effects of Rule 17Ad-22(e). In
2012, the BCBS first published the capital framework, which sets forth
rules governing the capital charges arising from bank exposures to CCPs
related to OTC derivatives, exchange-traded derivatives, and securities
financing transactions, and the BCBS finalized the framework in
2014.\596\ The BCBS capital framework is designed to create incentives
for banks to clear derivatives and securities financing transactions
with CCPs licensed in a jurisdiction where the relevant regulator has
adopted rules or regulations consistent with the PFMI. Specifically,
the BCBS capital framework introduces new capital charges based on
counterparty risk for banks conducting derivatives transactions or
securities financing transactions through a CCP.\597\
---------------------------------------------------------------------------
\596\ See supra note 44 and accompanying text.
\597\ Since the BCBS capital framework applies lower capital
requirements only to bank exposures related to OTC and exchange-
traded derivatives activity and securities financing transactions,
the Commission currently expects that, among all registered clearing
agencies, FICC, ICEEU, and OCC would be those affected by the BCBS
capital framework. Each would meet the definition of ``covered
clearing agency.''
---------------------------------------------------------------------------
Capital charges under the BCBS capital framework relate to a bank's
trade exposure and default fund exposure to a CCP and are a function of
multiplying these exposures by a corresponding risk weight.
Historically, these exposures have carried a risk weight of zero. These
weights have increased as banking regulators have adopted rules
consistent with the BCBS capital framework. The risk weight assigned
under the BCBS capital framework varies depending on whether the
counterparty is a QCCP. For example, risk weights for trade exposures
to a CCP generally would vary between twenty and 100 percent depending
on the CCP's credit quality, while trade exposures to a QCCP would
carry only a two-percent risk weight.\598\ In addition, bank exposures
to CCP default funds would carry a risk weight of 1250 percent. While
bank exposures to QCCP default funds will also carry a 1250 percent
risk weight at low levels, under the BCBS capital framework, default
fund exposures' contribution to a bank's risk weighted assets will be
limited to at most eighteen percent of the bank's trade exposures to a
given QCCP.
---------------------------------------------------------------------------
\598\ The BCBS capital framework, as well as the rules adopted
by the FRB and Office of the Comptroller of the Currency consistent
with that framework, applies lower risk weights of two or four
percent to indirect exposures of banks to QCCPs. See BCBS capital
framework, supra note 44, paras. 114-15; Regulatory Capital Rules,
supra note 45, at 62103.
---------------------------------------------------------------------------
Many jurisdictions have already adopted rules that implement
requirements under the BCBS capital framework. For example, the BCBS
reports that, as of March 2016, all twenty-seven member jurisdictions
have risk-based capital rules in force, twenty-four have rules for
countercyclical capital buffers, and twenty-three have implemented or
drafted rules related to systematically important banks.\599\ In the
United States, the FRB and Office of the Comptroller of the Currency
jointly issued regulatory capital rules for U.S. banks consistent with
the BCBS capital framework effective January 1, 2014. The rules subject
bank exposures to CCPs and QCCPs to increased risk weights as specified
in the BCBS capital framework.\600\ In addition to specifying risk
weights, the rules define the term QCCP for banks supervised by the FRB
and the Office of the Comptroller of the Currency. According to these
rules, QCCP status applies to any CCP that is a SIFMU or, if not
located in the United States, any CCP that is regulated and supervised
in a manner equivalent to a SIFMU.\601\ In addition, a CCP can become a
QCCP if it meets the following standards: It requires all parties to
contracts cleared by the CCP to be fully collateralized on a daily
basis; and it is regulated by the FRB and demonstrates to the
satisfaction of the FRB that the CCP is (i) in sound financial
condition, (ii) subject to supervision by the Commission, CFTC, or FRB
or, if not located in the United States, subject to effective oversight
by a national supervisory authority in its home country, and (iii)
meets or exceeds the risk management standards for CCPs established
under the Dodd-Frank Act or, if not located in the United States, meets
or exceeds similar risk-management standards established under the law
of its home country that are consistent with international standards
for CCP risk management as established by the relevant standard setting
body. Under this definition, each covered clearing agency would be a
QCCP either because it is a SIFMU or because it is a CCP that is
regulated and supervised in a manner equivalent to a SIFMU, and
therefore U.S. bank clearing members would be subject to the lower
capital requirements on exposures to QCCPs under the BCBS capital
framework.
---------------------------------------------------------------------------
\599\ See BCBS, Tenth progress report on adoption of the Basel
regulatory framework, at 1 (Apr. 2016), available at https://www.bis.org/bcbs/publ/d354.pdf.
\600\ See 12 CFR 217.2 (defining ``qualifying central
counterparty''); see also Regulatory Capital Rules, supra note 45,
at 62166.
\601\ See 12 CFR 217.2.
---------------------------------------------------------------------------
Within the European Union, EMIR permits legal persons incorporated
under the law of an EU member state to use non-EU CCPs only if those
CCPs have been recognized under EMIR. Further, only non-EU CCPs
recognized under EMIR will meet the conditions necessary to be
considered a QCCP for EU bank clearing members. Article 25 of EMIR
outlines a recognition procedure for non-EU CCPs and Article 89
provides a timeline for recognition.\602\ FICC, NSCC, and OCC have
applied for recognition under EMIR.\603\ In February
[[Page 70853]]
2016, the European Commission and CFTC announced that they will follow
a common approach for CCPs. The European Commission plans to adopt an
equivalence decision that will allow ESMA to recognize U.S. CCPs
regulated by the CFTC, such that these entities can provide services in
the EU while complying primarily with CFTC rules and regulations.\604\
---------------------------------------------------------------------------
\602\ See Eur. Comm'n, Practical Implementation of the EMIR
Framework to Non-EU Central Counterparties (CCPs) (May 13, 2013),
available at http://ec.europa.eu/internal_market/financial-markets/docs/derivatives/130513_equivalence-procedure_en.pdf.
\603\ These three clearing agencies agreed to have their names
publicly disclosed and do not necessarily represent the full set of
registered clearing agencies that applied for recognition under
EMIR. See ESMA, List of CCPs Established in Non-EEA Countries Which
Have Applied for Recognition Under Article 25 of Regulation (EU) No
648/2012 of the European Parliament and of the Council of 4 July
2012 on OTC Derivatives, CCPs and TRs (EMIR) (Dec. 16, 2013),
available at https://www.esma.europa.eu/sites/default/files/library/list_of_applicants_tc-ccps.pdf.
\604\ See ESMA, ESMA resumes U.S. CCP recognition process
following EU-U.S. agreement available at https://www.esma.europa.eu/sites/default/files/library/2016-278_eu-us_approach_ccp_equivalence.pdf.
---------------------------------------------------------------------------
Additionally, the BCBS capital framework, as adopted by the FRB,
Office of the Comptroller of the Currency, and banking regulators in
other jurisdictions, impose capital requirements related to
unconditionally cancellable commitments and other off-balance sheet
exposures. For example, the FRB and Office of the Comptroller of the
Currency require banks to include ten percent of the notional amount of
unconditionally cancellable commitments in their calculation of total
leverage exposure.\605\ The rules place a floor of three percent on the
ratio of tier one capital to total assets for banks subject to advanced
approaches to risk-based capital rules.\606\ To the extent that
clearing agencies rely on financial resources from banks as part of
their risk management activities, these constraints on off-balance
sheet exposures could raise the cost of such activities.
---------------------------------------------------------------------------
\605\ See Regulatory Capital Rules, supra note 45, at 62169.
\606\ See id. at 62284. The Regulatory Capital Rules require
compliance no later than 2018.
---------------------------------------------------------------------------
c. Other Regulatory Efforts
Efforts by the CFTC and FRB to adopt rules that are consistent with
the PFMI are also relevant to the economic analysis of the amendments
to Rule 17Ad-22. Both the CFTC and FRB have indicated publicly that
they have completed all measures necessary to incorporate fully the
PFMI into their regulatory frameworks.\607\
---------------------------------------------------------------------------
\607\ See supra note 43.
---------------------------------------------------------------------------
2. Current Practices
Current industry practices are a critical element of the economic
baseline for registered clearing agencies. Registered clearing agencies
must operate in compliance with Rule 17Ad-22, though they may vary in
the particular ways they achieve such compliance. Some variation in
practices across registered clearing agencies derives from the products
they clear and the markets they serve. The Commission also understands
that, since it published the CCA Standards proposing release, some
registered clearing agencies have amended their rules with the aim of
achieving consistency with some of the standards in the PFMI. Because
the Commission believes that the requirements in Rule 17Ad-22(e) are
consistent with the PFMI and further the objectives of Section 17A of
the Exchange Act, the Clearing Supervision Act, and Title VII of the
Dodd-Frank Act, the Commission also believes that Rule 17Ad-22(e)
represents, where it imposes higher minimum standards on covered
clearing agencies, an additional step towards improved risk management.
An overview of current practices is set forth below and includes
discussion of covered clearing agency policies and procedures regarding
general organization and risk management, including the management of
legal, credit, liquidity, business, custody, investment, and
operational risk. This discussion is based on the Commission's general
understanding of current practices as of the date of this adoption and
reflects the Commission's experience supervising registered clearing
agencies.
a. Legal Risk
Legal risk is the risk that a registered clearing agency's rules,
policies, or procedures may not be enforceable and concerns, among
other things, its contracts, the rights of members, netting
arrangements, discharge of obligations, and settlement finality. Cross-
border activities of a registered clearing agency may also present
elements of legal risk.
Rule 17Ad-22(d)(1) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for a well-founded,
transparent, and enforceable legal framework for each aspect of its
activities in all relevant jurisdictions.\608\ Each registered clearing
agency makes a large portion of these policies and procedures available
to members and participants. In addition, each also publishes their
rule books and other key procedures publicly to promote the
transparency of their legal frameworks.\609\
---------------------------------------------------------------------------
\608\ See 17 CFR 240.17Ad-22(d)(1); CCA Standards proposing
release, supra note 5, at 29580.
\609\ The rule book of each registered clearing agency, as well
as select policies and procedures, are publicly available on each
registered clearing agency's Web site.
---------------------------------------------------------------------------
b. Governance
Rule 17Ad-22(d)(8) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to have governance arrangements that are
clear and transparent to fulfill the public interest requirements in
Section 17A of the Exchange Act applicable to clearing agencies, to
support the objectives of owners and participants, and to promote the
effectiveness of the clearing agency's risk management procedures.\610\
Important elements of a registered clearing agency's governance
arrangements include its ownership structure; its charter, bylaws, and
charters for committees of its board and management committees; its
rules, policies, and procedures; the composition and role of its board,
including the structure and role of board committees; reporting lines
between management and the board; and the processes that provide for
management accountability with respect to the registered clearing
agency's performance.
---------------------------------------------------------------------------
\610\ See 17 CFR 240.17Ad-22(d)(8); see also CCA Standards
proposing release, supra note 5, at 29581.
---------------------------------------------------------------------------
Each registered clearing agency has a board that governs its
operations and supervises senior management. Each registered clearing
agency also has an independent audit committee of the board and has
established a board committee or committee of members tasked with
overseeing the clearing agency's risk management functions. The boards
of registered clearing agencies that would be subject to Rule 17Ad-
22(e) as covered clearing agencies currently include non-management
members.
Since the Commission proposed Rule 17Ad-22(e), certain registered
clearing agencies have revised their governance policies. For example,
some clearing agencies have established additional committees of the
board to focus on risk management and technology issues,\611\ and one
clearing agency has modified its nomination process for directors and
increased the number of public directors on its board of
directors.\612\
---------------------------------------------------------------------------
\611\ See, e.g., Exchange Act Release No. 34-77042 (Feb. 3,
2016), 81 FR 6915 (Feb. 9, 2016) (order approving the adoption by
OCC of a charter of a new committee of the board of directors, the
technology committee); Exchange Act Release No. 34-74026 (Jan. 9,
2015), 80 FR 2160 (Jan. 15, 2015) (order approving proposed rule
change related to ICE Clear Europe's board risk committee).
\612\ See Exchange Act Release No. 34-72564 (July 8, 2014), 79
FR 40824 (July 14, 2014) (order approving a proposed rule change by
OCC concerning the consolidation of the governance committee and
nominating committee into a single committee, changes to the
nominating process for directors, and increasing the number of
public directors on board of directors).
---------------------------------------------------------------------------
[[Page 70854]]
c. Framework for the Comprehensive Management of Risks
Rules 17Ad-22(b) and (d) require registered clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to measure and mitigate credit
exposures, identify operational risks, evaluate risks arising in
connection with cross-border and domestic links for the purpose of
clearing or settling trades, achieve DVP settlement, and implement risk
controls to cover the clearing agency's credit exposures to
participants.\613\ Rule 17Ad-22(d)(4) requires a registered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish business continuity
plans setting forth procedures for the recovery of operations in the
event of a disruption.\614\ Rule 17Ad-22(d)(11) further requires a
registered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to make key
aspects of the clearing agency's default procedures publicly available
and establish default procedures that ensure that the clearing agency
can take timely action to contain losses and liquidity pressures and to
continue meeting its obligations in the event of a participant
default.\615\
---------------------------------------------------------------------------
\613\ See 17 CFR 240.17Ad-22(b) and (d); see also Clearing
Agency Standards adopting release, supra note 5.
\614\ See 17 CFR 240.17Ad-22(d)(4); see also Clearing Agency
Standards adopting release, supra note 5, at 66248-49.
\615\ See 17 CFR 240.17Ad-22(d)(11).
---------------------------------------------------------------------------
In addition to meeting these requirements, the Commission
understands that registered clearing agencies also specify actions to
be taken when their resources are insufficient to cover their
losses.\616\ These actions may include assessment rights on clearing
members, forced allocation, and contract termination. Since the
Commission proposed Rule 17Ad-22(e), certain clearing agencies have
modified policies and procedures that address how resources are
collected from members to manage financial risks. For example, one
clearing agency has revised its rules to require that intraday margin
be collected and margin assets not withdrawn when a member's reasonably
anticipated settlement obligations would exceed the liquidity resources
available to the clearing agency to satisfy those clearing
obligations.\617\
---------------------------------------------------------------------------
\616\ See David Elliot, Central Counterparty Loss-Allocation
Rules, at tbl. 1A (Bank of England Financial Stability Paper No. 20,
Apr. 2013), available at http://www.bankofengland.co.uk/research/Documents/fspapers/fs_paper20.pdf (noting the loss-allocation rules
applied at the end of a clearing agency waterfall).
\617\ See Exchange Act Release No. 34-72266 (May 28, 2014), 79
FR 32008 (June 3, 2014) (notice of filing and immediate
effectiveness of proposed rule change by OCC to require that
intraday margin be collected and margin assets not be withdrawn when
a clearing member's reasonably anticipated settlement obligations to
the clearing agency would exceed the clearing agency's liquidity
resources available to satisfy such obligations).
---------------------------------------------------------------------------
d. Financial Risk Management
Registered clearing agencies that provide CCP services have a
variety of options available to mitigate the financial risks to which
they are exposed. While the manner in which a CCP chooses to mitigate
these financial risks depends on the precise nature of the CCP's
obligations, a common set of procedures have been implemented by many
CCPs to manage credit and liquidity risks. Broadly, these procedures
enable CCPs to manage their risks by reducing the likelihood of member
defaults, limiting potential losses and liquidity pressure in the event
of a member default, implementing mechanisms that allocate losses
across members, and providing adequate resources to cover losses and
meet payment obligations as required.
Registered clearing agencies that provide CCP services must be able
to effectively measure their credit exposures to properly manage those
exposures. A CCP faces the risk that its exposure to a member can
change as a result of a change in prices, positions, or both. CCPs can
ascertain current credit exposures to each member by, in some cases,
marking each member's outstanding contracts to current market prices
and, to the extent permitted by their rules and supported by law, by
netting any gains against any losses. Rule 17Ad-22 includes certain
requirements related to financial risk management by CCPs, including
requirements to measure credit exposures to members and to use margin
requirements to limit these exposures. These requirements are general
in nature and provide registered clearing agencies flexibility to
measure credit risk and set margin. Within the bounds of Rule 17Ad-22,
CCPs may employ models and choose parameters that they conclude are
appropriate to the markets they serve.
The current practices of registered clearing agencies that provide
CCP services generally include the following procedures: (1) Measuring
credit exposures at least once a day; (2) setting margin coverage at a
99% confidence level over some set period; (3) using risk-based models;
(4) establishing a fund that mutualizes losses of defaults by one or
more participants that exceed margin coverage; (5) maintaining
sufficient financial resources to withstand the default of at least the
largest participant family; and (6) in the case of security-based swap
transactions, maintaining enough financial resources to be able to
withstand the default of their two largest participant families.\618\
---------------------------------------------------------------------------
\618\ See, e.g., CFTC-SEC Staff Roundtable on Clearing of Credit
Default Swaps, at 123 (Oct. 2010), available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission7_102210-transcrip.pdf (Stan Ivanov of ICE stating,
``[A]t ICE we look at two simultaneous defaults of the two biggest
losers upon extreme conditions . . . .''); see also ICE, CDS Client
Clearing Overview, at 8 (Aug. 2013), available at https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Client_Clearing_Overview.pdf (noting that the
guaranty fund covers the simultaneous default of the two largest
clearing members); CME Rulebook, Ch. 8H, Rule 8H07, available at
http://www.cmegroup.com/rulebook/CME/I/8H/8H.pdf.
---------------------------------------------------------------------------
i. Credit Risk
Rule 17Ad-22(b)(1) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to measure their
credit exposures at least once per day.\619\ Several CCPs have policies
and procedures designed to require measuring credit exposures multiple
times per day.
---------------------------------------------------------------------------
\619\ See 17 CFR 240.17Ad-22(b)(1).
---------------------------------------------------------------------------
Rule 17Ad-22(b)(3) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
sufficient financial resources to withstand, at a minimum, a default by
the participant family to which it has the largest exposure in extreme
but plausible market conditions.\620\ It further requires CCPs for
security-based swaps to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
additional financial resources sufficient to withstand, at a minimum, a
default by the two participant families to which it has the largest
exposures in extreme but plausible market conditions, in its capacity
as a CCP for security-based swaps.\621\ Accordingly, the Commission
notes that Rule 17Ad-22(b)(3) imposes a ``cover two'' requirement on
CCPs for security-based swaps to protect such CCPs from the
[[Page 70855]]
extreme jump-to-default risk and nonlinear payoffs associated with the
nature of the financial products they clear and the participants in the
markets they serve. Meanwhile, CCPs that clear products other than
security-based swaps are subject to a ``cover one'' requirement.\622\
Rule 17Ad-22(b)(3) also states that such policies and procedures may
provide that additional financial resources be maintained by the CCP in
combined or separately maintained funds.\623\
---------------------------------------------------------------------------
\620\ See 17 CFR 240.17Ad-22(b)(2).
\621\ See id.
\622\ See supra Part II.C.4.a (discussing the requirements for
``cover one'' and ``cover two'').
\623\ See id.
---------------------------------------------------------------------------
Under existing rules, CCPs collect contributions from their members
for the purpose of establishing guaranty or clearing funds to mutualize
losses under extreme but plausible market conditions. Currently, the
guaranty funds or clearing funds consist of liquid assets and their
sizes vary depending on a number of factors, including the products the
CCP clears and the characteristics of CCP members. In particular, the
guaranty funds for CCPs that clear security-based swaps are relatively
larger, as measured by the size of the fund as a percentage of the
total and largest exposures, than the guaranty or clearing funds
maintained by CCPs for other financial instruments. CCPs generally take
the liquidity of collateral into account when determining member
obligations. Applying haircuts to assets posted as margin, among other
things, mitigates the liquidity risk associated with selling margin
assets in the event of a participant default.
Since the Commission proposed Rule 17Ad-22(e), certain clearing
agencies have amended some of their policies with regards to credit
risk. Such modifications include, for example, provisions that require
real-time submission of all locked-in trade data submitted for trade
recording and prohibit pre-netting and other practices that prevent
real-time trade submission.\624\ Another clearing agency has made
modifications to its policies and procedures for stress testing
frameworks.\625\
---------------------------------------------------------------------------
\624\ See Exchange Act Release No. 34-69890 (June 28, 2013), 78
FR 40538 (July 5, 2013) (order approving NSCC's proposed rule change
to require that all locked-in trade data submitted to it for trade
recording be submitted in real-time).
\625\ See Exchange Act Release No. 34-77982 (June 2, 2016), 81
FR 36979 (June 8, 2016) (order approving ICE Clear Credit's proposed
rule change to update and formalize its stress testing framework).
---------------------------------------------------------------------------
ii. Collateral and Margin
Rule 17Ad-22(b)(2) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to use margin
requirements to limit their exposures to participants.\626\ This margin
can also be used to reduce a CCP's losses in the event of a participant
default.
---------------------------------------------------------------------------
\626\ See 17 CFR 240.17Ad-22(b)(2).
---------------------------------------------------------------------------
Registered clearing agencies that provide CCP services take
positions as substituted counterparties once their trade guarantee goes
into effect. Therefore, if a counterparty whose obligations the
registered clearing agency has guaranteed defaults, the covered
clearing agency may face market risk, which can take one of two forms.
First, a covered clearing agency is subject to the risk of movement in
the market prices of the defaulting member's open positions. Where a
seller defaults and fails to deliver a security, the covered clearing
agency may need to step into the market to buy the security to complete
settlement and deliver the security to the buyer. Similarly, where a
buyer defaults, the covered clearing agency may need to meet payment
obligations to the seller. Thus, in the interval between when a member
defaults and when the covered clearing agency must meet its obligations
as a substituted counterparty to complete settlement, market price
movements expose the covered clearing agency to market risk. Second,
the covered clearing agency may need to liquidate non-cash margin
collateral posted by the defaulting member. The covered clearing agency
is therefore exposed to the risk that erosion in market prices of the
collateral posted by the defaulting member could result in the covered
clearing agency having insufficient financial resources to cover the
losses in the defaulting member's open positions.
To manage their exposure to market risk resulting from fulfilling a
defaulting member's obligations, registered clearing agencies compute
margin requirements using inputs such as portfolio size, volatility,
and sensitivity to various risk factors that are likely to influence
security prices. Moreover, since the size of price movements is, in
part, a function of time, registered clearing agencies may limit their
exposure to market risk by marking participant positions to market
daily and, in some cases, more frequently. CCPs also use similar
factors to determine haircuts applied to assets posted by members in
satisfaction of margin requirements. To manage market risk associated
with collateral liquidation, CCPs consider the current prices of assets
posted as collateral and price volatility, asset liquidity, and the
correlation of collateral assets and a member's portfolio of open
positions. Further, because CCPs need to value their margin assets in
times of financial stress, their rulebooks may include features such as
market-maker domination charges that increase clearing fund obligations
regarding open positions of members in securities in which the member
serves as a dominant market maker. The reasoning behind this charge is
that, should a member default, liquidity in products in which the
member makes markets may fall, leaving these positions more difficult
to liquidate for non-defaulting participants.
Rule 17Ab-22(b)(2) also requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to use risk-based
models and parameters to set margin requirements.\627\ The generally
recognized standard for such models and parameters is, under normal
market conditions, price movements that produce changes in exposures
that are expected to breach margin requirements or other risk controls
only 1% of the time (i.e., at a 99% confidence interval) over a
designated time horizon.\628\ Currently, CCPs use margin models to
ensure coverage at a single-tailed 99% confidence interval. Losses
beyond this level are typically covered by the CCP's guaranty fund.
This standard comports with existing international standards for bank
capital requirements, which require banks to measure market risks at a
99% confidence interval when determining regulatory capital
requirements.\629\
---------------------------------------------------------------------------
\627\ See id.
\628\ See 17 CFR 240.17Ad-22(a)(4). The Commission notes that
because of modifications to Rule 17Ad-22(a), the definition of
``normal market conditions'' is being moved to Rule 17Ad-22(a)(11).
The Commission is not altering the definition of ``normal market
conditions.'' See Rule 17Ad-22(a)(11), infra Part VI.
\629\ See BCBS, International Convergence of Capital Measurement
and Capital Standards: A Revised Framework (June 2004), available at
http://www.bis.org/publ/bcbs107.pdf; see also Darryll Hendricks &
Beverly Hirtle, New Capital Rule Signals Supervisory Shift
(Secondary Mortgage Mkts, Sept. 1998), available at http://www.freddiemac.com/finance/smm/july98/pdfs/hen_hirt.pdf.
Prior to this standard, banks measured value-at-risk using a
range of confidence intervals from 90-99%. See BCBS, An Internal
Model-Based Approach to Market Risk Capital Requirements, at 12
(Apr. 1995), available at http://www.bis.org/publ/bcbs17.pdf. When
determining the minimum quantitative standards for calculating risk
measurements, the BCBS noted then the importance of specifying ``a
common and relatively conservative confidence level,'' choosing the
99% confidence interval over other less conservative measures. See
id.
Since its adoption in 1998, the standard has become a generally
recognized practice of banks to quantify credit risk as the worst
expected loss that a portfolio might incur over an appropriate time
horizon at a 99% confidence interval. See Kenji Nishiguchi, Hiroshi
Kawai & Takanori Sazaki, Capital Allocation and Bank Management
Based on the Quantification of Credit Risk, at 83 (FRBNY Econ.
Policy Rev., Oct. 1998), available at http://www.newyorkfed.org/research/epr/98v04n3/9810nish.pdf; Jeff Aziz & Narat Charupat,
Calculating Credit Exposure and Credit Loss: A Case Study, at 34
(Sept. 1998), available at http://www.bis.org/bcbs/ca/alrequse98.pdf.
---------------------------------------------------------------------------
[[Page 70856]]
Rule 17Ad-22(b)(2) also requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to review such
margin requirements and the related risk-based models and parameters at
least monthly.\630\ CCPs are accordingly required to establish a model
validation process that evaluates the adequacy of margin models,
parameters, and assumptions. Additionally, CCPs are required to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for an annual model
validation consisting of evaluating the performance of the CCPs' margin
models and the related parameters and assumptions associated with such
models by a qualified person who is free from influence from the
persons responsible for the development or operation of the models
being validated.\631\
---------------------------------------------------------------------------
\630\ See 17 CFR 240.17Ad-22(b)(2).
\631\ See 17 CFR 240.17Ad-22(b)(4).
---------------------------------------------------------------------------
Certain clearing agencies have amended their policies and
procedures governing collateral and margin requirements since the
Commission proposed Rule 17Ad-22(e). For example, one clearing agency
has amended its rules to require that intraday margin be collected and
to prohibit margin from being withdrawn if the agency anticipates that
the settlement obligations would exceed the liquidity resources
available to the agency to satisfy such settlement obligations.\632\
---------------------------------------------------------------------------
\632\ See Exchange Act Release No. 34-72266 (May 28, 2014), 79
FR 32008 (June 3, 2014) (notice of filing and immediate
effectiveness of OCC's proposed rule change to require that intraday
margin be collected and margin assets not be withdrawn when a
clearing member's reasonably anticipated settlement obligations
would exceed the clearing agency's liquidity resources available to
satisfy such settlement obligations).
---------------------------------------------------------------------------
Other revisions include modifications to risk models to monitor
margin coverage and risk exposure. For example, modifications include
accounting for factors such as procyclicality or implied volatility of
certain options to reflect future market fluctuations.\633\ Amendments
to backtesting procedures are designed to assist clearing agencies in
determining the amount of margin to collect from clearing members.\634\
---------------------------------------------------------------------------
\633\ See, e.g., Exchange Act Release No. 34-72756 (Aug. 4,
2014), 79 FR 46479 (Aug. 8, 2014) (order approving ICE Clear
Europe's proposed rule change to credit default swap risk policies);
Exchange Act Release No. 34-76781 (December 28, 2015), 81 FR 135
(order approving OCC's proposed rule change to modify its margin
methodology by incorporating variations in implied volatility).
\634\ See, e.g., Exchange Act Release No. 34-75290 (June 24,
2015), 80 FR 37323 (June 30, 2015) (notice of no objection to OCC's
advance notice concerning modifications to backtesting procedures in
order to enhance monitoring of margin coverage and model risk
exposure).
---------------------------------------------------------------------------
Additionally, certain modifications address exposure to wrong-way
risk. For example, one clearing agency revised its margin methodology
as applied to the family-issued securities of certain members to
exclude these securities from the volatility component and then by
charging an amount calculated, in part, by applying a haircut rate to
the absolute value of the long net unsettled positions in the member's
family-issued securities.\635\ Other clearing agencies have adjusted
their risk models to account for accumulation of general wrong-way risk
at the portfolio level, while others have modified their policies with
respect to the assets accepted as permitted cover, as well as limits on
the value of the collateral that may be accepted as permitted
cover.\636\
---------------------------------------------------------------------------
\635\ See Exchange Act Release No. 34-76077 (Oct. 5, 2015), 80
FR 61256 (Oct. 9, 2015) (notice of no objection to NSCC's proposed
rule change to enhance its margining methodology as applied to
family-issued securities of certain members).
\636\ See, e.g., Exchange Act Release No. 34-75887 (Sept. 10,
2015), 80 FR 55672 (Sept. 16, 2015) (order approving ICE Clear
Credit's proposed rule change to revise its risk management
framework).
---------------------------------------------------------------------------
iii. Liquidity Risk
In addition to credit risk and the aforementioned market risk,
registered clearing agencies also face liquidity or funding risk.
Currently, covered clearing agencies have varying degrees of formality
with respect to their standards and practices relating to liquidity
shortfalls. To complete the settlement process, registered clearing
agencies that employ netting rely on incoming payments from
participants in net debit positions to make payments to participants in
net credit positions. If a participant does not have sufficient funds
or securities in the form required to fulfill a payment obligation
immediately when due (even though it may be able to pay at some future
time), or if a settlement bank is unable to make an incoming payment on
behalf of a participant, a registered clearing agency may face a
funding shortfall. Such funding shortfalls may occur due to a lack of
financial resources necessary to meet delivery or payment obligations,
however even registered clearing agencies that do hold sufficient
financial resources to meet their obligations may not carry those in
the form required for delivery or payments to participants.
A registered clearing agency that provides CCP services may hold
additional financial resources to cover potential funding shortfalls in
the form of collateral. As noted above, CCPs may take the liquidity of
collateral into account when determining member obligations. Applying
haircuts to illiquid assets posted as margin mitigates the liquidity
risk associated with selling margin assets in the event of participant
default. Some registered CCPs also arrange for liquidity provision from
other financial institutions using lines of credit. Additionally, some
registered clearing agencies enter into prearranged funding agreements
with their members pursuant to their rules. For example, members of one
registered clearing agency are obligated, under certain pre-defined
circumstances, to enter into repurchase agreements against securities
that would have been delivered to a defaulting member.
No rule under the Exchange Act currently requires a registered
clearing agency through its written policies and procedures to address
liquidity risk. Since the Commission proposed Rule 17Ad-22(e), certain
clearing agencies have amended their policies and procedures regarding
liquidity risk including, for example, through sources such as
committed credit facilities, private placements of debt, and committed
securities repurchase agreements. Such provisions can assist the
ability of clearing agencies to complete settlement obligations,
particularly in the instances where a clearing member defaults.
Additionally, certain clearing agencies have clarified certain rules by
which they manage liquidity, including how they will access and use
internal liquidity resources.\637\
---------------------------------------------------------------------------
\637\ See, e.g., Exchange Act Release No. 34-72944 (Aug. 28,
2014), 79 FR 52789 (Aug. 28, 2014) (order approving ICE Clear
Credit's proposed rule change related to its authority to use
guaranty fund and house initial margin as an internal liquidity
resource).
---------------------------------------------------------------------------
e. Settlement
Rule 17Ad-22(d)(5) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to employ money settlement arrangements
that eliminate
[[Page 70857]]
or strictly limit the clearing agency's settlement bank risks and
require funds transfers to the clearing agency to be final when
effected.\638\ Rule 17Ad-22(d)(12) further requires a registered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure that final
settlement occurs no later than the end of the settlement day.\639\
Accordingly, for example, certain registered clearing agencies provide
for final settlement of securities transfers no later than the end of
the day of the transaction. Rule 17Ad-22(d)(15) also requires a
registered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to state to
its participants the clearing agency's obligations with respect to
physical deliveries and identify and manage the risks from these
obligations.\640\
---------------------------------------------------------------------------
\638\ See 17 CFR 240.17Ad-22(d)(5).
\639\ See 17 CFR 240.17Ad-22(d)(12).
\640\ See 17 CFR 240.17Ad-22(d)(15).
---------------------------------------------------------------------------
Since the Commission proposed Rule 17Ad-22(e), certain clearing
agencies have amended their policies and procedures governing money
settlements. These include, for example, provisions to convert U.S.
Treasuries into cash when the sale of pledged securities cannot be
settled on a same-day basis.\641\
---------------------------------------------------------------------------
\641\ See Exchange Act Release No. 34-74456 (March 6, 2015), 80
FR 13055 (Mar. 12, 2015) (order approving ICE Clear Credit's
proposed rule change to revise its Treasury operations policies and
procedures).
---------------------------------------------------------------------------
f. CSDs
Rule 17Ad-22(d)(10) requires a registered clearing agency that
provides CSD services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to maintain
securities in an immobilized or dematerialized form for transfer by
book entry to the greatest extent possible. Currently, some securities,
such as mutual fund securities and government securities, are issued
primarily or solely on a dematerialized basis. Dematerialized shares do
not exist as physical certificates but are held in book entry form in
the name of the owner (which, where the master security holder file is
not maintained on paper due to the use of technology, is also referred
to as electronic custody). Other types of securities may be issued in
the form of one or more physical security certificates, which could be
held by the CSD to facilitate immobilization. Alternatively, securities
may be held by the beneficial owner in record name, in the form of
book-entry positions, where the issuer offers the ability for a
security holder to hold through the direct registration system. Whether
immobilization occurs at the CSD or through direct registration depends
on what is provided for by the issuer.
When a trade occurs, the depository's accounting system credits one
participant account and debits another participant account.
Transactions between counterparties in dematerialized shares are
recorded by the registrar responsible for maintaining the paper or
electronic register of security holders, such as by a transfer agent,
and reflected in customer accounts.
Registered CSDs currently reconcile ownership positions in
securities against CSD ownership positions on the security holders list
daily, mitigating the risk of unauthorized creation or deletion of
shares.
g. Exchange-of-Value Settlement Systems
Rule 17Ad-22(d)(13) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to eliminate principal risk by linking
securities transfers to funds transfers in a way that achieves delivery
versus payment,\642\ which serves to link obligations by conditioning
the final settlement of one upon the final settlement of the other. One
registered clearing agency, for example, operates a Model 2 DVP system
that provides for gross securities transfers during the day followed by
an end-of-day net funds settlement. Under the rules governing the
clearing agency's system, the delivering party in a DVP transaction is
assured that it will be paid for the securities once they are credited
to the receiving party's securities account. DVP eliminates the risk
that a buyer would lose the purchase price of a security purchased from
a defaulting seller or that a seller would lose the sold security
without receiving payment for a security acquired by a defaulting
buyer.
---------------------------------------------------------------------------
\642\ See 17 CFR 240.17Ad-22(d)(13); see also Clearing Agency
Standards adopting release, supra note 5, at 66256.
---------------------------------------------------------------------------
For example, one registered clearing agency has rules governing its
continuous net settlement (``CNS'') system, under which it becomes the
counterparty for settlement purposes at the point its trade guarantee
attaches, thereby assuming the obligation of its members that are
receiving securities to receive and pay for those securities, and the
obligation of members that are delivering securities to make the
delivery. Unless the clearing agency has invoked its default rules, it
is not obligated to make those deliveries until it receives from
members with delivery obligations deliveries of such securities;
rather, deliveries that come into CNS ordinarily are promptly
redelivered to parties that are entitled to receive them through an
allocation algorithm. Members are obligated to take and pay for
securities allocated to them in the CNS process. These rules also
provide mechanisms to allow receiving members a right to receive high
priority in the allocation of deliveries, and also permit a member to
buy-in long positions that have not been delivered to it by the close
of business on the scheduled settlement date.
h. Participant-Default Rules and Procedures
Rule 17Ad-22(d)(11) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to make key aspects of its default
procedures publicly available and establish default procedures that
ensure it can take timely action to contain losses and liquidity
pressures and to continue meeting its obligations in the event of a
participant default. The rules of registered clearing agencies
typically state what constitutes a default, identify whether the board
or a committee of the board may make that determination, and describe
what steps the clearing agency may take to protect itself and its
members. In this regard, registered clearing agencies typically
attempt, among other things, to hedge and liquidate a defaulting
member's positions. Rules of registered clearing agencies also include
information about the allocation of losses across available financial
resources.
i. Segregation and Portability
No rule under the Exchange Act currently requires a registered
clearing agency through its written policies and procedures to enable
the portability of positions of a member's customers and the collateral
provided in connection therewith. Additionally, no rule under the
Exchange Act currently requires a registered clearing agency through
its written policies and procedures to protect the positions of a
member's customers from the default or insolvency of the member.\643\
---------------------------------------------------------------------------
\643\ See supra note 434 (discussing existing rules applicable
to registered broker-dealers that address customer security
positions and funds in cash securities and listed option markets,
thereby promoting segregation and portability at the broker-dealer
level).
---------------------------------------------------------------------------
[[Page 70858]]
Since the Commission proposed Rule 17Ad-22(e), certain clearing
agencies have modified their policies and procedures on segregation and
portability. These amendments include implementing changes to the
structure of customer accounts to enhance segregation options for
customers and establishing new types of individually segregated
accounts and omnibus accounts for cleared transactions, as well as
modifications to these frameworks, as well as adopting an individual
client segregation framework and modifications related to the omnibus
client segregation model.\644\ There have also been changes specifying
certain fees applicable to segregated customer accounts, margin flow
comingled accounts, and individually segregated sponsored
accounts.\645\
---------------------------------------------------------------------------
\644\ See, e.g., Exchange Act Release Nos. 34-72755 (Aug. 4,
2014), 79 FR 46481 (Aug. 8, 2014), 34-72754 (Aug. 4, 2014), 79
FR46477 (Aug. 8, 2014) (approval orders related to ICE Clear
Europe's proposed rule changes related to segregation and
portability), and 34-73344 (Oct. 14, 2014), 76 FR 62694 (Oct. 20,
2014) (notice of filing and immediate effectiveness of proposed rule
change related to segregation and portability).
\645\ See, e.g., Exchange Act Release No. 34-75657 (Aug.10,
2015), 80 FR 48937 (Aug. 14, 2015) (notice of filing and immediate
effectiveness of ICE Clear Europe's proposed rule change to adopt
revised fee schedule).
---------------------------------------------------------------------------
j. General Business Risk
Business risk refers to the risks and potential losses arising from
a registered clearing agency's administration and operation as a
business enterprise that are neither related to member default nor
separately covered by financial resources designated to mitigate credit
or liquidity risk. While Rule 17Ad-22 sets forth requirements for
registered clearing agencies to identify, monitor, and mitigate or
eliminate a broad array of risks through written policies and
procedures, no rule under the Exchange Act expressly requires a
registered clearing agency through its written policies and procedures
to identify, monitor, and manage general business risk or to meet a
capital requirement. Nonetheless, registered clearing agencies
currently have certain internal controls in place to mitigate business
risk. Some clearing agencies, for instance, have policies and
procedures that identify an auditor who is responsible for examining
accounts, records, and transactions, as well as other duties prescribed
in the audit program. Other registered clearing agencies allow members
to collectively audit the books of the clearing agency on an annual
basis, at their own expense.
Since the Commission proposed Rule 17Ad-22(e), certain clearing
agencies have revised their policies and procedures related to general
business risk. Such modifications include amendments to a shareholder
agreement that are intended to increase the working capital available
to conduct the business of the operating subsidiaries and allow the
clearing agencies to maintain operations for a longer period during
times of financial stress.\646\
---------------------------------------------------------------------------
\646\ See Exchange Act Release No. 34-74142 (Jan. 27, 2015), 80
FR 5188 (Jan. 30, 2015) (notice of no objection to NSCC and FICC
advance notices to amend and restate the third and amended restated
shareholders agreement).
---------------------------------------------------------------------------
k. Custody and Investment Risks
Registered clearing agencies face default risk from commercial
banks that they use to effect money transfers among participants, to
hold overnight deposits, and to safeguard collateral. Rule 17Ad-
22(d)(3) requires a registered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to (i) hold assets in a manner that minimizes risk of loss or
delay in its access to them; and (ii) invest assets in instruments with
minimal credit, market, and liquidity risks.\647\ Registered clearing
agencies currently seek to minimize the risk of loss or delay in access
by holding assets that are highly liquid (e.g., cash, U.S. Treasury
securities, or securities issued by a U.S. government agency) and by
engaging banks to custody the assets and facilitate settlement.
Typically, registered clearing agencies take steps to ensure that
assets held in custody are protected from claims from the custodian's
creditors using trust accounts or equivalent arrangements.
Additionally, a designated clearing agency may have or gain access to a
Federal Reserve account and services.\648\ Since the Commission
proposed Rule 17Ad-22(e), certain clearing agencies have made
modifications to the procedures and policies related to custody and
investment risks. For example, one clearing agency adopted rules
addressing certain investment losses on margin and guaranty fund
contributions provided by clearing members.\649\
---------------------------------------------------------------------------
\647\ See 17 CFR 240.17Ad-22(d)(3).
\648\ See supra Part II.C.7 (discussing the requirements under
Rule 17Ad-22(e)(7)(iii)).
\649\ See Exchange Act Release No. 34-72551 (July 8, 2014), 79
FR 16361 (July 14, 2014) (order approving ICE Clear Europe's
proposed rule change regarding investment losses and non-default
losses).
---------------------------------------------------------------------------
l. Operational Risk
Operational risk refers to a broad category of potential losses
arising from deficiencies in internal processes, personnel, and
information technology. Registered clearing agencies face operational
risk from both internal and external sources, including human error,
system failures, security breaches, and natural or man-made disasters.
Rule 17Ad-22(d)(4) requires a registered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to identify sources of operational risk and to
minimize those risks through the development of appropriate systems,
controls and procedures.\650\ It also requires a registered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to (i) implement systems that are
reliable, resilient, and secure, and have adequate, scalable capacity;
and (ii) have business continuity plans that allow for timely recovery
of operations and fulfillment of a clearing agency's obligations.\651\
---------------------------------------------------------------------------
\650\ See 17 CFR 240.17Ad-22(d)(4).
\651\ See id.
---------------------------------------------------------------------------
As a result, registered clearing agencies have developed and
currently maintain plans to ensure the safeguarding of securities and
funds, the integrity of automated data processing systems, and the
recovery of securities, funds, or data under a variety of loss or
destruction scenarios.\652\ These plans may include turning operations
over to a secondary site that is located a sufficient distance from the
primary location to ensure a distinct geographic risk profile. In
addition, registered clearing agencies generally maintain an internal
audit department to review the adequacy of their internal controls,
procedures, and records with respect to operational risks. Some
registered clearing agencies also engage independent accountants to
perform an annual study and evaluation of the internal controls
relating to their operations.\653\
---------------------------------------------------------------------------
\652\ Many of these practices had been previously developed
pursuant to prior Commission guidelines. See supra Part I.A.1
(discussing related requirements under Regulation SCI).
\653\ See, e.g., NSCC, Assessment of Compliance with the CPSS/
IOSCO Recommendations for Central Counterparties (Nov. 2011),
available at http://www.dtcc.com/legal/policy-and-compliance.aspx.
---------------------------------------------------------------------------
As discussed above, the Commission adopted Regulation SCI in
November 2014, in part, to help reduce the occurrence of systems
issues, and improve resiliency when systems problems do occur at
certain SROs, such as registered clearing agencies and to enhance the
Commission's oversight and enforcement of securities market technology
infrastructure. Regulation
[[Page 70859]]
SCI requires that registered clearing agencies, as SCI entities, have
policies and procedures that include business continuity and disaster
recovery plans that include maintaining backup and recovery
capabilities sufficiently resilient and geographically diverse and that
are reasonably designed to achieve two-hour resumption of critical SCI
systems following a wide-scale disruption. In particular, as discussed
above, in the Regulation SCI adopting release the Commission explained
its view that for clearance and settlement systems a return to ``normal
operations'' following a systems disruption would include all steps
necessary to effectuate timely and accurate end of day settlement.\654\
Since the Commission proposed Rule 17Ad-22(e), certain clearing
agencies have revised aspects of their operational risk policies and
procedures, including for the purposes of complying with Regulation
SCI. For example, one clearing agency revised its policies and
procedures for testing of business continuity and disaster recovery
plans, including with respect to a member's requirement to participate
in such testing.\655\
---------------------------------------------------------------------------
\654\ See supra note 37 and accompanying text.
\655\ See Exchange Act Release No. 34-76278 (Oct. 27, 2015), 80
FR 67450 (Nov. 2, 2015) (notice of filing and immediate
effectiveness of FICC's proposed rule change to provide additional
details regarding the requirement that members participate in annual
testing of business continuity and disaster recovery plans).
---------------------------------------------------------------------------
m. Access and Participation Requirements
Rule 17Ad-22(b)(5) requires a registered clearing agency that
provides CCP services to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide the
opportunity for a person that does not perform any dealer or security-
based swap dealer services to obtain membership on fair and reasonable
terms at the clearing agency to clear securities for itself or on
behalf of other persons.\656\ Rule 17Ad-22(b)(6) requires a registered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to have membership standards that do not require participants
to maintain a portfolio of any minimum size or a minimum transaction
volume.\657\ Rule 17Ad-22(b)(7) requires a registered clearing agency
that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to provide
a person that maintains net capital equal or greater than $50 million
with the ability to obtain membership at the clearing agency, provided
such persons are able to comply with reasonable membership standards,
with higher net capital requirements permissible subject to Commission
approval.\658\
---------------------------------------------------------------------------
\656\ See 17 CFR 240.17Ad-22(b)(5).
\657\ See 17 CFR 240.17Ad-22(b)(6).
\658\ See 17 CFR 240.17Ad-22(b)(7).
---------------------------------------------------------------------------
In addition, Rule 17Ad-22(d)(2) requires a registered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to require participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the clearing agency, have
procedures in place to monitor that participation requirements are met
on an ongoing basis, and have participation requirements that are
objective and publicly disclosed, and permit fair and open access.\659\
Typically, a registered clearing agency's rulebook requires applicants
for membership to provide certain financial and operational information
prior to being admitted as a member and on an ongoing basis as a
condition of continuing membership. Registered clearing agencies review
this information to ensure that the applicant has the operational
capability to meet the other demands of interfacing with the clearing
agency. In particular, registered clearing agencies typically require
that an applicant demonstrate that it has adequate personnel capable of
handling transactions with the clearing agency and adequate physical
facilities, books and records, and procedures to fulfill its
anticipated commitments to, and to meet the operational requirements
of, the clearing agency and other members with necessary promptness and
accuracy. As a result, an applicant needs to demonstrate that it has
adequate personnel capable of handling transactions with the clearing
agency and adequate physical facilities, books and records, and
procedures to conform to conditions or requirements in these areas that
the clearing agency reasonably may deem necessary for its protection.
Registered clearing agencies have published these requirements on their
Web sites.
---------------------------------------------------------------------------
\659\ See 17 CFR 240.17Ad-22(d)(2).
---------------------------------------------------------------------------
Registered clearing agencies use an ongoing monitoring process to
help them understand relevant changes in the financial condition of
their members and to mitigate credit risk exposure of the clearing
agency to its members. The risk management staff analyzes financial
statements filed with regulators, as well as information obtained from
other SROs and gathered from various financial publications, so that
the clearing agency may evaluate, for instance, whether members
maintain sufficient financial resources and robust operational capacity
to meet their obligations as participants in the clearing agency
pursuant to existing Rule 17Ad-22(d)(2)(i).
Table 1 contains membership statistics for registered clearing
agencies.\660\ Current membership generally reflects features of
cleared markets. The decision to become a clearing member depends on
the products being cleared and the structure of these asset markets, as
well as the current state of regulation for cleared markets. For
example, the structure of security-based swap markets and the payoffs
to security-based swap contracts differs markedly from that of equity
markets and common stock, which may explain some of the differences
between the concentrated membership of certain clearing agencies and
the relatively broader membership of others.
---------------------------------------------------------------------------
\660\ See supra Part III.A.
---------------------------------------------------------------------------
n. Tiered Participation Arrangements
Tiered participation arrangements occur when clearing members
(direct participants) provide access to clearing services to third
parties (indirect participants). No rule under the Exchange Act
currently requires a registered clearing agency through its written
policies and procedures to identify, monitor, and manage material risks
arising from tiered participation arrangements. The Commission
understands, however, that certain registered clearing agencies have
policies and procedures currently in place to identify, monitor, or
manage such arrangements. Specifically, such clearing agencies rely on
information gathered from, and distributed by, direct participants to
manage these tiered participation arrangements. For example, under some
covered clearing agencies' rules, direct participants generally have
the responsibility to indicate to the clearing agency whether a
transaction submitted for clearing represents a proprietary or customer
position. Such rules further require direct participants to calculate,
and notify the clearing agency of the value of, each customer's
collateral. Direct participants also communicate with indirect
participants regarding the clearing agency's margin and other
requirements.
[[Page 70860]]
o. Links
Rule 17Ad-22(d)(7) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to evaluate the potential sources of
risks that can arise when the clearing agency establishes links either
cross-border or domestically to clear or settle trades, and ensure that
the risks are managed prudently on an ongoing basis.\661\
---------------------------------------------------------------------------
\661\ See 17 CFR 240.17Ad-22(d)(7).
---------------------------------------------------------------------------
Each registered clearing agency is linked to other clearing
organizations, trading platforms, and service providers. For instance,
a link between U.S. and Canadian clearing agencies allows U.S. members
to clear and settle valued securities transactions with participants of
a Canadian securities depository. The link is designed to facilitate
cross-border transactions by allowing members to use a single
depository interface for U.S. and Canadian dollar transactions and
eliminate the need for split inventories.\662\ Registered clearing
agencies that provide CCP services currently establish links to allow
members to realize collateral and other operational efficiencies.
---------------------------------------------------------------------------
\662\ See Exchange Act Release No. 52784 (Nov. 16, 2005), 71 FR
70902 (Nov. 23, 2005); Exchange Act Release No. 55239 (Feb. 5,
2007), 72 FR 6797 (Feb. 13, 2007).
---------------------------------------------------------------------------
p. Efficiency and Effectiveness
Rule 17Ad-22(d)(6) requires a registered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require the clearing agency to be
cost-effective in meeting the requirements of participants while
maintaining safe and secure operations.\663\ Registered clearing
agencies have procedures to control costs and to regularly review
pricing levels against operating costs. These clearing agencies may use
a formal budgeting process to control expenditures, and may review
pricing levels against their costs of operation during the annual
budget process. Registered clearing agencies also analyze workflows to
make recommendations to improve their operating efficiency.
---------------------------------------------------------------------------
\663\ See 17 CFR 240.17Ad-22(d)(6).
---------------------------------------------------------------------------
q. Communication Procedures and Standards
Although no rule under the Exchange Act expressly requires a
registered clearing agency through its written policies and procedures
to use or accommodate relevant internationally accepted communication
procedures and standards, the Commission believes that registered
clearing agencies already use these standards. Registered clearing
agencies typically rely on electronic communication with market
participants, including members. For example, some registered clearing
agencies have rules in place stating that clearing members must
retrieve instructions, notices, reports, data, and other items and
information from the clearing agency through electronic data retrieval
systems. Some registered clearing agencies have the ability to rely on
signatures transmitted, recorded, or stored through electronic,
optical, or similar means. Other clearing agencies have policies and
procedures that provide for certain emergency meetings using telephonic
or other electronic notice.
r. Disclosure
Disclosures by registered clearing agencies serve to limit the size
of potential information asymmetries between registered clearing
agencies, their members, and market participants. Rule 17Ad-22(d)(9)
requires a registered clearing agency to establish, implement, maintain
and enforce written policies and procedures reasonably designed to
provide market participants with sufficient information for them to
identify and evaluate risks and costs associated with using the
clearing agency's services.\664\ Information regarding the operations
and services of each registered clearing agency can be viewed publicly
either on the clearing agency's Web site or a Web site maintained by an
affiliate of the clearing agency. Because a registered clearing agency
is an SRO,\665\ it must file with the Commission any proposed rule or
any proposed change in, addition to, or deletion from its rules, and
the Commission reviews all proposed rule changes and publishes them for
comment.\666\ Proposed rule changes also are available for public
viewing on each clearing agency's Web site.
---------------------------------------------------------------------------
\664\ See 17 CFR 240.17Ad-22(d)(9).
\665\ See supra Part I.A.1.
\666\ See supra notes 12-13.
---------------------------------------------------------------------------
Besides providing market participants with information on the risks
and costs associated with their services, registered clearing agencies
regularly provide information to their members to assist them in
managing their risk exposures and potential funding obligations. Some
of these disclosures may be common to all members--such as information
about the composition of clearing fund assets--while other disclosures
that concern particular positions or obligations may only be made to
individual members.
Finally, the Commission notes that most registered clearing
agencies currently publish on their Web sites their responses to the
PFMI quantitative disclosures.\667\ These disclosures are to be updated
semi-annually.
---------------------------------------------------------------------------
\667\ See supra note 41.
---------------------------------------------------------------------------
B. Consideration of Benefits, Costs, and the Effect on Competition,
Efficiency, and Capital Formation
The discussion below sets forth the potential economic effects
stemming from the adopted rules. The section begins by framing more
general economic issues related to the amendments to Rule 17Ad-22 and
Rule 17Ab2-2. The discussion that follows considers the effects of the
rules on efficiency, competition, and capital formation. The section
ends with a discussion of the benefits and costs flowing from specific
provisions of the amendments to Rule 17Ad-22 and Rule 17Ab2-2.
1. General Economic Considerations
This section considers potential impacts of the amendments, as a
whole, through their effects on systemic risk, the discretion with
which covered clearing agencies operate, market integrity,
concentration in the market for clearing services and among clearing
members, and QCCP status.
a. Systemic Risk
A large portion of financial activity in the United States
ultimately flows through one or more registered clearing agencies that
would become covered clearing agencies under the amendments to Rule
17Ad-22. These clearing agencies have direct links to members and
indirect links to the customers of members. They are also linked to
each other through common members, operational processes, and in some
cases cross-margining and cross-guaranty agreements. These linkages
allow covered clearing agencies to provide opportunities for risk-
sharing but also allow them to serve as potential conduits for risk
transmission. Covered clearing agencies play an important role in
fostering the proper functioning of financial markets. If they are not
effectively managed, however, they may transmit financial shocks to
other financial market participants through their responses to clearing
member default.
The centralization of clearance and settlement activities at
covered clearing agencies allows market participants to reduce costs,
increase operational
[[Page 70861]]
efficiency, and manage risks more effectively.\668\ While providing
benefits to market participants, the concentration of these activities
at a covered clearing agency implicitly exposes market participants to
the risks faced by covered clearing agencies themselves, making risk
management at covered clearing agencies a key element of systemic risk
mitigation.
---------------------------------------------------------------------------
\668\ Cf. PFMI, supra note 2, at 9.
---------------------------------------------------------------------------
b. Discretion
The Commission recognizes that the degree of discretion permitted
by the amendments to Rule 17Ad-22 partially determines their economic
effect. Even where current practices at covered clearing agencies would
not need to change significantly to comply with the rules, as adopted,
covered clearing agencies could still potentially face costs associated
with the limitations on discretion that will result from the rules,
including costs related to limiting a clearing agency's flexibility to
respond to changing economic environments. For example, to the extent
that covered clearing agencies currently in compliance with Rule 17Ad-
22(e) value the ability to periodically allow net liquid assets to drop
below the minimum level specified by the rules, they may incur
additional costs because under Rule 17Ad-22(e) they lose the option to
do so.
Although there may be costs to limiting the degree of discretion
covered clearing agencies have over risk management policies and
procedures, the Commission believes there are also potential benefits.
As discussed above, clearing agencies may not fully internalize the
social costs of poor internal controls and thus, given additional
discretion, may not craft appropriate risk management policies and
procedures. For example, even if existing regulation provides clearing
agencies with the incentives necessary to manage risks appropriately in
a static sense, they may not provide clearing agencies with incentives
to update their risk management programs in response to dynamic market
conditions. Additionally, efforts at cost reduction or profit
maximization could encourage clearing agencies to reduce the quality of
risk management by, for example, choosing to update parameters and
assumptions rapidly in periods of low volatility while maintaining
stale parameters and assumptions in periods of high volatility. By
reducing covered clearing agencies' discretion over their policies and
procedures, the amendments to Rule 17Ad-22 may reduce the likelihood
that risk management practices lag behind changing market conditions by
requiring periodic analysis of model performance while paying
particular attention to periods of high volatility or low liquidity.
Subjecting covered clearing agencies to more specific requirements
may have other benefits for cleared markets as well. Academic research
has explored the ways in which regulation affects liquidity in
financial markets when participants are ``ambiguity averse,'' where
ambiguity is defined as uncertainty over the set of payoff
distributions for an asset.\669\ Such investors may heavily weigh
worst-case scenarios when they decide whether to hold the asset. The
Commission believes that regulation aimed at enhancing standards for
covered clearing agencies while reducing their discretion may reduce
the ambiguity associated with holding cleared assets in the presence of
credit risk and settlement risk \670\ and thus may allow investors to
rule out worst-case states of the world. In this regard, more specific
rules may encourage participation in cleared markets by investors that
benefit from resulting risk-sharing opportunities.\671\
---------------------------------------------------------------------------
\669\ See e.g., Itzhak Gilboa & David Schmeidler, Maxmin
Expected Utility with Non-Unique Prior, 18 J. Mathematical Econ. 141
(1989) (proposing an axiomatic foundation of a decision rule based
on maximizing expected minimum payoff of a strategy).
\670\ Specifically, by performing key roles in the transaction
process, clearing agencies serve to maintain higher minimum payoffs
in poor states of the world, by, for example, immobilizing
securities or adopting DVP systems.
\671\ See e.g., David Easley & Maureen O'Hara, Microstructure
and Ambiguity, 65 J. Fin. 1817 (2010) (using a theoretical model of
trade on venues that differ in rules, the authors show how rules
that reduce market-related ambiguity may induce a participatory
equilibrium).
---------------------------------------------------------------------------
c. Market Integrity
The Commission believes that the amendments to Rule 17Ad-22 could
provide the benefit of reduced potential for market fragmentation that
may arise from different requirements across regulatory regimes. These
benefits would flow to markets that are also supervised by the CFTC and
FRB, and internationally, since cleared markets are global in nature
and linked to one another through common participants.
Failure to maintain consistency with other regulators may disrupt
cleared markets in a number of ways. Significant differences across
regulatory regimes may encourage participants to restructure their
operations to avoid a particular regulatory regime.\672\ Such
differences may reduce the liquidity of cleared products in certain
markets if they result in an undersupply of clearing services. Further,
inconsistency in regulation across jurisdictions may increase the
likelihood that restructuring by market participants in response such
inconsistency results in concentrating clearing activity in regimes
with a weaker commitment to policies and procedures for sound risk
management. Differences across regulatory regimes could also affect the
products that a clearing agency chooses to clear. In turn, a shift in
product choice could result in more concentrated liquidity for certain
markets.
---------------------------------------------------------------------------
\672\ See, e.g., Arnoud W.A. Boot, Silva Dez[otilde]elan, & Todd
T. Milbourn, Regulatory Distortions in a Competitive Financial
Services Industry, 16 J. Fin. Serv. Res. 249 (2000) (showing that,
in a simple industrial organization model of bank lending, a change
in the cost of capital resulting from regulation results in a
greater loss of profits when regulated banks face competition from
non-regulated banks than when regulations apply equally to all
competitors); Victor Fleischer, Regulatory Arbitrage, 89 Tex. L.
Rev. 227 (2010) (discussing how, when certain firms are able to
choose their regulatory structure, regulatory costs are shifted onto
those entities that cannot engage in regulatory arbitrage).
---------------------------------------------------------------------------
In the case of clearing agency standards, there are additional
motivations for consistency with other regulatory requirements. The
Commission believes that such consistency would prevent the application
of inconsistent regulation and thereby reduce the likelihood that
participants in cleared markets would restructure and operate in less-
regulated markets. Additionally, such consistency would allow foreign
bank clearing members and foreign bank customers of clearing members of
covered clearing agencies to be subject to lower capital requirements
under the BCBS capital framework.\673\
---------------------------------------------------------------------------
\673\ See BCBS capital framework, supra note 44.
---------------------------------------------------------------------------
Based on its consultation and coordination with other regulators,
the Commission believes Rule 17Ad-22(e) is consistent and comparable,
where possible and appropriate, with the rules and policy statement
adopted by the FRB and the rules adopted by the CFTC, as well as the
headline principles in the PFMI. The Commission's rules differ from
those requirements adopted by the CFTC and FRB in terms of the specific
portions of the key considerations and explanatory text in the PFMI
that are, or are not, referenced or emphasized.
Further, CPMI-IOSCO members are also in various stages of
implementing the standards in the PFMI into their own regulatory
regimes, and the Commission believes that adopting a set of
requirements generally consistent with the relevant international
standards would result in diminished
[[Page 70862]]
likelihood that participants in cleared markets would restructure and
operate in less-regulated markets.\674\ Additionally, international
standards such as the BCBS capital framework could create complications
for U.S. clearing agencies not subject to regulations based on the PFMI
as a result of the BCBS capital framework's treatment of QCCPs. In
particular, if U.S. clearing agencies do not obtain QCCP status from
foreign banking regulators who have adopted rules conforming to the
BCBS capital framework because, for instance, the regulatory framework
is not consistent with the PFMI, foreign bank members of U.S. clearing
agencies may have incentives to move their clearing business to
clearing agencies in jurisdictions where they might obtain lower
capital requirements under the BCBS capital framework.\675\
---------------------------------------------------------------------------
\674\ See supra note 43.
\675\ See supra notes 44-45 and infra Part III.B.1.e (discussing
the BCBS capital framework and the economic effect of QCCP status
under the BCBS capital framework, respectively).
---------------------------------------------------------------------------
d. Concentration
The economic effects associated with the amendments to Rule 17Ad-22
may also be partially determined by the economic characteristics of
clearing agencies. Generally, the economic characteristics of FMIs,
including clearing agencies, include specialization, economies of
scale, barriers to entry, and a limited number of competitors.\676\
Such characteristics, coupled with the particulars of an FMI's legal
mandate, could result in market power, leading to lower levels of
service, higher prices, and under-investment in risk management
systems.\677\
---------------------------------------------------------------------------
\676\ See supra note 39 (defining ``financial market
infrastructure'').
\677\ Cf. PFMI, supra note 2, at 11.
---------------------------------------------------------------------------
The centralization of clearing activities in a relatively small
number of clearing agencies somewhat insulated from market forces may
result in a reduction in their incentives to innovate and to invest in
the development of appropriate risk management practices on an ongoing
basis,\678\ particularly when combined with the cost reduction
pressures noted previously.\679\ However, the Commission notes that the
inverse may not necessarily hold. In other words, additional
competition in the market for clearing services may not necessarily
result in improved risk management. For instance, aggressive price-
cutting in a ``race to the bottom'' may result in clearing agencies
accepting lower-quality collateral, requiring lower margin and default
fund contributions, lowering access requirements, or holding lower
reserves, potentially undermining their risk management efforts.\680\
---------------------------------------------------------------------------
\678\ The Commission notes that this result depends on the
relationship between the cost of innovations in risk management and
the private benefits to a clearing agency in terms of reduced
default risk. Absent competitive pressures, a clearing agency may
nevertheless invest in the development of risk management practices
so long as the marginal benefits of risk reduction exceed the
marginal cost.
\679\ See Kenneth J. Arrow, Economic Welfare and the Allocation
of Resources for Invention 609-626, in The Rate and Direction of
Inventive Activity: Economic and Social Factors (NBER, 1962),
available at http://www.nber.org/chapters/c2144.pdf.
\680\ See CPSS, Market Structure Development in the Clearing
Industry: Implications for Financial Stability, at sec. 5 (Nov.
2010), available at http://www.bis.org/publ/cpss92.pdf; see also
Siyi Zhu, Is There a `Race to the Bottom' in Central Counterparties
Competition?--Evidence from LCH.Clearnet SA, EMCF and EuroCCP, DNB
Occasional Studies, Vol. 9, No. 6 (2011); John Kiff et al., Credit
Derivatives: Systemic Risks and Policy Options (IMF Working Paper
No. 254, Nov. 2009), available at http://www.imf.org/external/pubs/ft/wp/2009/wp09254.pdf.
---------------------------------------------------------------------------
Market power may raise particular issues with respect to the
allocation of benefits and costs flowing from these amendments to Rule
17Ad-22 and precipitate changes in the structure of the financial
networks that are served by covered clearing agencies. For example, as
a result of limited competition,\681\ existing covered clearing
agencies may easily pass the incremental costs associated with enhanced
standards on to their members, who may share these costs with their
customers, potentially resulting in increased transaction costs in
cleared securities.
---------------------------------------------------------------------------
\681\ See generally Nadia Linciano, Giovanni Siciliano &
Gianfranco Trovatore, The Clearing and Settlement Industry:
Structure Competition and Regulatory Issues (Italian Secs. & Exch.
Comm'n Research Paper 58, May 2005), available at http://www.ssrn.com/abstract=777508 (concluding in part that the core
services offered by the clearance and settlement industry tend
toward natural monopolies because the industry can be characterized
as a network industry, where consumers buy systems rather than
single goods, consumption externalities exist, costs lock-in
consumers once they choose a system, and production improves with
economies of scale); Heiko Schmiedel, Markku Malkam[auml]ki & Juha
Tarkka, Economies of Scale and Technological Development in
Securities Depository and Settlement Systems, at 10 (Bank of Fin.
Discussion Paper 26, Oct. 2002), available at http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0226.pdf (``The overall results of this study reveal the
existence of substantial economies of scale among depository and
settlement institutions. On average, the centralized U.S. system is
found to be the most cost effective settlement system and may act as
the cost saving benchmark.'').
---------------------------------------------------------------------------
If incremental increases in costs lead clearing agencies to charge
higher prices for their services, then certain clearing members may
choose to terminate membership and cease to clear transactions for
their customers. Should this situation occur, the result may be further
concentration among clearing members, where each remaining member
clears a higher volume of transactions. In this case, clearing agencies
and the financial markets they serve would be more exposed to these
larger clearing members. Moreover, customers would have fewer resources
or options for obtaining such services, clearing agencies would have
fewer non-defaulting members to take on defaulting members portfolios,
and clearing agencies that rely on clearing members to participate in
default auctions would hold auctions with fewer participants. The
remaining clearing members may, however, each internalize more of the
costs their activity in cleared markets imposes on the financial
system.
The increased importance of a small set of clearing members, in
turn, may result in firms not previously systemically important
increasing in systemic importance. This is particularly true for
clearing members that participate in multiple markets, both cleared and
not cleared.\682\ However, adequate regulation of capital levels and
margin amounts at surviving clearing members could mean that, though
shocks to these members may be larger, the propagation of shocks may be
limited to a smaller set of entities and their equity holders.
---------------------------------------------------------------------------
\682\ See, e.g., Mark J. Roe, Clearinghouse Overconfidence, 101
Cal. L. Rev. 1641 (2013), available at http://scholarship.law.berkeley.edu/californialawreview/vol101/iss6/3
(arguing that counterparty risk concentrated within CCPs may be
transferred to the broader financial system through links between
clearing members and their clients).
---------------------------------------------------------------------------
e. QCCP Status and Externalities on Clearing Members
An effect of the amendments to Rule 17Ad-22 is that covered
clearing agencies required to comply with the adopted rules may be more
likely to qualify as QCCPs in non-U.S. jurisdictions that have adopted
the BCBS capital framework's QCCP definition. Under the BCBS capital
framework, a QCCP is defined as an entity operating as a CCP that is
prudentially supervised in a jurisdiction where the relevant regulator
has established, and publicly indicated that it applies to the CCP on
an ongoing basis, domestic rules and regulations that are consistent
with the PFMI.\683\ Because the amendments to Rule 17Ad-22 are
consistent with the PFMI, the Commission believes that foreign bank
clearing members of certain covered clearing agencies and foreign banks
[[Page 70863]]
clearing indirectly through clearing members of covered clearing
agencies may benefit from covered clearing agencies obtaining QCCP
status. In particular, bank clearing members and bank indirect
participants of covered clearing agencies that could attain QCCP status
would face lower capital requirements with respect to cleared
derivatives and repurchase agreement transactions because, under the
BCBS capital framework, capital requirements for bank exposures to
QCCPs are lower than capital requirements for bank exposures to non-
qualifying CCPs for these products. Although the FRB and the Office of
the Comptroller of the Currency have already adopted rules implementing
the BCBS capital framework that would identify all covered clearing
agencies (with the exception of ICEEU) as QCCPs for the purposes of
applying risk weights to assets at U.S. banks,\684\ the adopted
amendments to Rule 17Ad-22 may result in non-U.S. bank clearing members
experiencing lower capital requirements related to exposures against
covered clearing agencies relative to a baseline scenario in which
foreign banking regulators do not determine that a covered clearing
agency is a QCCP.\685\
---------------------------------------------------------------------------
\683\ See supra notes 44-45 and accompanying text (discussing
the BCBS capital framework).
\684\ See infra Part III.B.1.e.
\685\ The Commission notes that benefits to banks that may arise
as a result of the rules may be contingent upon regulators in other
jurisdictions taking action to recognize the QCCP status of covered
clearing agencies.
---------------------------------------------------------------------------
The BCBS capital framework affects capital requirements for bank
exposures to central counterparties in two important ways. The first
relates to trade exposures, defined under the BCBS capital framework as
the current and potential future exposure of a clearing member or
indirect participant in a CCP arising from OTC derivatives, exchange-
traded derivatives transactions, and securities financing transactions.
If these exposures are held against a QCCP, they will be assigned a
risk weight of 2%. In contrast, exposures against non-qualifying CCPs
do not receive lower capital requirements relative to bilateral
exposures and are assigned risk weights between 20% and 100%, depending
on counterparty credit risk. Second, the BCBS capital framework imposes
a cap on risk weights applied to default fund contributions, limiting
risk-weighted assets (subject to a 1250% risk weight) to a cap of 20%
of a clearing member's trade exposures against a QCCP. This is in
contrast to treatment of exposures against non-qualifying CCPs, which
are uncapped and subject to a 1250% risk weight. Because QCCP status
generally impacts capital treatment, any benefits of attaining QCCP
status will likely accrue, at least in part, to foreign clearing
members or foreign indirect participants subject to the BCBS capital
framework.\686\ As a result of lower risk weights applied to exposures
and a cap on capital requirements against default fund obligations,
clearing members of QCCPs subject to BCBS capital framework may
experience an improved capital position relative to bank members of
non-QCCPs. This may lower funding costs for bank members of QCCPs.\687\
---------------------------------------------------------------------------
\686\ For a discussion of the effects of QCCP status on
competition between bank and non-bank clearing members, see Part
III.B.2.a.
\687\ See supra note 597 (noting that the Commission currently
expects the lower capital treatment under the BCBS capital framework
to affect registered clearing agencies FICC, ICEEU, and OCC, each of
which would meet the definition of a ``covered clearing agency'').
---------------------------------------------------------------------------
Non-U.S. banks that are constrained by BCBS tier one capital
requirements would face a shock to risk-weighted assets once capital
rules come into force.\688\ The size of the shock depends on
regulators' determinations with regard to QCCP status. Regardless of
the size of the shock and to come into compliance with capital rules,
however, affected banks will have to raise capital or reduce leverage.
In the absence of perfect markets, these banks may incur ongoing costs
as a result.
---------------------------------------------------------------------------
\688\ As discussed above, the FRB and Office of Comptroller of
the Currency have adopted rules implementing capital requirements
under the BCBS capital framework that make capital treatment for
exposures to CCPs independent of the adopted rules for U.S. banks
regulated by these two agencies, and therefore the Commission
believes no benefits would accrue to U.S. bank clearing members of
FICC and OCC.
---------------------------------------------------------------------------
In quantifying the benefits of achieving QCCP status, the
Commission based its estimate on publicly available information with
regard to OCC.\689\ To estimate the upper bound for the potential
benefits accruing to bank clearing members at OCC as a result of QCCP
status, the Commission identified a sample of 28 bank clearing members
at OCC and, for each bank, collected information about total assets,
risk weighted assets, net income and tier one capital ratio at the
holding company level for 2015.\690\ The Commission then allocated
trade exposures and default fund exposures across the sample of bank
clearing members based on the level of risk-weighted assets.\691\ The
Commission measured the impact on risk-weighted assets for non-U.S.
bank clearing members under two different capital treatment regimes.
The first regime is in the absence of QCCP status, assuming a 100% risk
weight applied to trade exposures and 1250% risk weight applied to
default fund exposures for non-U.S. members. In the second regime, OCC
obtains QCCP status, and banks are allowed to apply a 2% risk weight
applied to trade exposures and a 1250% risk weight to default fund
exposures up to a total exposure cap of 20% of trade exposures.\692\ If
OCC is determined to be a QCCP, then the increase in risk weighted
assets will be smaller in magnitude, implying a smaller adjustment at
lower cost. The Commission estimates that benefits associated with OCC
obtaining QCCP status stemming from lower capital requirements against
trade exposures to QCCPs as a result of the adopted rules to have an
upper bound of $1.2 billion per year, or approximately 0.73% of the
total 2015 net income reported by the sample of bank clearing members
at OCC.
---------------------------------------------------------------------------
\689\ Under the BCBS capital framework, ICCEU and FICC's
repurchase agreement segment would also be eligible for QCCP status.
However, FICC does not report counterparties to repo agreements, and
ICEEU does not separately report exposures related to security-based
swap clearing, so we are currently unable to quantify potential
benefits related to QCCP status for these entities.
\690\ The Commission used the set of entities it identified as
banks on OCC's member list, available at http://www.optionsclearing.com/membership/member-information/. For U.S.
bank holding companies, 2015 total assets, risk weighted assets, net
income, and tier 1 capital ratios were collected from Y-9C reports
available at the National Information Center, https://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For non-U.S. bank holding companies,
Commission staff obtained corresponding data from financial
statements and supplementary financial materials posted to bank Web
sites. Where necessary, values were converted back to U.S. dollars
at December 31, 2015 exchange rates obtained from the Federal
Reserve, available at http://www.federalreserve.gov/releases/h10/hist/.
\691\ For example, one bank in the sample, with 5.53% of total
risk-weighted assets, was assigned 5.53% of the total trade and
default fund exposures while another bank in the sample, with 4.21%
of total risk weighted assets, was assigned 4.21% of these
exposures. Because trade exposures of OCC members against OCC are
nonpublic, the Commission used the balance of OCC margin deposits
and deposits in lieu of margin held at OCC, $73.54 billion, as a
proxy for trade exposures. OCC's 2015 clearing fund deposits were
valued at $12.08 billion. See OCC, 2015 Annual Report, available at
http://www.optionsclearing.com/components/docs/about/annual-reports/occ-2015-annual-report.pdf.
\692\ The BCBS capital framework allows banks to compute default
fund exposures in two ways. Method 1 involves computing capital
requirements for each member proportional to its share of an
aggregate capital requirement for all clearing members in a scenario
where to average clearing members default. The Commission currently
lacks data necessary to compute default fund exposures under this
approach, instead we use Method 2, which caps overall exposure to a
QCCP at 20% of trade exposures. See BCBS capital framework, supra
note 44, Annex 4, paras. 121-25 (outlining two methods for computing
default fund exposures).
---------------------------------------------------------------------------
The Commission's analysis is limited in several respects and relies
on several
[[Page 70864]]
assumptions. First, a limitation of our proxy for trade exposures and
our use of OCC's clearing fund is that the account balances include
deposits by bank clearing members, who would experience lower capital
requirements under the BCBS capital framework, and non-bank clearing
members who would not. The Commission assumes, for the purposes of
establishing an upper bound for the benefits to market participants
that are associated with QCCP status for OCC under the adopted rules,
that the balance of both OCC's margin account and OCC's default fund
are attributable only to bank clearing members. Additionally, we assume
an extreme case where, in the absence of QCCP status, trade exposures
against a CCP would be assigned a 100% risk weight, causing the largest
possible shock to risk-weighted assets for affected banks.
Lower capital requirements on trade exposures to OCC would produce
effects in the real economy only under certain conditions. First,
agency problems, taxes, or other capital market imperfections could
result in banks targeting a particular capital structure. Second,
capital constraints on bank clearing members subject to the BCBS
capital framework must bind so that higher capital requirements on bank
clearing members subject to the BCBS capital framework in the absence
of QCCP status would cause these banks to exceed capital constraints if
they chose to redistribute capital to shareholders or invest capital in
projects with returns that exceed their cost of capital. Using publicly
available data, however, it is not currently possible to determine
whether capital constraints will bind for bank clearing members when
rules applying the BCBS capital framework come into force, so to
estimate an upper bound for the effects of QCCP status on bank clearing
members we assume that tier one capital constraints for all bank
clearing members of OCC would bind in an environment with zero weight
placed on bank exposures to CCPs.\693\
---------------------------------------------------------------------------
\693\ The Commission notes that, at present, no bank in its
sample of bank clearing members of OCC is bound by capital
requirements under the BCBS capital framework. For U.S. bank holding
companies, tier 1 capital ratios were collected from Y-9C reports
available at the National Information Center, https://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For non-U.S. bank holding companies,
Commission staff obtained corresponding data from financial
statements and supplementary financial materials posted to bank Web
sites. The Commission used data from 2013-2016 for its sample of
U.S. bank clearing members, and from 2012-2015 for its sample of
non-U.S. bank clearing members and assumed no bank-specific
countercyclical capital buffers for these banks. This suggests a
minimum tier 1 capital ratio of 10.1%, exceeding the BCBS minimum by
1.6%.
---------------------------------------------------------------------------
For the purposes of quantifying potential benefits from QCCP
status, the Commission has also assumed that banks choose to adjust to
new capital requirements by deleveraging. In particular, the Commission
assumed that banks would respond by reducing risk-weighted assets
equally across all risk classes until they reach the minimum tier one
capital ratio under the Basel framework of 8.5%. We measure the ongoing
costs to each non-U.S. bank by multiplying the implied change in total
assets by each bank's return on assets, estimated using up to 14 years
of annual financial statement data.\694\
---------------------------------------------------------------------------
\694\ This data has been taken from Compustat and from publicly
available financial statements. Due to data limitations, for certain
banks a shorter window was used for this calculation. The minimum
sample window was six years.
---------------------------------------------------------------------------
The BCBS capital requirements for exposures to CCPs yield
additional benefits for QCCPs that the Commission is currently unable
to quantify due to lack of data concerning client clearing arrangements
by banks. For client exposures to clearing members, the BCBS capital
framework allows participants to reflect the shorter close-out period
of cleared transactions in their capitalized exposures. The BCBS
framework's treatment of exposures to CCPs also applies to client
exposures to CCPs through clearing members. This may increase the
likelihood that bank clients of bank clearing members that are subject
to the BCBS capital framework share some of the benefits of QCCP
status.
Furthermore, the fact that the BCBS capital framework applies to
bank clearing members may have important implications for competition
and concentration. While Rule 17Ad-22(e) may extend lower capital
requirements against exposures to CCPs to non-U.S. bank clearing
members of covered clearing agencies,\695\ the benefits of QCCP status
will still be limited to bank clearing members. However, the costs
associated with compliance with Rule 17Ad-22(e) may be borne by all
clearing members, regardless of whether or not they are supervised as
banks. A potential consequence of this allocation of costs and benefits
may be ``crowding out'' of members of QCCPs that are not banks and will
not experience benefits with respect to the BCBS capital framework.
This may result in an unintended consequence of increased concentration
of clearing activity among bank clearing members. As noted in Part
III.B.1.d, this increased concentration could mean that each remaining
clearing member becomes more important from the standpoint of systemic
risk transmission.
---------------------------------------------------------------------------
\695\ See supra note 45 and accompanying text (noting that banks
supervised by the FRB and Office of the Comptroller of the Currency
would treat covered clearing agencies as QCCPs for the purposes of
calculating regulatory capital ratios).
---------------------------------------------------------------------------
In addition to benefits for bank clearing members, certain benefits
resulting from QCCP status may also accrue to covered clearing
agencies. If banks value lower capital requirements attributable to
QCCP status, bank clearing members may prefer membership at QCCPs to
membership at CCPs that are not QCCPs. A flight of clearing members
from covered clearing agencies in the absence of QCCP status would
result in default-related losses being mutualized across a narrower
member base. Additionally, if the flight from covered clearing agencies
results in lower transactional volume at these clearing agencies, then
economies of scale may be lost, resulting in higher clearing fees and
higher transaction costs in cleared products.
2. Effect on Competition, Efficiency, and Capital Formation
The amendments to Rule 17Ad-22 and Rule 17Ab2-2 have the potential
to affect competition, efficiency, and capital formation. As with the
rest of the benefits and costs associated with the amendments to Rule
17Ad-22, the Commission believes that several of the effects described
below only occur to the extent that covered clearing agencies do not
already have operations and governance mechanisms that conform to the
requirements in Rule 17Ad-22(e). Additionally, the Commission believes
that consistency with international regulatory frameworks, as embodied
by the PFMI, which may promote the integrity of cleared markets, could
have substantial effects on competition, efficiency, and capital
formation.
a. Competition
Two important characteristics of the market for clearance and
settlement services are high fixed costs and economies of scale. Large
investments in risk management and information technology
infrastructure costs, such as financial data database and network
maintenance expenses, are components of high fixed costs for clearing
agencies. Consequently, the clearance and settlement industry exhibits
economies of scale in that the average total cost per transaction,
which includes fixed costs, diminishes with the increase in transaction
volume as high fixed costs are spread over a larger number of
transactions.
Furthermore, high fixed costs translate into barriers to entry that
[[Page 70865]]
preclude competition. Lower competition is an important source of
market power for clearing agencies. As a result, clearing agencies
possess the ability to exert market power and influence the fees
charged for clearance and settlement services in the markets they
serve.\696\ Any costs resulting from the adopted amendments may have
the effect of raising already high barriers to entry. As the potential
entry of new clearing agencies becomes more remote, existing clearing
agencies may be able to reduce service quality, restrict the supply of
services, or increase fees above marginal cost in an effort to earn
economic rents from participants in cleared markets.\697\
---------------------------------------------------------------------------
\696\ See, e.g., CCA Standards proposing release, supra note 5,
at 29593.
\697\ See id.
---------------------------------------------------------------------------
Even if they could not take advantage of a marginal increase in
market power, clearing agencies may use their market power to pass any
increases in costs that flow from the adopted amendments to their
members. This may be especially true in the cases of member-owned
clearing agencies, such as DTC, FICC, NSCC, and OCC, where members lack
the opportunity to pass costs through to outside equity holders.
Allowing clearing members to serve on the board of directors of a
covered clearing agency may align a covered clearing agency's
incentives with its membership. Certain complications may also arise,
however, when clearing members sit on boards of covered clearing
agencies as members of the board and may choose to allocate the costs
of enhanced risk management inefficiently across potential competitors,
in an effort to reduce their own share of these costs.
Members who are forced to internalize the costs of additional
requirements under Rule 17Ad-22(e) may seek to terminate their
membership. Additionally, prospective clearing members may find it
difficult to join clearing agencies, given the additional costs they
must internalize.\698\ Remaining clearing members may gain market power
as a result, enabling them to extract economic rents from their
customers. Rent extraction could take the form of higher transaction
costs in cleared markets, thereby reducing efficiency, as discussed
below.
---------------------------------------------------------------------------
\698\ See supra Part III.B.1.d (discussing concentration both in
the market for clearing services and among clearing members).
---------------------------------------------------------------------------
The Commission also acknowledges that Rule 17Ad-22(e)(19) may
affect competition among firms that choose to become clearing members,
and those who provide clearing services indirectly, through a clearing
member. Monitoring and managing the risks associated with indirect
participation in clearing may be costly. If monitoring and managing the
risks associated with indirect participation in clearing proves costly
for clearing agencies and if clearing agencies are able to pass the
additional costs related to monitoring and managing risks to clearing
members, it may cause marginal clearing members unable to absorb these
additional costs to exit. While these exits may be socially efficient,
since they reflect the internalization of costs otherwise imposed upon
other participants in cleared markets through increased probability of
clearing agency default, they may nevertheless result in lower
competition among clearing members for market share, potentially
providing additional market power to the clearing members that remain.
Exits by clearing members could also reduce the resources available for
customers to obtain replacement clearing services.
The Commission believes, however, that management of risks from
indirect participation is important in mitigating the risks that
clearing agencies pose to financial stability. The tiered participation
risk exposures, including credit, liquidity, and operational risks
inherent in indirect participation arrangements, may present risks to
clearing agencies, their members, and to the broader financial markets.
For instance, if the size of an indirect participant's positions is
large relative to a clearing member's capacity to absorb risks, this
may increase the clearing member's default risk. Consequently, a
clearing agency with indirect participation arrangements may be exposed
to the credit risk of an indirect participant through its clearing
members. Similarly, a margin call on, or a default by, an indirect
participant could constrain liquidity of its associated clearing
members, making it more difficult for these members to manage their
positions at the clearing agency.
The consistency across regulatory frameworks contemplated by the
adopted rules may also affect competition. Financial markets in cleared
products are global, encompassing many countries and regulatory
jurisdictions. Consistency with international regulatory frameworks may
facilitate entry of clearing agencies into new markets. By contrast,
conflicting or duplicative regulation across jurisdictions, or even
within jurisdictions, may cause competitive friction that inhibits
entry and helps clearing agencies behave like local monopolists.
Consistency in regulation can facilitate competition among clearing
agencies so long as regulation is not so costly as to discourage
participation in any market. Additionally, the Commission believes that
Rule 17Ad-22(e)(23) may facilitate competition among clearing agencies
across jurisdictions by requiring public disclosures that enable market
participants to compare clearing agencies more easily.
The consistency across regulatory requirements contemplated by the
adopted rules may affect competition among banks in particular.
Clearing derivative and repurchase agreement transactions through QCCPs
will result in lower capital requirements for banks under the BCBS
capital framework. Therefore, consistency with the PFMI may allow banks
that clear these products through covered clearing agencies to compete
on equal terms with banks that clear through other clearing agencies
accorded QCCP status. This effect potentially countervails higher
barriers to entry that enhanced risk management standards may impose on
clearing members by lowering the marginal cost of clearing these
transactions. Furthermore, covered clearing agencies potentially
compete with one another for volume from clearing members. Since
clearing members receive better treatment for exposures against QCCPs,
clearing members will find it less costly to deal with QCCPs. Failure
to establish requirements consistent with the PFMI may place U.S.
covered clearing agencies at a competitive disadvantage globally.
The ability of covered clearing agencies to obtain QCCP status may
also affect competition among clearing agencies. Under the BCBS capital
framework, QCCP status would have practical relevance only for covered
clearing agencies providing CCP services for derivatives, security-
based swaps, and securities financing transactions. To the extent that
the adopted rules increase the likelihood that banking regulators that
have implemented the BCBS capital framework in their jurisdiction
recognize covered clearing agencies as QCCPs, banks that clear at
covered clearing agencies will experience lower capital requirements.
Since clearing agencies may compete for volume from clearing members
that are also banks, the adopted rules may remove a competitive
friction between covered clearing agencies and other clearing agencies
that enjoy recognition as QCCPs by banking regulators. As a corollary,
the adopted rules could potentially disadvantage any registered
clearing agencies that are not covered
[[Page 70866]]
clearing agencies.\699\ The Commission also notes that the ability of
registered clearing agencies to voluntarily apply for covered clearing
agency status under Rule 17Ab2-2(a) may potentially allow entrants to
achieve QCCP status if the Commission determines they should receive
covered clearing agency status and they otherwise meet the requirements
of the BCBS capital framework.
---------------------------------------------------------------------------
\699\ See supra note 597 (noting that the Commission currently
expects the lower capital treatment under the BCBS capital framework
to affect registered clearing agencies FICC, ICEEU, and OCC, each of
which would meet the definition of a ``covered clearing agency'' in
Rule 17Ad-22(a)(5)).
---------------------------------------------------------------------------
Further competitive effects may flow from the adoption as a result
of the determinations under Rule 17Ab2-2 for clearing agencies engaged
in activities with a more complex risk profile and clearing agencies
that are systemically important in multiple jurisdictions. These
entities will be responsible for maintaining additional financial
resources sufficient to cover the default of the two participant
families that would potentially cause the largest aggregate credit
exposures in extreme but plausible market conditions as well as
undertake an annual feasibility analysis for extending liquidity risk
management from ``cover one'' to ``cover two.'' These clearing agencies
will have to collect these resources from participants, either through
higher margin requirements or guaranty fund contributions, or
indirectly through third-party borrowing arrangements secured by member
resources. Regardless of how clearing agencies obtain these additional
resources, the requirement to do so potentially raises the costs to use
services provided by covered clearing agencies. Moreover, these
additional costs could raise barriers to entry in the market or to opt
out of clearing altogether.
b. Efficiency
The amendments to Rule 17Ad-22 may affect efficiency in a number of
ways, though as discussed previously, most of these effects will only
flow to the extent that covered clearing agencies do not already comply
with the amendments. First, because the amendments result in general
consistency with the PFMI and requirements adopted by the CFTC and FRB,
consistency likely fosters efficiency by reducing the risk that covered
clearing agencies will be faced with conflicting or duplicative
regulation when clearing financial products across multiple regulatory
jurisdictions.
Consistency across regulatory regimes in multiple markets may also
result in efficiency improvements. Fully integrated markets would allow
clearing agencies to more easily exploit economies of scale because
clearing agencies tend to have low marginal costs and, thus, could
provide clearance and settlement services over a larger volume of
transactions at a lower average cost. Differences in regulation, on the
other hand, may result in market fragmentation, allowing clearing
agencies to operate as local monopolists. The resulting potential for
segmentation of clearing and settlement businesses along jurisdictional
lines may lead to overinvestment in the provision of clearing services
and reductions in efficiency as clearing agencies open and operate
solely within jurisdictional boundaries. If market segmentation
precludes covered clearing agencies from clearing transactions for
customers located in another jurisdiction with a market too small to
support a local clearing agency, fragmentation may result in under-
provisioning of clearing and settlement services in these areas, in
turn reducing the efficiency with which market participants share risk.
The amendments may also affect efficiency directly if they mitigate
covered clearing agencies' incentives to underinvest in risk management
and recovery and wind-down procedures. CCP default and liquidation is
likely a costly event, so to the extent that the rules mitigate the
risk of CCP default and prescribe rules for orderly recovery and wind-
down, they will produce efficiency benefits. Another direct effect on
efficiency may come if registered clearing agencies attempt to
restructure their operations in ways that would allow them to fall
outside of the scope of Rule 17Ad-22(e).
Finally, price efficiency and the efficiency of risk sharing among
market participants may be affected by the amendments. On one hand, the
cost of a transaction includes costs related to counterparty default
that are typically unrelated to fundamental asset payoffs. Academic
research using credit default swap transaction data has revealed a
statistically significant, though economically small, relationship
between the credit risk of a counterparty and the spreads implicit in
transaction prices.\700\ Enhanced risk management by clearing agencies
may reduce this component of transaction costs. By reducing deviations
of prices from fundamental value, the amendments may increase price
efficiency. If lower transaction costs or reduced ambiguity facilitates
participation in cleared markets by investors who would benefit from
opportunities for risk-sharing in these markets,\701\ then this
transmission channel may result in more efficient allocation of risk.
On the other hand, the amendments may have adverse implications for
price efficiency in cleared markets if they drive up transaction costs
as higher costs of risk management enter asset prices. An increase in
transaction costs could cause certain market participants to avoid
trading altogether, reducing liquidity in cleared products and
opportunities for risk sharing among investors in these markets.
---------------------------------------------------------------------------
\700\ See e.g., Navneet Arora, Priyank Gandhi & Francis
Longstaff, Counterparty Credit Risk and the Credit Default Swap
Market, 103 J. Fin. Econ. 280 (2012). Using transaction prices and
quotes by 14 different CDS dealers, the authors identified how
dealers' credit risk affects transaction prices. They observed a
relationship between spreads and credit risk implying that a 645-
basis-point increase in a dealer's credit spread would produce a
one-basis-point increase in transaction prices. They explain the
magnitude of this relationship by noting that their sample included
transactions that were mostly collateralized, which would diminish
the sensitivity of transaction prices to counterparty credit risk.
\701\ If investors who might benefit from risk-sharing in
cleared markets are ambiguity-averse, then regulation that addresses
payoffs in times of financial strain may induce their participation.
See supra note 669 and accompanying text.
---------------------------------------------------------------------------
c. Capital Formation
The implications for capital formation that flow from the
amendments to Rule 17Ad-22 and Rule 17Ab2-2 stem mainly from
incremental costs that result from compliance with more specific
standards and benefits in the form of more efficient risk sharing.
In cases where current practice falls short of the amendments,
covered clearing agencies may have to invest in infrastructure or make
other expenditures to come into compliance, which may divert capital
from other uses. In line with our previous discussion of cost
allocation in the market for clearing services, these resources may
come from clearing members and their customers.\702\
---------------------------------------------------------------------------
\702\ See supra Part III.B.1 (discussing the economic effects of
the rules on the market for clearing services).
---------------------------------------------------------------------------
At the same time, the Commission believes that the standards
contemplated under the rules may foster capital formation. As mentioned
earlier, clearing agencies that are less prone to failure may help
reduce transaction costs in the markets they clear.\703\ Conceptually,
the component of transaction costs that reflects counterparty credit
risk insures one counterparty against the default of
[[Page 70867]]
another.\704\ Reductions in counterparty default risk allow the
corresponding portion of transaction costs to be allocated to more
productive uses by market participants who otherwise would bear these
costs.
---------------------------------------------------------------------------
\703\ See supra Part III.B.1.a (discussing the economic effects
of the rules on systemic risk).
\704\ See supra note 700.
---------------------------------------------------------------------------
If, on balance, the adopted amendments cause transaction costs to
decrease in cleared markets, then the expected value of trade may
increase. Counterparties that are better able to diversify risk through
participation in cleared markets may be more willing to invest in the
real economy rather than choosing to engage in precautionary savings.
3. Effect of Amendments to Rule 17Ad-22 and Rule 17Ab2-2
The discussion below outlines the costs and benefits considered by
the Commission as they relate to the rules being adopted today. These
specific costs and benefits are in addition to the more general costs
and benefits anticipated under the Commission's proposal discussed in
Part III.B.1 and include, in particular, the costs and benefits
stemming from the availability of QCCP status under the BCBS capital
framework. Many of the costs and benefits discussed below are difficult
to quantify. This is particularly true where clearing agency practices
are anticipated to evolve and adapt to changes in technology and other
market developments. The difficulty in quantifying costs and benefits
of the adopted rules is further exacerbated by the fact that in some
cases the Commission lacks information regarding the specific practices
of clearing agencies that could assist in quantifying certain costs.
For example, as noted in Part I.A.1.a.i(4), without detailed
information about the composition of illiquid assets held by clearing
agencies and their members, the Commission cannot provide reasonable
estimates of costs associated with satisfying substantive requirements
under Rules 17Ad-22(e)(7)(i) and (ii). Another example, discussed in
Part I.A.1.a.i(5), is testing and validation of financial risk models,
where the Commission is only able to estimate that costs will fall
within a range. In this case, the costs associated with substantive
requirements under the rules may depend on the types of risk models
employed by clearing agencies, which are, in turn, dictated by the
markets they serve. As a result, much of the discussion is qualitative
in nature, though where possible, the costs and benefits have been
quantified.
a. Rule 17Ad-22(e)
The Commission recognizes that the scope of Rule 17Ad-22(e) is an
important determinant of its economic effect. Having considered the
anticipated costs and benefits associated with Rule 17Ad-22(e), the
Commission believes Rule 17Ad-22(e) should apply to a ``covered
clearing agency,'' as defined in Rule 17Ad-22(a)(5).\705\ In
particular, as discussed below, the Commission believes that an
important benefit resulting from the enhanced risk management
requirements in the rules is a reduction in the risk of a failure of a
covered clearing agency. For example, these benefits may be significant
due to the clearing agencies' size, exposure to, and interconnectedness
with market participants, and the effect their failure may have on
markets, market participants, and the broader financial system. For
complex risk profile clearing agencies, significant benefits may flow
as a result of their higher baseline default risk.
---------------------------------------------------------------------------
\705\ See Part II.A.1.
---------------------------------------------------------------------------
As an alternative, the Commission could have extended the scope of
Rule 17Ad-22(e) to cover all registered clearing agencies. The
Commission acknowledges, however, that clearing agencies are involved
in differing products and markets that carry varying levels of risk.
Further, the costs of compliance with the rules may represent barriers
to entry for clearing agencies. By continuing to apply Rule 17Ad-22(d)
to registered clearing agencies that are not covered clearing agencies,
the Commission believes that the scope of Rule 17Ad-22(e) appropriately
preserves the potential for the continuing development of the national
system for clearance and settlement and maintains innovation in the
operation of registered clearing agencies.\706\
---------------------------------------------------------------------------
\706\ The Commission notes that under Rule 17Ab2-2(a), a
registered clearing agency that is not involved in activities with a
more complex risk profile and is not a designated clearing agency
may apply for covered clearing agency status, which would subject
them to the requirements of Rule 17Ad-22(e). The Commission believes
that this may occur if the registered clearing agency believes such
status may credibly signal the quality of the services it provides
or if it is seeking to obtain QCCP status under the BCBS capital
framework.
---------------------------------------------------------------------------
i. Rule 17Ad-22(e)(1): Legal Risk
Because, as noted above, Rule 17Ad-22(e)(1) would require
substantially the same set of policies and procedures as Rule 17Ad-
22(d)(1),\707\ the Commission believes that Rule 17Ad-22(e)(1) would
likely impose limited material additional costs on covered clearing
agencies and produce limited benefits, in line with the general
economic considerations discussed in Part III.B.1.
---------------------------------------------------------------------------
\707\ See supra note 179; supra Part II.C.1 (discussing the full
set of requirements under Rule 17Ad-22(e)(1)); supra Part III.A.2.a
(discussing current practices among registered clearing agencies
regarding legal risk); see also 17 CFR 240.17Ad-22(d)(1).
---------------------------------------------------------------------------
ii. Rule 17Ad-22(e)(2): Governance
Each covered clearing agency has a board of directors that governs
its operations and oversees its senior management. Rule 17Ad-22(e)(2)
would establish more detailed requirements for governance arrangements
at covered clearing agencies relative to those imposed on registered
clearing agencies under Rule 17Ad-22(d)(8).\708\
---------------------------------------------------------------------------
\708\ See supra Part II.C.2 (discussing the full set of
requirements under Rule 17Ad-22(e)(2)).
---------------------------------------------------------------------------
The Commission understands that any covered clearing agency subject
to the rule has policies and procedures in place that clearly
prioritize the risk management and efficiency of the clearing agency.
However, the Commission believes that covered clearing agencies do not
already have in place policies and procedures with respect to other
requirements under Rule 17Ad-22(e)(2). Based on its supervisory
experience, the Commission believes that some covered clearing agencies
may need to update their policies and procedures to comply with Rule
17Ad-22(e)(2)(iv). These updates will entail certain basic compliance
costs, and covered clearing agencies may also incur assessment costs
related to analyzing current governance arrangements to determine the
extent to determine which they do not meet the requirements of the
amendments. The estimated costs in terms of paperwork are discussed in
Part IV. If, as a result of new policies and procedures, a covered
clearing agency is required to recruit new directors, the Commission
estimates a cost per director of $73,912.\709\
---------------------------------------------------------------------------
\709\ The Commission estimated a cost per director of $68,000 in
proposing Regulation MC. See Exchange Act Release No. 34-63107 (Oct.
14, 2010), 75 FR 65881, 65921 & n.215 (Oct. 26, 2010). The $73,912
estimate reflects this amount in 2015 dollars, using consumer price
inflation data provided by the Bureau of Labor Statistics.
---------------------------------------------------------------------------
While there are potential costs associated with compliance, the
Commission believes that benefits would potentially accrue from these
requirements. Specifically, the Commission believes that enhanced
governance arrangements would further promote safety and efficiency at
the clearing agency--motives that may not be part of a clearing
agency's governance arrangements in the absence of regulation. Policies
and procedures required under Rule 17Ad-22(e)(2)
[[Page 70868]]
would also reinforce governance arrangements at covered clearing
agencies by requiring board members and senior management to have
appropriate experience and skills to discharge their duties and
responsibilities.
Compliance with these requirements could reduce the risk that
insufficient internal controls within a covered clearing agency
endanger broader financial stability. While the benefits of compliance
are difficult to quantify, the Commission believes that they flow
predominantly from a reduced probability of covered clearing agency
default.
iii. Rule 17Ad-22(e)(3): Comprehensive Framework for the Management of
Risks
The Commission believes that Rule 17Ad-22(e)(3) would aid covered
clearing agencies in implementing a systematic process to examine risks
and assess the probability and impact of those risks.\710\ Rule 17Ad-
22(e)(3)(i) specifies that a risk management framework include policies
and procedures reasonably designed to identify, measure, monitor, and
manage the range of risks that arise in or are borne by the covered
clearing agency. Critically, these policies and procedures would be
subject to review on a specified basis and approval by the board of
directors annually. A sound framework for comprehensive risk management
under regular review would have the benefits of providing covered
clearing agencies with a better awareness of the totality of risks they
face in the dynamic markets they serve. In addition, the requirement to
have policies and procedures that provide for an independent audit
committee of the board and that provide internal audit and risk
management functions with sufficient resources, authority, and
independence from management, as well as access to risk and audit
committees of the board, would reinforce governance arrangements
directly related to risk management at covered clearing agencies. A
holistic approach to risk management could help ensure that policies
and procedures that covered clearing agencies adopt pursuant to the
rules work in tandem with one another. For example, such an approach
could result in risk-based membership standards under Rule 17Ad-
22(e)(18) that are consistent with policies and procedures related to
the allocation of credit losses under Rule 17Ad-22(e)(13)(i). The
Commission believes ensuring that a covered clearing agency's risk
management activities fit within a unified framework could mitigate the
risk of financial losses to covered clearing agencies' members and
participants in the markets they serve.
---------------------------------------------------------------------------
\710\ See supra Part II.C.3 (discussing the full set of
requirements under Rule 17Ad-22(e)(3)).
---------------------------------------------------------------------------
Additionally, the rule extends requirements under Rules 17Ad-
22(d)(4) and 17Ad-22(d)(11) by requiring plans for recovery and orderly
wind-down.\711\ To the extent that covered clearing agencies do not
already have such plans in place, they would incur incremental costs to
develop such plans. Recovery and resolution planning can benefit both
clearing members and, more generally, participants in markets where
products are cleared. Many of the costs and benefits of such plans
depend critically on the specific recovery and wind-down tools that
covered clearing agencies choose to include in their rules. The
presence of such plans could reduce uncertainty over the allocation of
financial losses to clearing members in the event that a covered
clearing agency faces losses due to member default or for other reasons
that exceed its prefunded default resources. Further, recovery and
orderly wind-down plans that detail the circumstances under which
clearing services may be suspended or terminated may mitigate the risk
of market disruption in periods of financial stress. Market
participants who face the possibility that the assets they trade may no
longer be cleared and settled by a CCP may be unwilling to trade such
assets at times when risk sharing is most valuable. While the effects
are difficult to quantify, the Commission believes that recovery and
orderly wind-down plans ensure that a covered clearing agency is able
to remain resilient in times of market stress.
---------------------------------------------------------------------------
\711\ See supra Part II.C.3.b.iii (discussing the requirements
for recovery and orderly wind-down plans under Rule 17Ad-
22(e)(3)(ii)).
---------------------------------------------------------------------------
Based on its supervisory experience, the Commission believes that
all covered clearing agencies have an independent audit committee of
the board. The Commission further believes that most covered clearing
agencies already have policies or procedures that may be relevant to
issues arising in recovery and/or wind-down of clearing operations. As
a result, the benefits and costs associated with these requirements
will likely be limited to incremental changes associated with covered
clearing agencies' review of such policies and procedures and further
development of plans for recovery and orderly wind-down and to
registered clearing agencies that become covered clearing agencies.
iv. Rules 17Ad-22(e)(4) through (7): Financial Risk Management
(1) Rule 17Ad-22(e)(4): Credit Risk
Rule 17Ad-22(e)(4) would establish requirements for credit risk
management by covered clearing agencies.\712\ Based on its supervisory
experience, the Commission believes that all entities that would be
covered clearing agencies are already in compliance with Rules 17Ad-
22(e)(4)(i) through (iv). Pursuant to Rule 17Ad-22(b)(3), registered
clearing agencies that provide CCP services currently maintain
additional financial resources to meet the ``cover one'' requirement,
and registered clearing agencies that would be complex risk profile
clearing agencies under the adopted rules currently maintain financial
resources to meet the ``cover two'' requirement.\713\ All covered
clearing agencies exclude resources that are not prefunded when
calculating this coverage.\714\ As a result, the Commission believes
little or no additional direct costs or benefits will result from these
requirements unless registered clearing agencies were to become covered
clearing agencies and include resources that are not prefunded towards
their resource requirements. The requirement to include only prefunded
resources when calculating the financial resources available to meet
the standards under Rules 17Ad-22(e)(4)(ii) and (iii) potentially
reduces the risk that covered clearing agencies request financial
resources from their members in times of financial stress, when members
are least able to provide these resources.
---------------------------------------------------------------------------
\712\ See supra Part II.C.4 (discussing the full set of
requirements under Rule 17Ad-22(e)(4)).
\713\ The Commission also notes that no covered clearing agency
would be systemically important in multiple jurisdictions unless and
until the Commission made such a determination pursuant to Rule
17Ab2-2. See supra Part II.D (discussing the determinations process
under Rule 17Ab2-2).
\714\ See supra Part III.A.2.d.i (discussing current practices
regarding credit risk management at registered clearing agencies).
---------------------------------------------------------------------------
While requiring ``cover two'' for complex risk profile clearing
agencies and for covered clearing agencies designated systemically
important in multiple jurisdictions would place additional requirements
on the affected clearing agencies, the Commission believes that the
requirement is appropriate because disruption to these entities due to
member default carries relatively higher expected costs than for other
covered clearing agencies. These relatively higher expected costs arise
from the fact that covered clearing agencies designated systemically
important in multiple jurisdictions are exposed to foreign financial
markets and
[[Page 70869]]
may serve as a conduit for the transmission of risk; for complex risk
profile clearing agencies, high expected costs may arise from discrete
jump-to-default price changes in the products they clear and higher
correlations in the default risk of members.\715\
---------------------------------------------------------------------------
\715\ Cf. PFMI, supra note 2, at 43 (discussing Principle 4,
Explanatory Note 3.4.19).
---------------------------------------------------------------------------
Rule 17Ad-22(e)(4)(vi) and (vii) would also impose additional costs
by requiring additional measures to be taken with respect to the
testing of a covered clearing agency's financial resources and model
validation of a covered clearing agency's credit risk models. These
requirements do not currently exist as part of the standards applied to
registered clearing agencies.\716\ Covered clearing agencies may incur
additional costs under expanded and more frequent testing of total
financial resources if the formal requirement that results of monthly
testing be reported to appropriate decision makers is a practice not
currently used by covered clearing agencies. A range of costs for these
new requirements is discussed in Part I.A.1.a.i(5).
---------------------------------------------------------------------------
\716\ Rule 17Ad-22(b)(4) requires a registered clearing agency's
policies and procedures be reasonably designed to provide for an
annual validation of its margin models and the related parameters
and assumptions. See 17 CFR 240.17Ad-22(b)(4).
---------------------------------------------------------------------------
Frequent monitoring and stress testing of total financial
resources, model validations, and reporting of results of the
monitoring and testing to appropriate personnel within the clearing
agency could help rapidly identify any gaps in resources required to
ensure stability, even in scenarios not anticipated on the basis of
historical data. Moreover, the requirement to test and, when necessary,
update the assumptions and parameters supporting models of credit risk
will support the adjustment of covered clearing agency financial
resources to changing financial conditions, and mitigate the risk that
covered clearing agencies will strategically manage updates to their
risk models in support of cost reduction or profit maximization.
The Commission believes that most covered clearing agencies will be
required to update their policies and procedures as a result of Rules
17Ad-22(e)(4)(viii) and (ix). Clearing members may experience benefits
from 17Ad-22(e)(4)(viii), which requires covered clearing agencies to
provide disclosure to members regarding the allocation of default
losses when these losses exceed the level of financial resource it has
available. As a result of this additional transparency, clearing
members may experience an improved ability to manage their expectations
of potential obligations against the covered clearing agency, which may
increase the likelihood of orderly wind-downs in the event of member
default. Crafting such allocation plans by covered clearing agencies
may entail certain compliance costs, as discussed further in Part
III.B.3.d. Further, covered clearing agencies may allocate default
losses in a number of ways that may themselves have implications for
participation, competition, and systemic risk.\717\ For example, if, as
a part of a default resolution plan, selective tear-up is contemplated
after a failed position auction, then clearing members who expect low
loss exposure in the tear-up may not have adequate incentives to
participate in the position auction, even if they are better able to
absorb losses than clearing members who expect high exposure in the
tear-up plan. This would increase the chances of a failed auction and
the chances of a protracted and more disruptive wind-down. Thus, the
total costs of any loss allocation plan may depend largely on the
particular choices embedded in covered clearing agencies' plans.
---------------------------------------------------------------------------
\717\ See, e.g., Elliot, supra note 616 (discussing various
loss-allocation rules and CCP recovery and wind-down).
---------------------------------------------------------------------------
Rule 17Ad-22(e)(4)(ix) contains new provisions related to the
replenishment of financial resources that do not appear in Rule 17Ad-
22(d)(11). The Commission believes that the rules related to
replenishment of financial resources may reduce the potential for
systemic risk and contagion in cleared markets, as they facilitate
covered clearing agencies' prompt access to these resources in times of
financial stress.
(2) Rule 17Ad-22(e)(5): Collateral
Rule 17Ad-22(e)(5) would require a covered clearing agency to have
policies and procedures reasonably designed to limit the assets it
accepts as collateral to those with low credit, liquidity, and market
risks, and to set and enforce appropriately conservative haircuts and
concentration limits. Collateral haircut and concentration limit models
would be subject to a not-less-than-annual review of their
sufficiency.\718\ Rule 17Ad-22(d)(3) currently requires registered
clearing agencies to have policies and procedures reasonably designed
to hold assets in a manner that minimizes risk of loss or risk of delay
in access to them and invest assets in instruments with minimal credit,
market, and liquidity risk.
---------------------------------------------------------------------------
\718\ See supra Part II.C.5 (discussing the full set of
requirements under Rule 17Ad-22(e)(5)).
---------------------------------------------------------------------------
By focusing on the nature of assets and not on accounts, the
Commission believes the adopted rule may allow covered clearing
agencies the ability to manage collateral more efficiently. In
particular, under the adopted rule, a covered clearing agency would
have the option of accepting collateral that is riskier than cash and
holding this collateral at commercial banks, potentially increasing
default risk exposure. On the other hand, the requirement to regularly
review concentration limits and haircuts mitigates the risk that a
covered clearing agency's collateral policies fail to respond to
changing economic conditions. Based on its supervisory experience, the
Commission understands that all registered clearing agencies that would
meet the definition of a covered clearing agency already conform to the
requirements under the adopted rule related to the nature of assets
they may accept as collateral and the haircuts and concentration limits
they apply to collateral assets, so the associated costs and benefits
that would result from these requirements would apply only if
registered clearing agencies not already in compliance were to become
covered clearing agencies.
As a result of the rule, these covered clearing agencies and
registered clearing agencies that become covered clearing agencies may
experience additional costs as a result of the annual review
requirements for the sufficiency of collateral haircut and
concentration limit models. Based on its supervisory experience, the
Commission believes that many clearing agencies that require collateral
would need to develop policies and procedures to review haircuts and
concentration limits annually. Enforcement of the haircut requirement
would also require additional resources. A range of costs for these new
requirements is discussed in Part I.A.1.a.i(5). Adherence to these
requirements by these entrants could extend the benefits of prompt loss
coverage, incentive alignment, and systemic risk mitigation to a larger
volume of cleared transactions.
(3) Rule 17Ad-22(e)(6): Margin
Rule 17Ad-22(e)(6) would require a covered clearing agency that
provides CCP services to have policies and procedures reasonably
designed to require it to cover credit exposures using a risk-based
margin system and to establish minimum standards for such a system. It
would require these policies and procedures to cover daily collection
of variation margin. The rule also
[[Page 70870]]
requires a set of policies and procedures generally designed to support
a reliable margin system. Among these are policies and procedures to
ensure the use of reliable price data sources and appropriate methods
for measuring credit exposure, which could improve margin system
accuracy. Finally, covered clearing agencies would be required to have
policies and procedures related to the testing and verification of
margin models.\719\ Rules 17Ad-22(a)(6) and (14) support these
requirements by addressing the means of verification for margin models
and the level of coverage required of a margin system against potential
future exposures, respectively. Based on its supervisory experience,
however, the Commission understands that all current covered clearing
agencies have policies and procedures that conform to the requirements
under Rules 17Ad-22(e)(6)(i) through (v) and (vii), and some will have
to update their policies and procedures to comply with Rule 17Ad-
22(e)(6)(vi).
---------------------------------------------------------------------------
\719\ See supra Part II.C.6 (discussing the full set of
requirements under Rule 17Ad-22(e)(6)).
---------------------------------------------------------------------------
Similar to Rules 17Ad-22(e)(4) and (7), covered clearing agencies
that do not already engage in backtesting of margin resources at least
once each day or engage in a monthly analysis of assumptions and
parameters, as well as registered clearing agencies that become covered
clearing agencies in the future, may incur incremental compliance costs
as a result of the adopted rule. Since margin plays a key role in
clearing agency risk management, however, requiring that margin be
periodically verified and modified as a result of changing market
conditions may mitigate the risks posed by covered clearing agencies to
financial markets in periods of financial stress. Further, periodic
review of model specification and parameters reduces the likelihood
that covered clearing agencies opportunistically update margin models
in times of low volatility and fail to update margin models in times of
high volatility. A range of costs for verification and modification of
margin models is discussed in Part I.A.1.a.i(5). Further, since risk-
based initial margin requirements may cause market participants to
internalize some of the costs borne by the CCP as a result of large or
risky positions,\720\ ensuring that margin models are well-specified
and correctly calibrated with respect to economic conditions will help
ensure that they continue to align the incentives of clearing members
with the goal of financial stability.
---------------------------------------------------------------------------
\720\ See, e.g., Philipp Haene & Andy Sturm, Optimal Central
Counterparty Risk Management (Swiss Nat'l Bank Working Paper, June
2009) (addressing the tradeoff between margin and default fund,
considering collateral costs, clearing member default probability,
and the extent to which margin requirements are associated with risk
mitigating incentives).
---------------------------------------------------------------------------
(4) Rule 17Ad-22(e)(7): Liquidity Risk
Rule 17Ad-22(e)(7) would require a covered clearing agency to have
policies and procedures reasonably designed to effectively monitor,
measure, and manage liquidity risk.\721\ Parties to securities and
derivatives transactions rely on clearing agencies for prompt clearance
and settlement of transactions. Market participants in centrally
cleared and settled markets are often linked to one another through
intermediation chains in which one party may rely on proceeds from
sales of cleared products to meet payment obligations to another party.
If insufficient liquidity causes a clearing agency to fail to meet
settlement or payment obligations to its members, consequences could
include the default of a clearing member who may be depending on these
funds to make a payment to another market participant, with losses then
transmitted to others that carry exposure to this market participant if
the market participant is depending on payments from the clearing
members to make said payments to others. Therefore, the benefits
related to liquidity risk management generally flow from the reduced
risk of systemic risk transmission by covered clearing agencies as a
result of liquidity shortfalls, either in the normal course of
operation or as a result of member default.
---------------------------------------------------------------------------
\721\ See supra Part II.C.7 (discussing the full set of
requirements under Rule 17Ad-22(e)(7)).
---------------------------------------------------------------------------
Enhanced liquidity risk management may produce additional benefits.
Clearing members would face less uncertainty over whether a covered
clearing agency has the liquidity resources necessary to make prompt
payments which would reduce any need to hedge the risk of nonpayment.
Potential benefits from enhanced liquidity risk management may also
extend beyond members of covered clearing agencies or markets for
centrally cleared and settled securities. Clearing members are often
members of larger financial networks, and the ability of a covered
clearing agency to meet payment obligations to its members can directly
affect its members' ability to meet payment obligations outside of the
cleared market. Thus, management of liquidity risk may mitigate the
risk of contagion between asset markets.
Based on its supervisory experience, the Commission believes that
some covered clearing agencies would need to create new policies and
procedures, or update existing policies and procedures, to meet
requirements under the various subsections of Rule 17Ad-22(e)(7). These
actions would entail compliance costs, as described in Part III.B.3.d.
Further, the Commission believes that for some covered clearing
agencies the adopted requirements would require them to establish new
practices. The cost of adherence to the rule would likely be passed on
to market participants in cleared markets, as discussed in more detail
below.
Under Rule 17Ad-22(e)(7)(i), a covered clearing agency would be
required to have policies and procedures reasonably designed to require
maintaining sufficient resources to achieve ``cover one'' for liquidity
risk. This requirement mirrors the ``cover one'' requirement for credit
risk in Rule 17Ad-22(e)(4)(iii). Based on its supervisory experience,
the Commission believes that many covered clearing agencies do not
currently meet a ``cover one'' requirement for liquidity and thus will
likely incur costs to comply with this rule. As discussed earlier,
whether covered clearing agencies choose to gather liquidity directly
from members or instead choose to rely on third-party arrangements, the
costs of liquidity may be passed on to other market participants,
eventually increasing transaction costs.\722\ The requirement may,
however, reduce the procyclicality of covered clearing agencies'
liquidity demands, which may reduce costs to market participants in
certain situations. For instance, the requirement would reduce the
likelihood that a covered clearing agency would have to call on its
members to contribute additional liquidity in periods of financial
stress, when liquidity may be most costly.
---------------------------------------------------------------------------
\722\ See supra Part III.B.1.d (discussing the effect of the
rules on concentration in the market for clearing services and among
clearing members).
---------------------------------------------------------------------------
Under Rule 17Ad-22(e)(7)(ii), a covered clearing agency would be
required to have policies and procedures reasonably designed to ensure
that it meets the minimum liquidity resource requirement in Rule 17Ad-
22(e)(7)(i) with qualifying liquid resources.\723\ Qualifying liquid
resources would include cash held at the central bank or at a
creditworthy commercial bank, assets that are readily converted into
cash pursuant to committed lines of credit, committed foreign exchange
swaps, committed
[[Page 70871]]
repurchase agreements or other highly reliable prearranged funding
agreements, or assets that may be pledged to a central bank in exchange
for cash (if the covered clearing agency has access to routine credit
at a central bank). The Commission notes that the adopted rules allow
covered clearing agencies some measure of flexibility, subject to their
obligations and responsibilities as SROs under the Exchange Act, to
manage their qualifying liquid resources and that covered clearing
agencies would be able to use creditworthy commercial bank services
where appropriate.
---------------------------------------------------------------------------
\723\ See Rule 17Ad-22(a)(14), infra Part VI (defining
``qualifying liquid resources'').
---------------------------------------------------------------------------
Based on its supervisory experience, the Commission believes that
some covered clearing agencies currently do not meet the liquidity
requirements with qualifying liquid resources. As an alternative to the
adopted rules, the Commission could have restricted the definition of
qualifying liquid resources to assets held by covered clearing
agencies. These covered clearing agencies and the markets they serve
would benefit from the adopted minimum requirements for liquidity
resources in terms of the reduced risk of liquidity shortfalls and
associated contagion risks described above. However, qualifying liquid
resources may be costly for covered clearing agencies to maintain on
their own balance sheets. Such resources carry an opportunity cost.
Assets held as cash are, by definition, not available for investment in
less liquid assets that may be more productive uses of capital. This
cost may ultimately be borne by clearing members who contribute liquid
resources to covered clearing agencies to meet minimum requirements
under Rule 17Ad-22(e)(7)(ii) and their customers.
The Commission notes that, under the adopted rules, covered
clearing agencies have flexibility, subject to their obligations and
responsibilities as SROs under the Exchange Act, to meet their
qualifying liquid resource requirements in a number of ways. In perfect
capital markets, maintaining on-balance-sheet liquidity resources
should be no more costly than entering into committed lines of credit
or prearranged funding agreements backed by less-liquid assets that
would allow these assets to be converted into cash. However, market
frictions, such as search frictions, may enable banks to obtain
liquidity at lower cost than other firms. In the presence of such
frictions, obtaining liquidity using committed and uncommitted funding
arrangements provided by banks may prove a less costly option for some
covered clearing agencies than holding additional liquid resources on
their balance sheets. In particular, the Commission believes that
requiring covered clearing agencies to enter into committed or
uncommitted funding arrangements would decrease the costs that would be
experienced by them in the event they sought to liquidate securities
holdings during periods of market disruptions and increase the
likelihood that they meet funding obligations to market participants by
reducing the risk of delay in converting non-cash assets into cash.
The Commission notes that committed or uncommitted funding
arrangements would only count towards minimum requirements to the
extent that covered clearing agencies had securities available to post
as collateral, so use of these facilities may require covered clearing
agencies to require their members to contribute more securities. If
these securities are costly for clearing members to supply, then
additional required contributions to meet minimum requirements under
Rule 17Ad-22(e)(7)(ii) may impose costs on clearing members and their
customers. Similarly, prearranged funding arrangements may entail
implicit costs to clearing members. Prearranged funding arrangements
could impose costs on clearing members if they are obligated to
contribute securities towards a collateral pool that the covered
clearing agency would use to back borrowing. Alternatively, clearing
members may be obligated under a covered clearing agency's rules to act
as counterparties to repurchase agreements. Under the latter scenario,
clearing members would bear costs associated with accepting securities
in lieu of cash. Additionally, the Commission notes certain explicit
costs specifically associated with these arrangements outlined below.
Counterparties to committed arrangements allowable under Rule 17Ad-
22(a)(14) charge covered clearing agencies a premium to provide firm
liquidity commitments and additional out-of-pocket expenses will be
incurred establishing and maintaining committed liquidity arrangements.
The Commission estimates that the total cost of committed funding
arrangements will be approximately 30 basis points per year, including
upfront fees, legal fees, commitment fees, and collateral agent
fees.\724\ Furthermore, the Commission is aware of other potential
consequences of these arrangements. In some instances, they may cause
entities outside of a covered clearing agency to bear risks ordinarily
concentrated within the covered clearing agency, while, in others,
these arrangements may result in increased exposure of covered clearing
agencies to certain members.\725\ Financial intermediaries that
participate in committed credit facilities may be those least able to
provide liquidity in times of financial stress, so these commitments
may represent a route for risk transmission.\726\ Finally, the
Commission notes that covered clearing agencies may face constraints in
the size of credit facilities available to them. Recent market
statistics have estimated the total size of the committed credit
facility market in the U.S. at $2.3 trillion with 15 of 3,740
facilities exceeding $10 billion in size.\727\ Given the volume of
activity at covered clearing agencies, it is possible that they may
only be able to use committed credit facilities to meet a portion of
their liquidity requirements under Rule 17Ad-22(e)(7)(ii).
---------------------------------------------------------------------------
\724\ See Letter from Kim Taylor, President, CME Clearing, to
Melissa Jurgens, Office of the Secretariat, CFTC (Sept. 16, 2013),
at 13 & n.48 (noting CME's assumption that the cost of committed
liquidity or committed repurchase facilities is approximately $3
million for every $1 billion of required committed facilities,
including upfront fees, commitment fees, legal fees, and collateral
agent fees).
\725\ See id. at 11.
\726\ See Letter from Robert C. Pickel, CEO, ISDA to Secretary,
CFTC (Sept. 16, 2013), at 4 (discussing collateral and liquidity
requirements); see also Craig Pirrong, Clearing and Collateral
Mandates: A New Liquidity Trap?, 24 J. Applied Corp. Fin. 67 (2012).
\727\ These estimates are based on the number of deals issued in
2015 as reported by the DealScan database from Thomson Reuters
Markets LLC. Suspended and cancelled deals were omitted. U.S. deals
were defined based on the country of the borrower's principal
executive offices, as reported in DealScan, due to data
availability. In cases of multiple facilities within the deal, the
loan deal date is the earliest facility date. Estimates for
corporate borrowers refer to non-financial private sector borrowers.
---------------------------------------------------------------------------
A covered clearing agency may alternatively use a prearranged
funding arrangement determined to be highly reliable in extreme but
plausible market conditions to raise liquid resources backed by non-
cash assets but that does not require firm commitments from liquidity
providers. This strategy would avoid certain of the explicit fees
associated with firm commitments, while incurring costs related to the
annual review and maintenance of such arrangements. Based on its
supervisory experience and discussions with market participants, the
Commission believes the cost associated with commitment fees to be
between 5 and 15 basis points per year. Given the 30 basis point cost
associated with committed funding arrangements, mentioned above,
uncommitted facilities could entail
[[Page 70872]]
costs of between 15 and 25 basis points.\728\ Prearranged funding
arrangements may ultimately prove less costly than holding cash and may
be more widely available than committed arrangements, while still
reducing the likelihood of delay faced by covered clearing agencies
that attempt to market less-liquid assets. As mentioned above in the
context of committed credit facilities, the Commission acknowledges
that financial institutions who offer to provide liquidity to covered
clearing agencies on an uncommitted basis may be least able to do so in
times of financial stress, when access to liquidity is most needed by
the covered clearing agency. Without a commitment in place,
counterparties retain the option to fail to provide liquidity during
stressed conditions, when liquidity is most valuable to clearing
agencies and the markets they serve. To the extent covered clearing
agencies may establish requirements for clearing members to provide
liquidity to ensure compliance with the Commission's adopted rules, the
costs experienced by members indirectly may exceed those associated
with committed credit facilities.
---------------------------------------------------------------------------
\728\ Subtracting the lower bound of commitment fees (5 basis
points) from the estimated total cost of a committed facility (30
basis points) yields an estimate of the upper bound of the fees
associated with an uncommitted facility (30-5 = 25 basis points). We
estimate the lower bound of fees associated with an uncommitted
facility analogously (30-15 = 15 basis points).
---------------------------------------------------------------------------
Finally, covered clearing agencies that have access to routine
credit at a central bank could meet the qualifying liquid resources
requirement with assets that are pledgeable to a central bank, if that
jurisdiction permits such pledges or the transactions by the covered
clearing agency. The Commission notes that this may represent the
lowest cost option for covered clearing agencies, but understands that
this latter provision would represent an advantage only if and when a
covered clearing agency receives the benefit of access to routine
central bank borrowing. The Commission anticipates that at such future
time access to routine credit at a central bank would provide covered
clearing agencies with additional flexibility, subject to their
obligations and responsibilities as SROs under the Exchange Act, with
respect to resources used to comply with the liquidity risk management
requirements of Rules 17Ad-22(e)(7)(i) and (ii).
The total cost of maintaining qualifying liquid resources pursuant
to Rules 17Ad-22(e)(7)(i) and (ii) is composed of the cost of each
liquidity source including assets held by covered clearing agencies,
committed credit facilities and prearranged funding agreements,
multiplied by the quantity of each of these liquidity sources held by
covered clearing agencies. The Commission is unable to quantify the
cost of cash held by clearing agencies and securities required to back
credit facilities since such estimates would require detailed
information about additional required contributions of clearing members
under the adopted rules, as well as clearing members' best alternative
to holding cash and securities.\729\ As mentioned above, however, the
Commission has limited information about the costs associated with
committed and uncommitted credit facilities. Based on this information,
we are able to quantify the costs associated with committed credit
facilities that will result from the requirement to maintain qualifying
liquid resources. The Commission estimates that the cost of compliance
with the adopted rules will be between $122 million and $204 million
per year as a result of the requirement to enter into prearranged
funding agreements for non-cash assets used to meet liquidity
requirements under Rules 17Ad-22(e)(7)(i) and (ii). This analysis
assumes that covered clearing agencies will enter into such agreements
at arm's length on an uncommitted basis. Based on staff discussions
with market participants, the Commission understands that alternative
arrangements between covered clearing agencies and their members may be
obtained at lower cost, though these arrangements may come with
increased wrong-way risk.\730\
---------------------------------------------------------------------------
\729\ Covered clearing agencies may choose to allocate the costs
associated with increased liquidity requirements based on a number
of factors related to the markets they serve and their membership.
See, e.g., Exchange Act Release No. 34-70999 (Dec. 5, 2013), 78 FR
75400 (Dec. 11, 2013) (Commission order approving NSCC rule change
to institute supplemental liquidity deposits to its clearing fund
designed to increase liquidity resources to meet its liquidity
needs).
\730\ To produce this range, the Commission used a combination
of publicly available information from SRO rule filings, comment
letters, and 2015 annual financial statements, and non-public
information gathered as a result of its regulatory role. For each
covered clearing agency, the Commission assumed that the covered
clearing agency's guaranty fund represents the sole source of
liquidity used to satisfy its minimum liquidity requirements under
the adopted rules. To compute the level of qualifying liquid
resources currently held by each covered clearing agency, the
Commission assumed that cash in the covered clearing agency's
guaranty fund remains fixed at current levels and added to this any
amount from credit facilities that could be backed by the value of
securities held in the covered clearing agency's guaranty funds.
Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
the ``cover one'' guaranty fund requirement over all covered
clearing agencies results in the total shortfall relative to minimum
requirements under Rules 17Ad-22(e)(7)(i) and (ii). The Commission
further assumed that covered clearing agencies would cover this
shortfall using prearranged funding agreements backed by additional
securities posted to guaranty funds by clearing members. Finally,
the Commission multiplied the total prearranged funding amount by
between 0.15% and 0.25% to arrive at a range of ongoing costs.
This range estimate has been updated since the proposal. While
it relies on the same methodology, this estimate relies on more
recent financial information from covered clearing agencies. Cf. CCA
Standards proposing release, supra note 5, at 29600.
---------------------------------------------------------------------------
U.S. Treasury securities would not fall under the definition of
qualifying liquid resources. The Commission understands that U.S.
Treasury markets represent some of the largest and most liquid markets
in the world, see Part III.A.2.k, and that, in ``flights to quality''
and ``flights to liquidity'' in times of financial stress, U.S.
Treasuries trade at a premium to other assets.\731\ If, as an
alternative to the adopted rules, the Commission included U.S.
government securities in the definition of qualifying liquid resources,
the Commission estimates the cost of complying with requirements under
Rule 17Ad-22(e)(7)(i) and (ii) would be reduced by between $32 million
and $204 million per year.\732\ The Commission believes,
[[Page 70873]]
however, that there are benefits to including government securities
only if prearranged funding agreements exist. In particular, given the
quantity of these securities financed by the largest individual
dealers, fire-sale conditions could materialize if collateral is
liquidated in a disorderly manner, which could prevent covered clearing
agencies from meeting payment obligations.\733\
---------------------------------------------------------------------------
\731\ See Alessandro Beber, Michael W. Brandt & Kenneth A.
Kavajecz, Flight-to-Quality or Flight-to-Liquidity? Evidence from
the Euro-Area Bond Market, 22 Rev. Fin. Stud. 925 (2009)
(decomposing sovereign yield spreads into credit and liquidity
components and showing that credit quality matters for bond
valuation but that, in times of market stress, investors chase
liquidity, not quality); Markus K. Brunnermeier & Lasse Heje
Pedersen, Market Liquidity and Funding Liquidity, 22 Rev. Fin. Stud.
2201 (2009) (showing, in a theoretical model, how with low wealth
shocks, demand for illiquid assets falls off more sharply than
demand for liquid assets); Francis A. Longstaff, The Flight-to-
Liquidity Premium in U.S. Treasury Bond Prices, 77 J. Bus 511 (2004)
(estimating the liquidity premium associated with U.S. Treasuries
relative to close substitutes); Dimitri Vayanos Flight to Quality,
Flight to Liquidity, and the Pricing of Risk (NBER Working Paper No.
10327, Feb. 2004) (showing, in a theoretical model, that during
volatile times, assets' liquidity premia increase), available at
http://www.nber.org/papers/w10327.pdf.
\732\ The Commission re-estimated the level of prearranged
funding agreements required to meet requirements under Rules 17Ad-
22(e)(7)(i) and (ii) using the data and methodology described in
note 730, except in this case the Commission assumed that all non-
defaulting member resources applied to funding obligations were a
mix of cash and U.S. Treasuries for a lower bound, and assumed that
all resources applied to funding obligations were a mix of cash and
U.S. Treasuries for an upper bound.
Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
cover one guaranty fund requirement over all covered clearing
agencies results in the total shortfall relative to minimum
requirements under Rules 17Ad-22(e)(7)(i) and (ii) if U.S.
government and agency securities were considered qualifying liquid
resources. As above, the Commission further assumed that covered
clearing agencies would cover this shortfall using prearranged
funding agreements backed by additional securities posted to
guaranty funds by clearing members and multiplied this amount by
between 0.15% and 0.25% to arrive at a range of ongoing costs.
As above, this range estimate has been updated since the
proposal. While it relies on the same methodology, this estimate
relies on more recent financial information from covered clearing
agencies. Cf. CCA Standards proposing release, supra note 5, at
29601.
\733\ See Brian Begalle et al., The Risk of Fire Sales in the
Tri-Party Repo Market, at 19 & n.37 (FRBNY Staff Report No. 616, May
2013), available at http://www.newyorkfed.org/research/staff_reports/sr616.pdf.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(7)(iii) requires a covered clearing agency to
establish implement, maintain and enforce written policies and
procedures reasonably designed to ensure it uses accounts and services
at a Federal Reserve Bank or other relevant central bank, when
available and where determined to be practical by the board of
directors, to enhance its management of liquidity risk.\734\ The
Commission believes that it may be beneficial for covered clearing
agencies to use central bank account services because doing so would
reduce exposure to commercial bank default risk. Moreover, for some
covered clearing agencies, central bank services may represent the
lowest-cost admissible funding arrangement under the adopted rule. The
Commission understands, however, that central bank services may not be
practical because direct access to central bank accounts and services
may not be available to all clearing agencies or members in all
circumstances.
---------------------------------------------------------------------------
\734\ See Rule 17Ad-22(e)(7)(iii), infra Part VI.
---------------------------------------------------------------------------
Rules 17Ad-22(e)(7)(iv) and (v) address relations between covered
clearing agencies and their liquidity providers. The Commission
believes that a key benefit of these adopted rules would be an
increased level of assurance that liquidity providers would be able to
supply liquidity to covered clearing agencies on demand. Such assurance
is especially important because of the possibility that covered
clearing agencies may rely on outside liquidity providers to convert
non-cash assets into cash using prearranged funding arrangements or
committed facilities, pursuant to Rule 17Ad-22(e)(7)(ii) and the
definition of qualifying liquid resources in Rule 17Ad-22(a)(14). The
required policies and procedures would ensure the covered clearing
agency undertakes due diligence to confirm that it has a reasonable
basis to believe each of its liquidity providers understand the
liquidity risk borne by the liquidity provider, and that the liquidity
provider would have the capacity to provide liquidity under commitments
to the covered clearing agency. Finally, covered clearing agencies
would be required, under the adopted rule, to maintain and test the
covered clearing agency's procedures and operational capacity for
accessing liquidity under their agreements. The Commission believes
that, besides the costs associated with new or updated policies and
procedures discussed in Part IV.C, covered clearing agencies and
liquidity providers may experience costs associated with the adopted
rules as a result of the requirement to test liquidity resources, such
as, for example, fees associated with conducting test draws on a
covered clearing agency's credit lines. Costs associated with ongoing
monitoring and compliance related to testing are included in the
Commission's estimate of quantifiable costs presented in Part
III.B.3.d.
Rules 17Ad-22(e)(7)(vi) and (vii) may impose costs on covered
clearing agencies as a result of requirements for testing the
sufficiency of liquidity resources and validating models used to
measure liquidity risk. The testing and model validation requirements
of these adopted rules are similar to requirements for testing and
model validation for credit risk in Rules 17Ad-22(e)(4)(vi) and (vii),
and the Commission believes that these adopted rules would yield
similar benefits. Frequent monitoring and testing liquidity resources
could help rapidly identify any gaps in resources required to meet
payment obligations. Moreover, the requirement to test and, when
necessary, update the assumptions and parameters supporting models of
liquidity risk will support the adjustment of covered clearing agency
liquidity resources to changing financial conditions and mitigate the
risk that covered clearing agencies will strategically manage updates
to their liquidity risk models in support of cost-reduction or profit-
maximization.
Rule 17Ad-22(e)(7)(viii) addresses liquidity shortfalls at a
covered clearing agency, and the Commission believes the adopted rule
would reduce ambiguity related to settlement delays in the event of
liquidity shocks. Among other things, by requiring procedures that seek
to avoid delay of settlement payments, this adopted rule would require
covered clearing agencies to address liquidity concerns in advance
rather than relying on strategies of delaying accounts payable in the
event of liquidity shocks. As discussed previously, effective liquidity
risk management by covered clearing agencies that serves to eliminate
uncertainty on the part of clearing members that payments by the
covered clearing agency will be made on time may allow these clearing
members to allocate their liquidity resources to more efficient uses
than holding precautionary reserves.\735\ The Commission believes the
rule may reduce some of the flexibility covered clearing agencies have
in the absence of the rule, which could impose additional costs on
these clearing agencies as discussed in Part III.B.1.b.
---------------------------------------------------------------------------
\735\ See supra Part III.B.2.b.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(7)(ix) would require a covered clearing agency to
have policies and procedures reasonably designed to describe its
process for replenishing any liquid resources that it may employ during
a stress event.\736\ The ability to replenish liquidity resources is
critical to ensure that covered clearing agencies are able to continue
operations after a stress event. Beyond the general benefits associated
with liquidity risk management noted earlier, this adopted rule would
yield particular benefits insofar as it would reduce uncertainty about
covered clearing agency liquidity resources at precisely those times
when information about liquidity may be most important to market
participants.
---------------------------------------------------------------------------
\736\ See Rule 17Ad-22(e)(7)(ix), infra Part VI.
---------------------------------------------------------------------------
Finally, Rule 17Ad-22(e)(7)(x) would require a covered clearing
agency that provides CCP services and is either systemically important
in multiple jurisdictions or is a clearing agency involved in
activities with a more complex risk profile to conduct a feasibility
analysis for ``cover two.'' \737\ The primary cost associated with this
rule will be an annual analysis by the affected covered clearing
agencies. Costs associated with a feasibility study would likely
include the cost of staffing and consulting, which will depend on the
scope of products cleared and the particular approach taken by each
covered clearing agencies. The costs associated with this requirement
are included in Part III.B.3.d.
---------------------------------------------------------------------------
\737\ See Rule 17Ad-22(e)(7)(x), infra Part VI.
---------------------------------------------------------------------------
[[Page 70874]]
(5) Testing and Validation of Risk Models
Rules 17Ad-22(e)(4) through (7) include requirements for covered
clearing agencies to have policies and procedures reasonably designed
to test and validate models related to financial risks. Covered
clearing agencies may incur additional costs under expanded and more
frequent testing of financial resources if the requirements for testing
and validation do not conform to practices currently used by covered
clearing agencies.\738\ These costs are composed of two portions. The
first encompasses startup costs related to collection and storage of
data elements necessary to implement testing and validation, along with
investments in software tools and human capital to support these
functions. The second portion of costs includes the ongoing, annual
costs of conducting testing and validation under the adopted rules.
---------------------------------------------------------------------------
\738\ The Commission notes that while the stress testing
provisions in Rules 17Ad-22(e)(4) through (7) include new
requirements for covered clearing agencies, Rule 17Ad-22(b)(4)
requires registered clearing agencies that provide CCP services for
security-based swaps to have policies and procedures for a general
margin model validation requirement. See supra note 716.
---------------------------------------------------------------------------
Based on its supervisory experience and discussions with industry
participants, the Commission believes that startup costs to support
testing and validation of credit risk, margin, and liquidity risk
models at covered clearing agencies could fall in the range of $5
million to $25 million for each covered clearing agency. This range
primarily reflects investments in information technology to process
data already available to covered clearing agencies for stress testing
and validation purposes. The range's width reflects differences in
markets served by, as well as the scope of operations of, each covered
clearing agency. Based on its supervisory experience and discussions
with industry participants, the Commission estimates a lower bound of
$1 million per year for ongoing costs related to testing of risk
models.
Should each covered clearing agency choose to hire external
consultants for the purposes of performing model validation required
under Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) through written policies
and procedures, the Commission estimates the ongoing cost associated
with hiring such consultants would be approximately $4,509,120 in the
aggregate.\739\
---------------------------------------------------------------------------
\739\ This figure was calculated as follows: 2 Consultants for
40 hours per week at $653 per hour = $52,240 x 12 weeks = $644,160
per clearing agency x 7 covered clearing agencies = $4,509,120. The
$671 per hour figure for a consultant was calculated using
www.payscale.com, modified by Commission staff to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits, and overhead.
The Commission previously estimated that ongoing costs
associated with hiring external consultants to fulfill the
requirements of Rule 17Ad-22(b)(4) would be approximately $3.9
million per year. See Clearing Agency Standards adopting release,
supra note 5, at 66261.
---------------------------------------------------------------------------
The Commission acknowledges that it could have, as an alternative,
rules that would require testing and validation of financial risk
models at covered clearing agencies at different frequencies. For
example, the Commission could have required backtesting of margin
resources less frequently than daily. Such a policy could imply less
frequent adjustments in margin levels that may result in over- or
under-margining. The Commission believes that the frequencies of
testing and validation of financial risk models that it has adopted are
appropriate given the risks faced by covered clearing agencies and
current market practices related to frequency of meetings of risk
management committees and boards of directors at covered clearing
agencies.
v. Rules 17Ad-22(e)(8) Through (10): Settlement and Physical Delivery
Rules 17Ad-22(e)(8) through (10) require covered clearing agencies
to have policies and procedures reasonably designed to address
settlement risk. Many of the issues raised by settlement are similar to
those raised by liquidity. Uncertainty in settlement may make it
difficult for clearing members to fulfill their obligations to other
market participants within their respective financial networks if they
hold back precautionary reserves, as discussed above. Based on its
supervisory experience, the Commission believes that the benefits and
costs for the majority of covered clearing agencies will likely be
limited. Registered clearing agencies that become covered clearing
agencies in the future, by contrast, may bear more significant costs as
a result of the enhanced standards.
Settlement finality is important to market participants for a
number of reasons. Reversal of transactions can be costly to
participants. For example, if transactions are reversed, buyers and
sellers of securities may be exposed to additional market risk as they
attempt to reestablish desired positions in cleared products.
Similarly, reversal of transactions may render participants expecting
to receive payment from the covered clearing agency unable to fulfill
payment obligations to their counterparties, exposing these additional
parties to the transmitted credit risk. Finally, settlement finality
can help facilitate default management procedures by covered clearing
agencies since they improve transparency of members' positions. Unless
settlement finality is established by covered clearing agencies, market
participants may attempt to hedge reversal risk for themselves. This
could come at the cost of efficiency if it means that, on the margin,
participants are less likely to use cleared products as collateral in
other financial transactions.
In addition, settlement in central bank money, where available and
determined to be practical by the board of directors of the covered
clearing agency, as the adopted rules would require, greatly reduces
settlement risk related to payment agents. Using central bank accounts
to effect settlement rather than settlement banks removes a link from
the intermediation chain associated with clearance and settlement. As a
result, a covered clearing agency would be less exposed to the default
risk of its settlement banks. In cases where settlement banks maintain
links to other covered clearing agencies, for example as liquidity
providers or as members, reducing exposure to settlement bank default
risk may be particularly valuable.
As in the case of Rule 17Ad-22(e)(7)(iii), the Commission
acknowledges there may be circumstances where it is appropriate for
covered clearing agencies to use commercial banks for conducting money
settlements even when comparable services are available from a central
bank. Accordingly, the Commission believes it is appropriate to allow
covered clearing agencies flexibility, subject to their obligations and
responsibilities as SROs under the Exchange Act, to also use commercial
bank account services to effect settlement, subject to a requirement
that covered clearing agencies monitor and manage the risks associated
with such arrangements.
vi. Rule 17Ad-22(e)(11): CSDs
CSDs play a key role in modern financial markets. For many issuers,
many transactions in their securities involve no transfer of physical
certificates.
Paperless trade generally improves transactional efficiency. Book-
entry transfer of securities may facilitate conditional settlement
systems required by Rule 17Ad-22(e)(12). For example, book-entry
transfer in a delivery versus payment system allows securities to be
credited to an account immediately upon debiting the account for the
payment amount. Institutions and individuals may elect to no longer
hold and exchange certificates that represent
[[Page 70875]]
their ownership of securities. An early study showed that the creation
of DTC resulted in a 30-35% reduction in the physical movement of
certificates.\740\ Among other benefits, to the extent that delays in
exchanging paper certificates result in settlement failures,
immobilization and dematerialization of shares reduces the frequency of
these failures.\741\
---------------------------------------------------------------------------
\740\ See Neal L. Wolkoff & Jason B. Werner, The History of
Regulation of Clearing in the Securities and Futures Markets, and
Its Impact on Competition, 30 Rev. Banking & Fin. L. 313, 323
(2010).
\741\ See Commission, Study of Unsafe and Unsound Practices of
Brokers and Dealers, H.R. Doc. No. 231, 92nd Cong., 1st Sess. 13, at
168 (1971) (suggesting that the delivery and transfer process for
paper certificates were a principal cause of failures to deliver and
receive during the ``paperwork crisis'' of the late 1960s).
---------------------------------------------------------------------------
For markets to realize the transactional benefits of paperless
trade, however, requires confidence that CSDs can correctly account for
the number of securities in their custody and for the book entries that
allocate these securities across participant accounts. To realize these
benefits, the rules also require covered CSDs to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to ensure the integrity of securities issues, minimize the
risks associated with transfer of securities, and protect assets
against custody risk. Based on its supervisory experience, the
Commission believes that registered CSDs already have infrastructure in
place to meet these requirements. However, CSDs may face incremental
compliance costs in instances where they must modify their rules to
implement appropriate controls. Compliance costs may be higher for
potential new CSDs that are determined to be covered clearing agencies
in the future.
vii. Rule 17Ad
22(e)(12): Exchange-of-Value Settlement Systems
Clearance and settlement of transactions between two parties to a
trade involves an exchange of one obligation for another. Regarding
transactions in securities, these claims can be securities or payments
for securities. A particular risk associated with transactions is
principal risk, which is the risk that only one obligation is
successfully transferred between counterparties. For example, in a
purchase of common stock, a party faces principal risk if, despite
successfully paying the counterparty for the purchase, the counterparty
may fail to deliver the shares.
The adopted requirements under Rule 17Ad-22(e)(12) are
substantially the same as those in Rule 17Ad-22(d)(13).\742\ As a
result, covered clearing agencies that have been in compliance with
Rule 17Ad-22(d)(13) face no substantially new requirements under Rule
17Ad-22(e)(12). The Commission expects the adopted rule would likely
impose limited material additional costs on covered clearing agencies.
It would also produce benefits in line with the general economic
considerations discussed in Part III.B.1. The economic effects may
differ for registered clearing agencies that become covered clearing
agencies in the future.
---------------------------------------------------------------------------
\742\ See supra Part II.C.13 (discussing the full set of
requirements under Rule 17Ad-22(e)(13)); supra Part III.A.2.g
(discussing current practices among registered clearing agencies
regarding exchange-of-value settlement systems); see also 17 CFR
240.17Ad-22(d)(13).
---------------------------------------------------------------------------
viii. Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures
Rule 17Ad-22(e)(13) requires covered clearing agencies to have
policies and procedures for participant default with additional
specificity relative to current requirements for registered clearing
agencies under Rule 17Ad-22(d)(11). In particular, Rule 17Ad-22(e)(13)
requires policies and procedures that address the testing and review of
default procedures.
Based on its supervisory experience, the Commission believes all
covered clearing agencies currently test and review default procedures
at least annually, so the costs of this requirement would apply only to
registered clearing agencies that may become covered clearing agencies
in the future. The Commission also believes that broad-based
participation in the testing of default procedures could reduce
disruption to cleared markets in the event of default. However, to the
extent that testing of these procedures requires participation by
members of covered clearing agencies, members' customers, and other
stakeholders, these parties may bear costs under the rules. The
Commission is unable to quantify the economic effects of participation
in these tests at this time.
As an alternative to the rules, the Commission could have adopted
more prescriptive requirements for default procedures at covered
clearing agencies. The Commission believes that differences in cleared
assets and in the characteristics of clearing members supports allowing
each covered clearing agency flexibility, subject to its obligations
and responsibilities as an SRO under the Exchange Act, to determine its
own default procedures pursuant to Rule 17Ad-22(e)(13).
ix. Rule 17Ad-22(e)(14): Segregation and Portability
Rule 17Ad-22(e)(14) applies only to a covered clearing agency that
is either a security-based swap clearing agency or a complex risk
profile clearing agency. It requires such a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to enable the segregation and
portability of positions of a participant's customers and the
collateral provided to the covered clearing agency with respect to
those positions, and effectively protect such positions and related
collateral from the default or insolvency of that participant.\743\
---------------------------------------------------------------------------
\743\ See supra Part II.B.14.a (discussing applicability of Rule
17Ad-22(e)(14) and the existing rules for the cash securities and
listed options markets applicable to broker-dealers which already
promote segregation and portability to protect customer positions
and funds in those markets).
---------------------------------------------------------------------------
Segregation and portability of customer positions serves a number
of useful purposes in certain cleared markets. In the normal course of
business, the ability to efficiently identify and move an individual
customer's positions and collateral between clearing members enables
customers to easily terminate a relationship with one clearing member
and initiate a relationship with another. This may facilitate
competition between clearing members by ensuring customers are free to
move their accounts from one clearing member to another based on their
preferences, without being unduly limited by operational barriers.\744\
---------------------------------------------------------------------------
\744\ See, e.g., Paul Klemperer, Competition When Consumers Have
Switching Costs: An Overview with Applications to Industrial
Organization, Macroeconomics, and International Trade, 62 Rev. Econ.
Stud. 515 (1995) (presenting an overview of switching costs and
their effects on competition).
---------------------------------------------------------------------------
Segregation and portability may be especially important in the
event of participant default. By requiring that customer collateral and
positions remain segregated, covered clearing agencies can facilitate,
in the event of a clearing member's insolvency, the recovery of
customer collateral and the movement of customer positions to one or
more other clearing members. Further, portability of customer positions
may facilitate the orderly wind down of a defaulting member if customer
positions may be moved to a non-defaulting member. Porting of positions
in a default scenario may yield benefits for customers if the
alternative is closing-out positions at one clearing
[[Page 70876]]
member and reestablishing them at another clearing member. The latter
strategy would cause customers to bear transactions costs, which might
be especially high in times of financial stress.
The Commission notes that, in its view, for those clearing agencies
to which Rule 17Ad-22(e)(14) applies, these adopted rules are flexible
in their approach to implementing segregation and portability
requirements. The most efficient means of implementing these
requirements may depend on the products that a covered clearing agency
clears as well as other business practices at a covered clearing
agency. For example, a clearing agency's decision whether or not to
collect margin on a gross or net basis may bear on its decision to port
customer positions and collateral on an individual or omnibus basis,
and while an individual account structure may provide a higher degree
of protection from a default by another customer, it may be
operationally and resource intensive for a covered clearing to
implement and may reduce the efficiency of its operations. Moreover,
some clearing agencies may already employ the LSOC model for
segregation and portability of customer positions in security-based
swaps because of existing CFTC requirements for swaps.
As a result, the costs and benefits of Rule 17Ad-22(e)(14) will
depend on specific rules implemented by covered clearing agencies as
well as how much these rules differ from current practice. Based on its
supervisory experience, the Commission believes that the current
practices at covered clearing agencies to which the rule would apply
already meet segregation requirements under the rule, so any costs and
benefits for covered clearing agencies would flow from implementing
portability requirements, though the rule potentially raises a barrier
to entry for security-based swap clearing agencies or clearing agencies
involved in activities with a more complex risk profile that seek to
become covered clearing agencies.
x. Rule 17Ad-22(e)(15): General Business Risk
While Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) require that covered
clearing agencies have policies and procedures reasonably designed to
address credit risk and liquidity risk, Rule 17Ad-22(e)(15) requires
that covered clearing agencies have policies and procedures reasonably
designed to address general business risk. The Commission believes that
general business losses experienced by covered clearing agencies
represent a distinct risk to cleared markets, given limited competition
and specialization of clearing agencies. In this regard, the loss of
clearing services due to general business losses would likely result in
major market disruption. The rule requires a covered clearing agency to
have policies and procedures reasonably designed to mitigate the risk
that business losses result in the disruption of clearing services.
Under these policies and procedures covered clearing agencies would
hold sufficient liquid resources funded by equity to cover potential
general business losses, which at a minimum would constitute six months
of operating expenses. The Commission believes that the benefits of
such policies and procedures would flow primarily from covered clearing
agencies that would be required to increase their holdings of liquid
net assets funded by equity, enabling them to sustain their operations
for sufficient time and achieve orderly wind-down if such action is
eventually necessary.
The Commission could have adopted a higher or lower minimum level
of resources, for example, corresponding to one quarter of operating
expenses or one year of operating expenses. The Commission believes,
however, that the rules, as adopted, afford covered clearing agencies
sufficient flexibility, subject to their obligations and
responsibilities as SROs under the Exchange Act, to determine the level
of resources to hold while maintaining a minimum standard that supports
continued operations in the event of general business losses. As
another alternative, the Commission could have allowed covered clearing
agencies additional flexibility to determine the nature of the
financial resources held to mitigate the effects of general business
risk or the means by which these resources are funded. The Commission
believes, however, that by specifying that these resources be liquid in
nature, the rule would limit any delays by covered clearing agencies
that suffer business losses from paying expenses required for continued
operations. Additionally, by specifically requiring that a covered
clearing agency draw liquid net resources from members as equity
capital, the rules may also encourage members to more closely monitor
the business operations of a covered clearing agency, which may reduce
the likelihood of losses.
Based on its supervisory experience, the Commission believes that
certain covered clearing agencies would be required to establish and
maintain policies and procedures providing for specified levels of
equity capital and higher levels of liquid net assets as a result of
Rule 17Ad-22(e)(15).\745\ However, the Commission believes that based
on current market practices, covered clearing agencies may not bear
substantial costs to implement these policies and procedures. Table 2
contains summary information from five registered clearing agencies
obtained from quantitative disclosures made by these registered
clearing agencies pursuant to the PFMI.\746\ These disclosures suggest
that all five of these registered clearing agencies each currently hold
more net liquid assets funded by equity than would be required to cover
six months of operating expenses. While similar quantitative
disclosures are not currently published by DTC, DTC does publish an
annual disclosure framework pursuant to the PFMI,\747\ which states
that as of June 30, 2014, DTC maintained liquid net assets funded by
equity in an amount exceeding six months of its projected operating
expenses.\748\ This analysis suggests that based on available
information about liquid net assets funded by equity operating
expenses, covered clearing agencies would not be required to raise
additional equity capital to implement these policies and procedures
with respect to net liquid assets.
---------------------------------------------------------------------------
\745\ Additional equity capital may be raised through share
issuance or by retaining earnings.
\746\ See supra note 41.
\747\ See id.
\748\ See The Depository Trust Company Disclosure under the
Principles for Financial Market Infrastructures (Dec. 2015), at 80,
available at http://www.dtcc.com/legal/policy-and-compliance.
Table 2--Net Liquid Assets Funded by Equity and Operating Expenses at Registered Clearing Agencies \749\
----------------------------------------------------------------------------------------------------------------
FICC ICC ICEEU NSCC OCC
----------------------------------------------------------------------------------------------------------------
Value of liquid net assets funded by equity.............. 214 53 358 321 247
[[Page 70877]]
Six months of current operating expenses................. 77 23 138 144 243
----------------------------------------------------------------------------------------------------------------
However, the Commission acknowledges that policies and procedure
adopted by covered clearing agencies pursuant to Rule 17Ad-22(e)(15)
may nevertheless result in certain costs for covered clearing agencies.
First, covered clearing agencies would incur ongoing costs to
implement, maintain, and enforce policies and procedures under Rule
17Ad-22(e)(15). To the extent that maintenance and enforcement of these
policies and procedures indicate that additional capital is required to
manage a covered clearing agency's general business risks, it may
determine that it needs to increase liquid net assets. Second, as a
result of these new policies and procedures, covered clearing agencies
will have less control over their capital structures, as by
implementing these policies and procedures they would be compelled to
maintain a certain minimum level of liquid net assets despite the
availability of new, less liquid, investment opportunities. Absent
market frictions, such a change in capital structure should have no
effect on the value of a covered clearing agency.\750\ Nevertheless,
the Commission acknowledges that market imperfections such as
asymmetric information, moral hazard, and regulation may imply that
covered clearing agencies that would need to raise additional equity
capital incur opportunity costs for holding this additional capital
rather than investing it in projects or distributing it back to equity
holders who might, in turn, invest in projects.
---------------------------------------------------------------------------
\749\ The figures in Table 2 are based on quantitative
disclosures published by registered clearing agencies pursuant to
the PFMI. Figures for FICC and NSCC were obtained from CPMI IOSCO
Quantitative Disclosure Results--2016 Q1 (June 30, 2016), available
at http://www.dtcc.com/legal/policy-and-compliance; figures for OCC
were obtained from PFMI Quantitative Disclosure (Mar. 31, 2016),
available at http://www.optionsclearing.com/components/docs/about/corporate-information/pfmi-disclosures/quant-disclosure-janmar2016.pdf; figures for Ice Clear Europe were obtained from ICE
Clear Europe--CDS (2016 Q1) available at https://www.theice.com/clear-europe/regulation#quantitative-disclosures; and figures for
ICE Clear Credit were obtained from Regulatory Disclosures (2016 Q1)
available at https://www.theice.com/clear-credit/regulation.
\750\ See Franco Modigliani & Merton H. Miller, The Cost of
Capital, Corporation Finance and the Theory of Investment, 48 a.m.
Econ. Rev. 261 (1958) (showing the irrelevance of capital structure
in perfect markets).
---------------------------------------------------------------------------
Clearing agencies that issue equity to satisfy the new requirements
would additionally face costs related to issuance. The Commission
recognizes that the cost of maintaining additional equity resembles an
insurance premium against the losses associated by market disruption in
the absence of clearing services.
xi. Rule 17Ad-22(e)(16): Custody and Investment Risks
Rule 17Ad-22(e)(16) requires a covered clearing agency to have
policies and procedures reasonably designed to safeguard both their own
assets as well as the assets of participants, broadening the
requirement applicable to registered clearing agencies in Rule 17Ad-
22(d)(3) to the protection of participants' assets.
The Commission believes that this may have benefits in terms of
protecting against systemic risk, to the extent that covered clearing
agencies to this point have treated their own assets differently by
applying greater safeguards to those assets than with respect to assets
of their members and members' clients. Protection of member assets is
important to cleared markets because, for example, the assets of a
member in default serve as margin and represent liquidity supplies that
a covered clearing agency may access to cover losses. If covered
clearing agencies can quickly access these liquidity sources, they may
be able to limit losses to non-defaulting members.
Participants may benefit from Rule 17Ad-22(e)(16) in other ways.
Requiring a covered clearing agency's policies and procedures to
safeguard its assets and participant assets and to invest in assets
with minimal credit, liquidity, and market risk may reduce uncertainty
in the value of participant assets and participants' exposure to
mutualized losses. This may allow participants to deploy their own
capital more efficiently. Furthermore, easy access to their own capital
enables members to more freely terminate their participation in covered
clearing agencies.
Based on its supervisory experience, the Commission believes that
current practices at covered clearing agencies meet the requirements
under Rule 17Ad-22(e)(16) in most cases, so the additional costs and
benefits flowing from these requirements would be generally limited to
registered clearing agencies that may enter the set of covered clearing
agencies in the future.
xii. Rule 17Ad-22(e)(17): Operational Risk Management
Because, as noted above, Rule 17Ad-22(e)(17) would require
substantially the same set of policies and procedures as Rule 17Ad-
22(d)(4),\751\ the Commission believes that Rule 17Ad-22(e)(17) would
likely impose limited material additional costs on covered clearing
agencies and produce limited benefits, in line with the general
economic considerations discussed in Part III.B.1.
---------------------------------------------------------------------------
\751\ See supra Part II.C.17 (discussing the full set of
requirements under Rule 17Ad-22(e)(17)); see also 17 CFR 240.17Ad-
22(d)(4).
---------------------------------------------------------------------------
xiii. Rules 17Ad-22(e)(18) Through (20): Membership Requirements,
Tiered Participation, and Linkages
As discussed earlier, covered clearing agencies play an important
role in the markets they serve. They often enjoy a central place in
financial networks that enables risk sharing, but may also enable them
to serve as conduits for the transmission of risk throughout the
financial system. Rules (18) through (20) require covered clearing
agencies to have policies and procedures reasonably designed to
explicitly consider and manage the risks associated with the particular
characteristics of their network of direct members, the broader
community of customers, and other parties that rely on the services
provided by the covered clearing agencies or other partners that the
covered clearing agency is connected to through relevant linkages. The
Commission believes that these efforts carry benefits insofar as they
reduce the extent to which covered clearing agencies may impose
negative externalities on financial markets.
As economies of scale contribute to the business dynamics of
clearing and settlement, there is often only one clearing agency or a
small number of clearing agencies for a particular class of security.
Consequently, membership in a clearing agency may influence competitive
dynamics between members and indirect participants, such as
intermediaries, in cleared markets.
[[Page 70878]]
Members and indirect participants may compete for the same set of
customers, but indirect participants must have relationships with
members to access clearing services. Members, therefore, may have
incentives in place to extract economic rents from indirect
participants by imposing higher fees or restricting access to clearing
services.
Permitting fair and open access to clearing agencies and their
services may promote competition among market participants and may
result in lower costs and efficient clearing and settlement services.
Open access to clearing agencies may reduce the likelihood that credit
and liquidity risk become concentrated among a small number of clearing
members, each of which retain a large number of indirect participants
through tiered arrangements. Further, links between clearing agencies
may facilitate risk management across multiple security classes and
improve the efficiency of collateral arrangements.
(1) Rule 17Ad-22(e)(18): Member Requirements
While fair and open access to clearing agencies may promote
competition and enhance the efficiency of clearing and settlement
services, these improvements should not come at the expense of prudent
risk management. The soundness of clearing members contributes directly
to the soundness of a clearing agency and mutualization of losses
within clearing agencies expose each clearing member to the default
risk of every other clearing member. Accordingly, it is important for
clearing agencies to control and effectively manage the risks to which
they are exposed by their direct and indirect participants by
establishing risk-related requirements for participation.
Based on its supervisory experience, the Commission believes that
current practices among most covered clearing agencies involve a mix of
objective financial and business requirements stipulated in publicly-
available rulebooks and discretion exercised by the covered clearing
agency. As a result and based on its supervisory experience, the
Commission believes that some changes to policies and procedures at
covered clearing agencies may be required under the rule.
(2) Rule 17Ad-22(e)(19): Tiered Participation Arrangements
The Commission believes that Rule 17Ad-22(e)(19) may improve
covered clearing agencies' ability to manage their exposure to market
participants that are not clearing members, but access payment,
clearing, or settlement facilities through their relationships with
clearing members. A covered clearing agency that is able to effectively
manage its exposure to its members but fails to identify, monitor, and
manage its exposures to non-member firms may overlook dependencies that
are critical to the stability of cleared markets. This is particularly
true if indirect participants in the covered clearing agency are large
and might potentially precipitate the default of one or more direct
members.
The data necessary to compute summary statistics that would be
helpful in quantifying the costs and benefits of the rule, including
those that would indicate the size of indirect participants and the
volume of transactions in which they are involved, are not available.
Nevertheless, the Commission is sensitive to the fact that costs
associated with the rules may result in concentration of clearing
services among fewer clearing members. Part of this process of
consolidation may mean an increase in the volume of trading activity
that involves indirect members, making identification of risks
associated with indirect members even more critical. Based on its
supervisory experience, however, the Commission believes that certain
covered clearing agencies already have policies and procedures in place
that would satisfy the requirements of the rule even in the absence of
such explicit requirements under existing rules. Costs and benefits
from the rule would come from those other registered clearing agencies
that require updates to their policies and procedures to come into
compliance with the rule.
The Commission is sensitive to the fact that indirect participants
play a key role in maintaining competition in markets for
intermediation of trading in securities insofar as they offer investors
a broader choice of intermediaries to deal with in centrally cleared
and settled securities markets. If elements of policies and procedures
under this rule make indirect participation marginally more costly,
then transactions costs for investors may increase.
(3) Rule 17Ad-22(e)(20): Links
Links between clearing agencies and their members are only one way
that clearing agencies interface with the financial system. A clearing
agency may also establish links with other clearing agencies and FMUs
through a set of contractual and operational arrangements. For a
clearing agency, the primary purpose of establishing a link would be to
expand its clearing and settlement services to additional financial
instruments, markets, and institutions. Established links among
clearing agencies and FMUs may enable direct and indirect market
participants to have access to a broader spectrum of clearing and
settlement services.
Sound linkages between clearing agencies that provide CCP services
may also provide their customers with more efficient collateral
arrangements and cross-margining benefits. Cross-margining potentially
relaxes liquidity constraints in the financial system by reducing total
required margin collateral. Resources that would otherwise be posted as
margin may be allocated to more productive investment opportunities.
A clearing agency that establishes a link or multiple links may
also impose costs on participants in markets it clears by indirectly
exposing them to systemic risk from linked entities. The Commission
acknowledges that clearing agencies that form linkages may be exposed
to additional risks, including credit and liquidity risks, as a
consequence of these links. Links may, however, produce benefits for
members to the extent that diversification and hedging across their
combined portfolio reduces their margin requirements. At the same time,
because such an agreement requires the linked clearing agencies to each
guarantee cross-margining participants' obligations to the other
clearing agency, cross-margining potentially exposes members of one
clearing agency to default risk from members of the other.
By requiring that covered clearing agencies have policies and
procedures reasonably designed to identify, monitor, and manage risks
related to any link, Rule 17Ad-22(e)(20), like Rule 17Ad-22(d)(7),
reduces the likelihood that such links serve as channels for systemic
risk transmission. Because Rule 17Ad-22(e)(20) differs only marginally
from Rule 17Ad-22(d)(7), the Commission believes that the costs and
benefits flowing from the adopted rule will be incremental, to the
extent that the additional specificity in Rule 17Ad-22(e)(20) causes
covered clearing agencies to modify current practices. The Commission
has aggregated these costs below.
xiv. Rule 17Ad-22(e)(21): Efficiency and Effectiveness
Rule 17Ad-22(e)(21) would impose on covered clearing agencies
requirements in addition to those currently applied to registered
clearing agencies under Rule 17Ad-22(d)(6) by also requiring covered
clearing agencies to have policies and procedures that ensure that a
covered clearing agency's
[[Page 70879]]
management review efficiency and effectiveness in four key areas:
Efficiency and effectiveness in clearing and settlement
arrangements may reduce participants' transaction costs and enhance
liquidity by reducing the amount of collateral that customers must
provide for transactions and the opportunity cost associated with
providing such collateral. Where appropriate, net settlement
arrangements can reduce collateral requirements. Similarly, clearing
arrangements that include a broad scope of products enable clearing
members to take advantage of netting efficiencies across positions.
Efficient and effective operating structures, including
risk management policies, procedures, and systems, may reduce the
likelihood of failures that may lead to impairment of a clearing
agency's capacity to complete settlement and interfering with its
ability to monitor and manage credit exposures.
An efficient scope of products that a clearing agency
clears, settles, or records may provide its participants and customers
with more efficient collateral arrangements and cross-margining
benefits that ultimately reduce transaction costs and improve liquidity
in cleared markets.
Efficient and effective use of technology and
communication procedures facilitates effective payment, clearing and
settlement, and recordkeeping.
The Commission believes that requirements related to the efficient
and effective operation of covered clearing agencies are appropriate
given the market power enjoyed by these entities, as discussed in Part
III.B.1.d. Limited competition in the market for clearing services may
blunt incentives for covered clearing agencies to provide high quality
services at low cost to market participants in the absence of
regulation.
Based on its supervisory experience, the Commission believes that
some covered clearing agencies would be required to make updates to
their policies and procedures as a result of the rule. As a result, the
Commission expects incremental costs and benefits to flow from the
adopted rule only to the extent that this additional specificity causes
covered clearing agencies to modify current practices.
xv. Rule 17Ad-22(e)(22): Communication Procedures and Standards
Based on its supervisory experience, the Commission believes that
some changes to policies and procedures would be necessary to meet
requirements under Rule 17Ad-22(e)(22).\752\ These costs are included
as a part of implementation costs, as discussed below. However, the
Commission understands that covered clearing agencies already
accommodate internationally accepted communication procedures and
standards and anticipates only incremental costs resulting from the
rule, in addition to the above discussed benefits. Registered clearing
agencies that may become covered clearing agencies in the future may
need to conform their practices to internationally accepted
communication procedures and standards, as well as adopt new policies
and procedures as a result of the rule, resulting in more substantial
costs.
---------------------------------------------------------------------------
\752\ See supra Part II.C.22 (discussing the full set of
requirements under Rule 17Ad-22(e)(22)).
---------------------------------------------------------------------------
xvi. Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures, and
Market Data
Enhanced disclosure may also improve the efficiency of transactions
in cleared products and improve financial stability more generally by
improving the ability of members of covered clearing agencies to manage
risks and assess costs. Additional information would reduce the
potential for uncertainty on the part of clearing members regarding
their obligations to covered clearing agencies. Rule 17Ad-22(e)(23)
requires a covered clearing agency to establish, implement, maintain,
and enforce written policies and procedures reasonably designed to
require specific disclosures. As in Rules 17Ad-22(d)(9) and (11),
covered clearing agencies would be required under Rule 17Ad-22(e)(23)
to disclose default procedures to the public and disclose sufficient
information to participants to allow them to manage the risks, fees,
and other material costs associated with membership.
Under Rule 17Ad-22(e)(23), a covered clearing agency must
establish, implement, maintain and enforce written policies and
procedures reasonably designed to update, on a biannual basis, public
disclosures that describe the covered clearing agency's market and
activities, along with information about the agency's legal,
governance, risk management, and operating frameworks, including
specifically covering material changes since the last disclosure, a
general background on the covered clearing agency, a rule-by-rule
summary of compliance with Rules 17Ad-22(e)(1) through (22), and an
executive summary. The rule adds a new requirement, relative to
existing requirements for registered clearing agencies under Rule 17Ad-
22(d)(9), to update the disclosure biannually and to include, among
other things, specific data elements, including details about system
design and operations, transaction values and volumes, average intraday
exposure to participants, and statistics on operational reliability.
Additional transparency may have benefits for participants and
cleared markets more generally. For example, if information about the
systems that support a covered clearing agency is public, investors may
be more certain that the market served by this agency is less prone to
disruption and more accommodating of trade. Furthermore, public
disclosure of detailed operating data may facilitate evaluation of each
covered clearing agency's operating record by market participants.
Further, under Rule 17Ad-22(e)(23)(iv), these disclosures would be made
about specific categories related to the compliance with Rule 17Ad-
22(e) that potentially facilitate comparisons between covered clearing
agencies. Additional availability of information on operations may
increase the likelihood that clearing agencies compete to win market
share from participants that value operational stability. This
additional market discipline may provide additional incentives for
covered clearing agencies to maintain reliability. Finally, updating
the public disclosure every two years or more frequently following
certain changes as required pursuant to Rule 17Ad-22(e)(23)(v) would
support the benefits of enhanced public disclosures by ensuring that
information provided to the public remains up-to-date. The Commission
believes this would reduce the likelihood that market participants are
forced to evaluate covered clearing agencies on the basis of stale
data.
Clearing members, in particular, may benefit from additional
disclosure of risk management and governance arrangements. These
details potentially have significant bearing on clearing members' risk
management because they may remove uncertainty surrounding members'
potential obligations to a covered clearing agency. In certain
circumstances, additional disclosures may reveal to members that the
expected costs of membership exceed the expected benefits of
membership, and that exit from the clearing agency may be privately
optimal. In addition to the costs of concentration among members
discussed in earlier sections, the Commission also recognizes the
potential for systemic benefits from termination. Member exit on the
basis of
[[Page 70880]]
more precise information may reduce the risk posed to other financial
market participants by members who, given additional information, might
prefer to terminate their membership, due to an inability to manage the
risks to which a covered clearing agency exposes them. While exit from
clearing agencies may have consequences for competition among clearing
members, the Commission believes that encouraging the participation of
firms that are not able to bear the risks of membership is not an
appropriate means of mitigating the effects of market power on
participants in cleared markets.
While it is possible that some covered clearing agencies will
require changes to policies and procedures as a result of the adopted
rules, the Commission believes that the effect of Rule 17Ad-22(e)(23)
will not have a substantial impact on compliance costs because covered
clearing agencies already gather data and information for preparing
their responses to the PFMI quantitative disclosures, which are updated
semiannually.
b. Rule 17Ab2-2
Rule 17Ab2-2 provides procedures for the Commission to determine
whether a covered clearing agency is systemically important in multiple
jurisdictions or has a complex risk profile and therefore should be
subject to stricter risk management standards under Rule 17Ad-22(e).
The Commission intends for Rule 17Ab2-2 to provide the Commission with
discretion to consider those criteria relevant to the facts and
circumstances of a registered clearing agency when subject to a
determination.
Rule 17Ab2-2(a) includes criteria the Commission may consider in
determining whether a covered clearing agency is systemically important
in multiple jurisdictions. These criteria are based on input from a set
of other bodies comprised of FSOC and regulators in other
jurisdictions. As a result, it is possible that the flow of costs and
benefits from Rule 17Ad-22(e) may be partially determined by the
decisions of other regulatory bodies.
Rule 17Ab2-2(b), includes criteria that the Commission may use to
determine that a clearing agency has a complex risk profile. For
example, the Commission may consider the extent to which the clearing
agency clears financial instruments that are characterized by discrete
jump-to-default price changes or that are highly correlated with
potential participant defaults.
Indirect effects of the determination process may have important
economic effects on the ultimate volume of clearing activity, beyond
the economic effects of the proposed requirements themselves. An
important feature of Rule 17Ab2-2 is providing transparency for the
determinations process. Transparency may allow a registered clearing
agency to plan for resulting obligations under Rule 17Ad-22(e).
To the extent that Rule 17Ad-22(e) may increase costs for a covered
clearing agency relative to its peers, such clearing agency may have
incentives to restructure its business to avoid a Commission
determination or otherwise exit any services made prohibitively
expensive by such a determination. Such potential consequential effects
would be among the considerations for the Commission to review in
connection with any specific decision under Rule 17Ab2-2. Restructuring
may involve spinning off business lines into separate entities,
limiting the scope of clearing activities to certain markets, or
limiting the scale of clearing activities within a single market. Any
of these outcomes could result in inefficiencies. As discussed in Part
III.B.1.c, registered clearing agencies may incur costs as a result of
restructuring. Registered clearing agencies that break up along product
lines or fail to consolidate when consolidation is efficient may fail
to take advantage of economies of scope and result in inefficient use
of collateral. Similarly, clearing agencies that limit their scale may
provide lower levels of clearing services to the markets that they
serve.
The impact of adopting Rule 17Ab2-2, which can affect the
application of Rule 17Ad-22(e), could have direct costs on covered
clearing agencies in the form of legal or consulting costs incurred as
a result of seeking a determination from the Commission. In instances
where these clearing agencies choose to apply to the Commission for
status under Rule 17Ab2-2, the Commission believes that a registered
clearing agency's voluntary application would suggest that the
applicant's private benefits from enhanced requirements under Rule
17Ad-22(e) as a result of the Commission's determination that it is
systemically important in multiple jurisdictions justify its costs.
Quantifiable costs related to determinations under Rule a17Ab2-2 are
noted in Part III.B.3.d.
In response to a comment about establishing a process for a covered
clearing agency to be removed from that status, the Commission has
decided to adopt such procedures in Rule 17Ab2-2(c). Specifically, if a
clearing agency no longer meets the determination of covered clearing
status, it can apply to be removed. This ability to remove the enhanced
requirements can facilitate a clearing agency's ability innovate or
enter new markets. Collectively, this could support the continued
development of the national system for clearance and settlement.
c. Rule 17Ad-22(f)
Rule 17Ad-22(f) includes a provision that specifies Commission
authority over designated clearing agencies for which it is the
supervisory agency. Since this provision codifies existing statutory
authority, the Commission does not anticipate any economic effects from
this rule.
d. Quantifiable Costs and Benefits
As discussed above, the amendments to Rule 17Ad-22 and Rule 17Ab2-2
would impose certain costs on covered clearing agencies. As discussed
in Part III.B.3.a.ii, if a covered clearing agency is required to
recruit new directors, the Commission estimates a cost per director of
$73,912.\753\ As discussed in Part I.A.1.a.i(4), the Commission
estimates costs associated with liquidity resources under Rules 17Ad-
22(e)(7) and (a)(15) would likely fall between $122 million and $204
million per year across all covered clearing agencies. As discussed in
Part I.A.1.a.i(5), the Commission believes that startup costs related
to financial risk management systems for existing covered clearing
agencies, related to new testing and model validation requirements to
be between $5 million to $25 million. The Commission also estimates a
lower bound on ongoing costs related to these requirements of $1
million per year. If covered clearing agencies were to hire external
consultants for the purposes of performing model validation required
under Rules 17Ad-22(e)(4) and (7) through policies and procedures, the
Commission estimates the ongoing cost associated with hiring such
consultants would be about $4,509,120 in the aggregate.\754\
---------------------------------------------------------------------------
\753\ See supra note 709.
\754\ See supra Part I.A.1.a.i(5), in particular note 739.
---------------------------------------------------------------------------
In addition, Rules 17Ad-22(e)(3), (4), (6), (7), (15) and (21) all
include elements of review by either a covered clearing agency's board
or its management on an ongoing basis. The Commission estimates the
cost of ongoing review for these adopted rules at approximately $39,376
per year.\755\
[[Page 70881]]
The rules would also impose certain implementation burdens and related
costs on covered clearing agencies.\756\ These costs generally include
assessment costs to determine compliance with the adopted rules and
costs related to new policies and procedures and updates to existing
policies and procedures required by the rules. In Part IV.C, the
Commission estimates the burdens of these implementation requirements
for covered clearing agencies.
---------------------------------------------------------------------------
\755\ To monetize the cost of board review, the Commission used
a recent report by Bloomberg stating that the average director works
250 hours and earns $251,000, resulting in an estimated $1000 per
hour for board review. As a proxy for the cost of management review,
the Commission is estimating $461 per hour, based upon the Director
of Compliance cost data from the SIFMA table, see infra note 756.
The Commission estimates the total cost of review for each clearing
agency as follows: ((Board Review for 32 hours at $1000 per hour) +
(Management Review for 16 hours at $461 per hour)) = $39,376.
\756\ To monetize the internal costs the Commission staff used
data from the SIFMA publications, Management and Professional
Earnings in the Security Industry--2013, and Office Salaries in the
Securities Industry--2013, modified by the Commission staff to
account for an 1800 hour work-year and multiplied by 5.35
(professionals) or 2.93 (office) to account for bonuses, firm size,
employee benefits and overhead. These figures have been adjusted for
inflation using data published by the Bureau of Labor Statistics.
Commission staff also estimated an hourly rate for a Chief Financial
Officer. The Web site www.salary.com reports that median CFO annual
salaries in 2016 were $306,789. A Grant Thornton LLP survey
estimated that in 2016 public company CFOs will receive an average
annual salary of $303,975. Using an approximate midpoint of these
two estimates of $305,000 per year, and dividing by an 1800-hour
work year and multiplying by the 5.35 factor which normally is used
to include benefits but here is used as an approximation to offset
the fact that New York salaries are typically higher than the rest
of the country, the result is $906 per hour.
---------------------------------------------------------------------------
For a new entrant into the set of covered clearing agencies from
the set of registered clearing agencies, the Commission estimates the
startup compliance costs associated with policies and procedures to be
$592,215,\757\ and compliance costs associated with the determinations
process under Rule 17Ab2-2 to be $7,764.\758\ Based on its supervisory
experience, the Commission believes that in many cases registered
clearing agencies are already in compliance with many of the
requirements included in the rules, so this cost represents an upper
bound on upfront costs. Conditioned on its current understanding of
current market practice at covered clearing agencies, the Commission
estimates that the total costs across all existing covered clearing
agencies will be $4,268,075.\759\ The Commission estimates that in the
aggregate existing covered clearing agencies would be subject to
ongoing costs associated with the rule in the amount of approximately
$926,603 per year.\760\
---------------------------------------------------------------------------
\757\ The total initial cost for an entrant that is not a CSD
and does engage in activities with a more complex risk profile was
calculated as follows: ((Assistant General Counsel for 428 hours at
$440 per hour) + (Compliance Attorney for 365 hours at $334 per
hour) + (Administrative Assistant for 2 hours at $76 per hour) +
(Computer Operations Department Manager for 300 hours at $416 per
hour) + (Senior Business Analyst for 85 hours at $259 per hour) +
(Senior Risk Management Specialist for 114 hours at $338 per hour) +
(Chief Compliance Office for 102 hours at $501 per hour) + (Senior
Programmer for 53 hours at $313 per hour) + (Chief Financial Officer
for 50 hours at $906 per hour) + (Financial Analyst for 70 hours at
$259 per hour)) = $626,850.
\758\ The total cost associated with determinations under Rule
17Ab2-2 was calculated as follows: ((Assistant General Counsel for 2
hours at $440 per hour) + (Compliance Attorney for 3 hours at $300
per hour) + (Outside Counsel for 5 hours at $400 per hour)) x 2
registered clearing agencies = $7,764.
\759\ The total initial cost was calculated as follows:
((Assistant General Counsel for 2,906 hours at $440 per hour) +
(Compliance Attorney for 2,475 hours at $334 per hour) +
(Administrative Assistant for 14 hours at $76 per hour) + (Computer
Operations Department Manager for 2,030 hours at $416 per hour) +
(Senior Business Analyst for 565 hours at $259 per hour) + (Senior
Risk Management Specialist for 773 hours at $338per hour) + (Chief
Compliance Office for 699 hours at $501 per hour) + (Senior
Programmer for 361 hours at $313 per hour) + (Chief Financial
Officer for 350 hours at $906 per hour) + (Financial Analyst for 490
hours at $259 per hour) + (Intermediate Accountant for 15 hours at
$162 per hour)) = $4,268,075.
\760\ The total ongoing cost was calculated as follows:
((Compliance Attorney for 1,851 hours at $334 per hour) +
(Administrative Assistant for 137 hours at $76 per hour) + (Senior
Business Analyst for 151 hours at $259 per hour) + (Senior Risk
Management Specialist for 70 hours at $338 per hour) + (Risk
Management Specialist for 1,251 hours at $188 per hour)) = $926,603.
---------------------------------------------------------------------------
A benefit of the rules that the Commission is able to quantify is
the impact of QCCP status of OCC to non-U.S. bank clearing members at
OCC. This benefit comes as a result of lower capital requirements
against exposures to QCCPs relative to non-qualifying CCPs. In Part
III.B.1.e, the Commission provided an estimate of the upper bound of
this benefit, $1.2 billion per year, or 0.73% of the aggregate 2015 net
income reported by bank clearing members at OCC. The Commission
believes that the actual benefits flowing from QCCP status would likely
be higher due to benefits for foreign bank members of FICC and ICEEU,
in addition to the benefits with respect to OCC discussed above.\761\
---------------------------------------------------------------------------
\761\ See supra note 689 and accompanying text.
---------------------------------------------------------------------------
The Commission believes that the rules will result in an increase
in financial stability insofar as they result in minimum standards at
covered clearing agencies that are higher than those standards implied
by current practices at covered clearing agencies. Some of this
increased stability may come as a result of lower activity as the
adopted rules cause participants to internalize a greater proportion of
the costs that their activity imposes on the financial system, reducing
the costs of default, conditional on a default event occurring.
Increased stability may also come as a result of higher risk management
standards at covered clearing agencies that effectively lower the
probability that either covered clearing agencies or their members
default.
IV. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') imposes certain
requirements on federal agencies in connection with the conducting or
sponsoring of any ``collection of information.'' \762\ An agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number. Further, 44 U.S.C. 3507(a) provides that, before adopting or
revising a collection of information requirement, an agency must, among
other things, publish notice in the Federal Register stating that the
agency has submitted the proposed collection of information to the
Office of Management and Budget (``OMB'') and setting forth certain
required information, including (i) a title for the collection of
information; (ii) a summary of the collection of information; (iii) a
brief description of the need for the information and the proposed use
of the information; (iv) a description of the likely respondents and
proposed frequency of response to the collection of information; (v) an
estimate of the paperwork burden that shall result from the collection
of information; and (vi) notice that comments may be submitted to the
agency and director of OMB.\763\
---------------------------------------------------------------------------
\762\ See 44 U.S.C. 3501 et seq.; 44 U.S.C. 3502(3).
\763\ See 44 U.S.C. 3507(a)(1)(D); see also 5 CFR
1320.5(a)(1)(iv).
---------------------------------------------------------------------------
Certain provisions of Rule 17Ad-22(e) impose new collection of
information requirements under the PRA. The Commission submitted these
collections of information to the OMB for review in accordance with 44
U.S.C. 3507 and 5 CFR 1320.11. Because the Commission is revising the
collection of information under Rule 17Ad-22 to account for new Rule
17Ad-22(e), the Commission will use the same title and control number:
``Clearing Agency Standards for Operation and Governance,'' OMB Control
No. 3235-0695. Since Rule 17Ab2-2 contains a new collection of
information requirement, the title and control number are
``Determinations Affecting Covered Clearing Agencies,'' OMB Control No.
3235-0728.
The Commission provided notice of the below PRA estimates in the
CCA Standards proposing release and
[[Page 70882]]
received no comments in response.\764\ As discussed further below, the
Commission has modified the final PRA estimates to account for the
modifications to Rules 17Ad-22(e) and 17Ab2-2 described in Part II and
to Rule 17Ad-22(c)(1) described in Part I.C.3.
---------------------------------------------------------------------------
\764\ See CCA Standards proposing release, supra note 5, at
29560-75.
---------------------------------------------------------------------------
A. Summary of Collection of Information and Use of Information
Below is a summary of the collection of information and the use of
information for Rules 17Ad-22(e) and 17Ab2-2. The Commission received
no comments regarding the summary or the use of information. In
addition, because the Commission is modifying Rule 17Ad-22(c)(1) in
response to comments addressed above, Rule 17Ad-22(c)(1) is also
discussed below.\765\ The Commission notes that the policies and
procedures would also be used by the Commission as part of its ongoing
efforts to monitor and enforce compliance with the federal securities
laws through, among other things, examinations and inspections.
---------------------------------------------------------------------------
\765\ See supra Part I.C.3.
---------------------------------------------------------------------------
1. Rule 17Ad-22(e)(1)
As proposed, Rule 17Ad-22(e)(1) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to provide for a well-founded,
clear, transparent and enforceable legal basis for each aspect of its
activities in all relevant jurisdictions. The Commission is adopting
Rule 17Ad-22(e)(1) as proposed.\766\
---------------------------------------------------------------------------
\766\ See supra Part II.C.1.
---------------------------------------------------------------------------
The purpose of this information collection is to reduce the
potential for legal risk at covered clearing agencies, such as the risk
that participants face legal uncertainty due to a lack of clarity or
completeness regarding conflicts with applicable laws.
2. Rule 17Ad-22(e)(2)
As proposed, Rules 17Ad-22(e)(2)(i) through (iii) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for
governance arrangements that are clear and transparent, clearly
prioritize the safety and efficiency of the covered clearing agency,
and support the public interest requirements in Section 17A of the
Exchange Act and the objectives of owners and participants. Proposed
Rule 17Ad-22(e)(2)(iv) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for governance arrangements
establishing that the board of directors and senior management have
appropriate experience and skills to discharge their duties and
responsibilities.\767\
---------------------------------------------------------------------------
\767\ See supra Part II.C.2.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(2) with two
modifications, as previously discussed in Part II.C.2.c. First, the
Commission is adding new paragraph (v) to require policies and
procedures that specify clear and direct lines of responsibility. The
Commission believes that clearly delineating lines of responsibility
will help foster accountability of the board of directors and senior
management, a concern expressed by commenters. The Commission also
believes that this requirement complements the requirements in Rule
17Ad-22(e)(iv) addressing the qualifications of the board and
management.\768\ Second, the Commission is adopting new paragraph (vi)
to require a covered clearing agency's governance arrangements to
consider the interests of participants' customers, securities issuers
and holders, and other relevant stakeholders of the covered clearing
agency. The Commission believes that the comments received in response
to Rule 17Ad-22(e)(2), at a general level, express concern as to
whether a covered clearing agency will have governance arrangements
sufficiently robust to incorporate the views of the relevant
stakeholders and to withstand the influence of potentially improper
incentives. The Commission believes that this modification helps
mitigate these concerns by adding a requirement to consider the
interests of the relevant stakeholders. The Commission also believes
that they complement the other requirements in Rule 17Ad-22(e)(2) and
flow from the existing requirements in Section 17A of the Exchange Act,
in particular the fair representation, investor protection, and public
interest requirements discussed previously.\769\
---------------------------------------------------------------------------
\768\ See supra Part II.C.2.b.iii.
\769\ See supra Part II.C.2.c.
---------------------------------------------------------------------------
The purpose of this information collection is to prioritize the
safety and efficiency of covered clearing agencies, to help ensure that
each covered clearing agency's governance arrangements consider the
interests of the relevant stakeholders, to promote the establishment of
boards of directors at covered clearing agencies that are composed of
qualified members with clear and direct lines of responsibility, and to
promote accountability of the board of directors and senior management.
3. Rule 17Ad-22(e)(3)
As proposed, Rule 17Ad-22(e)(3) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain a sound risk management
framework for comprehensively managing legal, credit, liquidity,
operational, general business, investment, custody, and other risks
that arise in or are borne by the covered clearing agency. Proposed
Rule 17Ad-22(e)(3)(i) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for risk management policies,
procedures, and systems designed to identify, measure, monitor, and
manage the range of risks that arise in or are borne by the covered
clearing agency, and subject them to review on a specified periodic
basis and approval by the board of directors annually. Proposed Rule
17Ad-22(e)(3)(ii) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to ensure it establishes plans for the recovery and
orderly wind-down of the covered clearing agency necessitated by credit
losses, liquidity shortfalls, losses from general business risk, or any
other losses. Proposed Rule 17Ad-22(e)(iii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide risk management
and internal audit personnel with sufficient authority, resources,
independence from management, and access to the board of directors.
Proposed Rule 17Ad-22(e)(3)(iv) would require a covered clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide risk management and internal
audit personnel with oversight by and a direct reporting line to a risk
management committee and an audit committee of the board of directors,
respectively. Proposed Rule 17A-22(e)(3)(v) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for an
independent audit committee.
The Commission is adopting Rule 17Ad-22(e)(3) with one
modification. To make clear that the audit committee described in Rule
17Ad-22(e)(3)(iv) and the independent audit committee described in Rule
17Ad-22(e)(3)(v) are
[[Page 70883]]
not separate audit committees, the Commission is adding ``independent''
before audit committee in Rule 17Ad-22(e)(3)(iv).\770\
---------------------------------------------------------------------------
\770\ See supra Part II.C.3.
---------------------------------------------------------------------------
The purpose of this information collection is to enhance each
covered clearing agency's ability to identify, monitor, and manage the
risks that covered clearing agencies face, including by subjecting the
relevant policies and procedures to regular review, and to facilitate
an orderly recovery and wind-down process in the event that a covered
clearing agency is unable to continue operating as a going concern.
4. Rule 17Ad-22(e)(4)
As proposed, Rule 17Ad-22(e)(4) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively identify, measure,
monitor, and manage its credit exposures to participants and those
exposures arising from its payment, clearing, and settlement processes.
Proposed Rule 17Ad-22(e)(4)(i) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain sufficient financial
resources to cover its credit exposure to each participant fully with a
high degree of confidence. Proposed Rule 17Ad-22(e)(4)(ii) would
require a covered clearing agency that provides CCP services, and that
is ``systemically important in multiple jurisdictions'' or ``a clearing
agency involved in activities with a more complex risk profile,'' to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain additional financial
resources, to the extent not already maintained pursuant to proposed
Rule 17Ad-22(e)(4)(i), at a minimum level necessary to enable it to
cover a wide range of foreseeable stress scenarios, including but not
limited to the default of the two participant families that would
potentially cause the largest aggregate credit exposure for the covered
clearing agency in extreme but plausible market conditions (hereinafter
the ``cover two'' requirement). Meanwhile, proposed Rule 17Ad-
22(e)(4)(iii) would require a covered clearing agency that is not
subject to proposed Rule 17Ad-22(e)(4)(ii) to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain additional financial resources, to the extent not
already maintained pursuant to proposed Rule 17Ad-22(e)(4)(i), at the
minimum to enable it to cover a wide range of foreseeable stress
scenarios, including the default of the participant family that would
potentially cause the largest aggregate credit exposure for the covered
clearing agency in extreme but plausible market conditions (hereinafter
the ``cover one'' requirement). Proposed Rule 17Ad-22(e)(4)(iv) would
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to include
prefunded financial resources, excluding assessments for additional
guaranty fund contributions or other resources that are not prefunded,
when calculating the financial resources available to meet the
standards under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable. Proposed Rule 17Ad-22(e)(4)(v) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to maintain the financial
resources required under proposed Rules 17Ad-22(e)(4)(i) through (iii),
as applicable, in combined or separately maintained clearing or
guaranty funds.
Proposed Rule 17Ad-22(e)(4)(vi) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to test the sufficiency of its total
financial resources available to meet the minimum financial resource
requirements under proposed Rules 17Ad-22(e)(4)(i) through (iii), as
applicable, by conducting a stress test of its total financial
resources at least once each day using standard predetermined
parameters and assumptions. Proposed Rule 17Ad-22(e)(4)(vi) would also
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to conduct
a comprehensive analysis on at least a monthly basis of the existing
stress testing scenarios, models, and underlying parameters and
assumptions, and consider modifications to ensure they are appropriate
for determining the covered clearing agency's required level of default
protection in light of current market conditions. When the products
cleared or markets served by a covered clearing agency display high
volatility or become less liquid, and when the size or concentration of
positions held by the entity's participants increases significantly,
the proposed rule would require a covered clearing agency to have
policies and procedures for conducting comprehensive analyses of stress
testing scenarios, models, and underlying parameters and assumptions
more frequently than monthly. Proposed Rule 17Ad-22(e)(4)(vi) would
also require a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to provide for the reporting of the results of this analysis
to the appropriate decision makers at the covered clearing agency,
including its risk management committee or board of directors, and to
require the use of the results to evaluate the adequacy of and to
adjust its margin methodology, model parameters, and any other relevant
aspects of its credit risk management policies and procedures, in
supporting compliance with the minimum financial resources requirements
in proposed Rules 17Ad-22(e)(4)(i) through (iii), as applicable.\771\
---------------------------------------------------------------------------
\771\ See id. at 29526-27.
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-22(e)(4)(vii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to require a conforming
model validation for its credit risk models to be performed not less
than annually or more frequently as may be contemplated by the covered
clearing agency's risk management policies and procedures. The
Commission also proposed to define ``conforming model validation'' to
mean an evaluation of the performance of each material risk management
model used by a covered clearing agency, including initial margin
models, liquidity risk models, and models used to generate guaranty
fund requirements, along with the related parameters and assumptions
associated with such models. The proposed definition would further
require that the model validation be performed by a qualified person
who is free from influence from the persons responsible for the
development or operation of the models or policies being validated so
that risk models can be candidly assessed.\772\
---------------------------------------------------------------------------
\772\ See supra Part II.C.4.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(4) with modifications,
as previously discussed in Part II.C.4.c. The Commission is adopting
two modifications to Rule 17Ad-22(e)(4)(vii). First, because the
Commission is modifying the definition of ``conforming model
validation'' by striking ``conforming,'' as previously discussed in
Part II.C.4.c, the Commission is modifying Rule 17Ad-22(e)(4)(vii) to
conform to the revised
[[Page 70884]]
definition. Second, to be consistent with the corresponding requirement
for model validation of liquidity risk models in Rule 17Ad-
22(e)(7)(vii), the Commission is modifying Rule 17Ad-22(e)(4)(vii) by
striking ``to be performed.'' \773\
---------------------------------------------------------------------------
\773\ See supra Part II.C.4.c.
---------------------------------------------------------------------------
The Commission is also adopting four other modifications to Rule
17Ad-22(e)(4), as previously discussed in Part II.C.4.c. First, the
Commission is modifying Rule 17Ad-22(e)(4)(v) so that it references
only paragraphs (e)(4)(ii) and (iii) (and not paragraph (e)(4)(i)),
consistent with the Commission's discussion of the proposed rule in the
CCA Standards proposing release. Second, to make clear that prefunded
financial resources should be exclusive of assessments for additional
guaranty fund contributions or other resources that are not prefunded,
the Commission is modifying Rule 17Ad-22(e)(4)(iv) to state ``exclusive
of'' assessments rather than ``excluding'' assessments. Third, the
Commission is modifying Rule 17Ad-22(e)(4)(vi)(A) to refer to ``stress
testing'' rather than ``a stress test'' to improve consistency with the
definition of ``stress testing'' in Rule 17Ad-22(a)(17). Fourth, the
Commission is revising Rule 17Ad-22(e)(4)(vi)(C) to replace ``and''
with ``or'' so that the criteria for conducting analysis more
frequently than monthly are disjunctive rather than conjunctive, since
the criteria described may not be correlated to each other. Fifth, the
Commission is correcting a technical error in Rule 17Ad-
22(e)(4)(vi)(D): references to paragraphs (e)(4)(iv)(B) and (C) will be
changed to paragraphs (e)(4)(vi)(B) and (C) respectively. Sixth, the
Commission is moving requirements proposed in Rule 17Ad-22(e)(13) to
Rule 17Ad-22(e)(4) so that all requirements pertinent to a covered
clearing agency's management of credit risk are contained in one rule.
This modification is discussed below in Part IV.A.13.\774\
---------------------------------------------------------------------------
\774\ See also supra Part II.C.13.c.
---------------------------------------------------------------------------
The purpose of this information collection is to identify and limit
credit exposures to participants and to satisfy all of its settlement
obligations in the event of a participant default, to address the
allocation of credit losses if collateral and other resources are
insufficient to fully cover its credit exposures following a
participant default, and to describe the covered clearing agency's
process to replenish financial resources following such a default.
5. Rule 17Ad-22(e)(5)
As proposed, Rule 17Ad-22(e)(5) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to limit the assets it accepts as
collateral to those with low credit, liquidity, and market risks, and
also require policies that set and enforce appropriately conservative
haircuts and concentration limits if the covered clearing agency
requires collateral to manage its own or its participants' credit
exposures. In addition, Rule 17Ad-22(e)(5) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to include a not-less-than-
annual review of the sufficiency of a covered clearing agency's
collateral haircuts and concentration limits. The Commission is
adopting Rule 17Ad-22(e)(5) as proposed.\775\
---------------------------------------------------------------------------
\775\ See supra Part II.C.5.
---------------------------------------------------------------------------
The purpose of the information collection is to enable a covered
clearing agency to be able to maintain sufficient collateral by using
appropriately conservative haircuts and concentration limits.
6. Rule 17Ad-22(e)(6)
As proposed, Rule 17Ad-22(e)(6) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to cover
its credit exposures to its participants by establishing a risk-based
margin system that is monitored by management on an ongoing basis and
regularly reviewed, tested, and verified. Proposed Rule 17Ad-
22(e)(6)(i) would require a covered clearing agency that provides CCP
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in a margin system that,
at a minimum, considers and produces margin levels commensurate with
the risks and particular attributes of each relevant product,
portfolio, and market. Proposed Rule 17Ad-22(e)(6)(ii) would require a
covered clearing agency that provides CCP services to establish
implement, maintain and enforce written policies and procedures
reasonably designed to ensure that the margin system would mark
participant positions to market and collect margin, including variation
margin or equivalent charges if relevant, at least daily, and include
the authority and operational capacity to make intraday margin calls in
defined circumstances. Proposed Rule 17Ad-22(e)(6)(iii) would require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to calculate margin sufficient to cover its
potential future exposure to participants in the interval between the
last margin collection and the close out of positions following a
participant default. Proposed Rule 17Ad-22(e)(6)(iv) would require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to ensure that it uses reliable sources of timely
price data and procedures and sound valuation models for addressing
circumstances in which pricing data are not readily available or
reliable. Proposed Rule 17Ad-22(e)(6)(v) would require a covered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to ensure the use of an appropriate method for measuring
credit exposure that accounts for relevant product risk factors and
portfolio effects across products.
Proposed Rule 17Ad-22(e)(6)(vi) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to
establish a risk-based margin system that is monitored by management on
an ongoing basis. Proposed Rule 17Ad-22(e)(6)(vi) would also require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to regularly review, test, and verify its risk-
based margin system by conducting backtests of its margin resources at
least once each day using standard predetermined parameters and
assumptions. Proposed Rule 17Ad-22(e)(6)(vi) would require a covered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to regularly review, test, and verify its risk-based margin
system by conducting a conforming sensitivity analysis of its margin
resources and its parameters and assumptions for backtesting on at
least a monthly basis, and considering modifications to ensure the
backtesting practices are appropriate for determining the adequacy of
the covered clearing agency's margin resources. Proposed Rule 17Ad-
22(e)(6)(vi) would require a covered clearing agency that provides CCP
[[Page 70885]]
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to regularly review, test, and
verify its risk-based margin system by conducting a conforming
sensitivity analysis of its margin resources and its parameters and
assumptions for backtesting more frequently than monthly during periods
of time when the products cleared or markets served display high
volatility or become less liquid, and when the size or concentration of
positions held by the covered clearing agency's participants increases
or decreases significantly. Proposed Rule 17Ad-22(e)(6)(vi) would
require a covered clearing agency that provides CCP services to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to regularly review, test, and verify
its risk-based margin system by reporting the results of its analyses
above to appropriate decision makers at the covered clearing agency,
including but not limited to, its risk management committee or board of
directors, and using these results to evaluate the adequacy of and
adjust its margin methodology, model parameters, and any other relevant
aspects of its credit risk management framework.\776\
---------------------------------------------------------------------------
\776\ See id. at 29530.
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-22(e)(6)(vii) would require a covered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to require not less than annually a conforming model
validation of the covered clearing agency's margin system and related
models.\777\
---------------------------------------------------------------------------
\777\ See supra Part II.C.6.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(6) with modifications,
as previously discussed in Part II.C.6.c. First, the Commission is
modifying Rule 17Ad-22(e)(6) to remove references to ``conforming''
consistent with the modification to the definitions of ``sensitivity
``analysis'' discussed in Part II.C.6.c and of ``model validation''
discussed in Part II.C.4.c. Second, to improve clarity, the Commission
is modifying Rule 17Ad-22(e)(6)(v) to require policies and procedures
that use reliable sources of timely price data and that ``use''
procedures and sound valuation models for addressing circumstances in
which pricing data are not readily available or reliable. Third,
because backtests are conducted with respect to the margin model and
not margin resources, the Commission is modifying Rule 17Ad-
22(e)(6)(vi)(A) to replace the phrase ``margin resources'' with
``margin model.'' Fourth, to avoid conflating sensitivity analysis with
backtesting, the Commission is modifying Rules 17Ad-22(e)(6)(vi)(B) and
(C) to clarify that a sensitivity analysis should be conducted of the
margin model and not of margin resources. Fifth, the Commission is
modifying Rule 17Ad-22(e)(6)(vi)(C) to replace ``and'' with ``or'' so
that the criteria for conducting analysis more frequently than monthly
are disjunctive rather than conjunctive, since the criteria described
may not be correlated to each other.
The purpose of the information collection is to enable a covered
clearing agency to be able to collect sufficient margin subject to
regular sensitivity analysis, monthly backtesting, and an annual model
validation.
7. Rule 17Ad-22(e)(7)
As proposed, Rule 17Ad-22(e)(7) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively measure, monitor, and
manage the liquidity risk that arises in or is borne by it, by meeting,
at a minimum, the ten requirements specified in the rule.
Proposed Rule 17Ad-22(e)(7)(i) would require that a covered
clearing agency's policies and procedures be reasonably designed to
ensure that it maintains sufficient liquid resources in all relevant
currencies to effect same-day and, where appropriate, intraday and
multiday settlement of payment obligations with a high degree of
confidence under a wide range of potential stress scenarios that
includes the default of the participant family that would generate the
largest aggregate payment obligation for it in extreme but plausible
market conditions.
Proposed Rule 17Ad-22(e)(7)(ii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it holds qualifying
liquid resources sufficient to meet the minimum liquidity resource
requirement in each relevant currency for which the covered clearing
agency has payment obligations owed to clearing members.
Proposed Rule 17Ad-22(e)(7)(iii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it uses accounts and
services at a Federal Reserve Bank, pursuant to Section 806(a) of the
Clearing Supervision Act, or other relevant central bank, when
available and where determined to be practical by the board of
directors of the covered clearing agency, to enhance its management of
liquidity risk.
Proposed Rule 17Ad-22(e)(7)(iv) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it undertakes due
diligence to confirm that it has a reasonable basis to believe each of
its liquidity providers, whether or not such liquidity provider is a
clearing member, has sufficient information to understand and manage
the liquidity provider's liquidity risks, and the capacity to perform
as required under its commitments to provide liquidity.
Proposed Rule 17Ad-22(e)(7)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency maintains and, on at least an annual basis, tests with each
liquidity provider, to the extent practicable, its procedures and
operational capacity for accessing each type of relevant liquidity
resource.
Proposed Rule 17Ad-22(e)(7)(vi)(A) through (C) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to determine the
amount and regularly test the sufficiency of the liquid resources held
for purposes of meeting the minimum liquid resource requirement of
proposed Rule 17Ad-22(e)(7)(i) by (A) conducting a stress test of its
liquidity resources at least once each day using standard and
predetermined parameters and assumptions; (B) conducting a
comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources, and considering modifications to ensure
they are appropriate for determining the covered clearing agency's
identified liquidity needs and resources in light of current and
evolving market conditions at least once each month; and (C) conducting
a comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources more frequently when products cleared or
markets served display high volatility or become less liquid, when the
size or concentration of positions held by participants increases
significantly, or in other circumstances described in the covered
clearing agency's policies and procedures. Proposed Rule 17Ad-
22(e)(7)(vi)(D) would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures
[[Page 70886]]
reasonably designed to result in reporting the results of the analyses
performed under proposed Rule 17Ad-22(e)(7)(vi)(B) and (C) to
appropriate decision makers, including the risk management committee or
board of directors, at the covered clearing agency for use in
evaluating the adequacy of and adjusting its liquidity risk management
framework.
Proposed Rule 17Ad-22(e)(7)(vii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in performing an annual or
more frequent conforming model validation of its liquidity risk
models.\778\
---------------------------------------------------------------------------
\778\ See id.; see also supra notes 275-305 and accompanying
text (discussing generally the requirements accompanying the
definition of ``model validation'').
---------------------------------------------------------------------------
Proposed Rule 17Ad-22(e)(7)(viii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to address foreseeable liquidity
shortfalls that would not be covered by its liquid resources and seek
to avoid unwinding, revoking, or delaying the same-day settlement of
payment obligations.
Proposed Rule 17Ad-22(e)(7)(ix) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to describe its process for
replenishing any liquid resources that it may employ during a stress
event.
Finally, proposed Rule 17Ad-22(e)(7)(x) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure that it, at least
once a year, evaluates the feasibility of maintaining sufficient liquid
resources at a minimum in all relevant currencies to effect same-day
and, where appropriate, intraday and multiday settlement of payment
obligations with a high degree of confidence under a wide range of
foreseeable stress scenarios that includes, but is not limited to, the
default of the two participant families that would potentially cause
the largest aggregate credit exposure for the covered clearing agency
in extreme but plausible market conditions if the covered clearing
agency provides CCP services and is either systemically important in
multiple jurisdictions or a clearing agency involved in activities with
a more complex risk profile.\779\
---------------------------------------------------------------------------
\779\ See supra Part II.C.7.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(7) with modifications,
as previously discussed in Part II.C.7.c. First, the Commission is
modifying Rule 17Ad-22(e)(7)(vi)(A) to refer to ``stress testing''
rather than ``a stress test'' to improve consistency with the
definition of ``stress testing'' in Rule 17Ad-22(a)(17). Second, the
Commission is modifying Rule 17Ad-22(e)(7)(vi)(C) in two ways. To
improve consistency with Rule 17Ad-22(e)(4)(vi)(C), the Commission is
adding ``or'' to link ``display high volatility'' with ``become less
liquid'' because these concepts are intended to describe events related
to the products cleared or markets served. The Commission is also
replacing ``and'' with ``or'' in Rule 17Ad-22(e)(7)(vi)(C) so that the
criteria for conducting analysis more frequently than monthly are
disjunctive rather than conjunctive, since the list of criteria is open
to other appropriate circumstances described in a covered clearing
agency's policies and procedures and may not be correlated. Third, the
Commission is making two modifications in adopting Rule 17Ad-
22(e)(7)(vi)(D) to correct technical errors in the proposed rule text:
(i) References to paragraphs (e)(6)(vii)(B) and (C) will be changed to
paragraphs (e)(7)(vi)(B) and (C) respectively; and (ii) the rule will
refer to the covered clearing agency's ``liquidity'' risk management
framework, rather than its ``credit'' risk management framework.
Fourth, the Commission is striking ``conforming'' from Rule 17Ad-
22(e)(7)(vii) to be consistent with the modifications to the definition
of ``model validation'' discussed in Part II.C.4.c.
The purpose of this information collection is to identify and limit
liquidity risk so that a covered clearing agency can satisfy its
settlement obligations on an ongoing and timely basis by holding a
sufficient amount of qualifying liquid resources and performing regular
stress testing of its liquid resources. The purpose of this information
collection is also to help ensure that a covered clearing agency
addresses foreseeable liquidity shortfalls and can replenish any liquid
resources that it may employ in a stress event. The purpose of this
information collection is also to help ensure that a covered clearing
agency manages the risks posed by its liquidity providers.
8. Rule 17Ad-22(e)(8)
As proposed, Rule 17Ad-22(e)(8) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to define the point at which
settlement is final no later than the end of the day on which the
payment or obligation is due and, where necessary or appropriate,
intraday or in real time.\780\
---------------------------------------------------------------------------
\780\ See supra Part II.C.8.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(8) with one
modification, as previously discussed in Part II.C.8.c. To remove
potential ambiguity as to the timing of settlement finality under the
rule, the Commission is modifying Rule 17Ad-22(e)(8) to state that the
point at which settlement is final is ``to be'' no later than the end
of the day on which the payment or obligation is due and, where
necessary or appropriate, intraday or in real time.
The purpose of this information collection is to promote consistent
standards of timing and reliability in the settlement process.
9. Rule 17Ad-22(e)(9)
As proposed, Rule 17Ad-22(e)(9) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to conduct its money settlements in
central bank money, where available and determined to be practical by
the board of directors of the covered clearing agency, and minimizes
and manages credit and liquidity risk arising from conducting its money
settlements in commercial bank money if central bank money is not used
by the covered clearing agency. The Commission is adopting Rule 17Ad-
22(e)(9) as proposed.\781\
---------------------------------------------------------------------------
\781\ See supra Part II.C.9.
---------------------------------------------------------------------------
The purpose of this information collection is to promote
reliability in a covered clearing agency's settlement operations.
10. Rule 17Ad-22(e)(10)
As proposed, Rule 17Ad-22(e)(10) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish and maintain
transparent written standards that state its obligations with respect
to the delivery of physical instruments and operational practices that
identify, monitor, and manage the risk associated with such physical
deliveries. The Commission is adopting Rule 17Ad-22(e)(10) as
proposed.\782\
---------------------------------------------------------------------------
\782\ See supra Part II.C.10.
---------------------------------------------------------------------------
The purpose of this information collection is to provide a covered
clearing agency's participants with the information necessary to
evaluate the risks and costs associated with participation in the
covered clearing agency.
11. Rule 17Ad-22(e)(11)
As proposed, Rule 17Ad-22(e)(11)(i) would require a covered
clearing agency
[[Page 70887]]
that provides CSD services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to maintain
securities in an immobilized or dematerialized form for their transfer
by book entry, ensure the integrity of securities issues, and minimize
and manage the risks associated with the safekeeping and transfer of
securities. Proposed Rule 17Ad-22(e)(11)(ii) would require a covered
clearing agency that provides CSD services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to implement internal auditing and other controls to safeguard
the rights of securities issuers and holders and prevent the
unauthorized creation or deletion of securities, and conduct periodic
and at least daily reconciliation of securities issues it maintains.
Proposed Rule 17Ad-22(e)(11)(iii) would require a covered clearing
agency that provides CSD services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to protect
assets against custody risk through appropriate rules and procedures
consistent with relevant laws, rules, and regulations in jurisdictions
where it operates. The Commission is adopting Rule 17Ad-22(e)(11) as
proposed.\783\
---------------------------------------------------------------------------
\783\ See supra Part II.C.11.
---------------------------------------------------------------------------
The purpose of this information collection is to reduce securities
transfer processing costs and the risks associated with securities
settlement and custody, as well as increase the speed and efficiency of
the settlement process.
12. Rule 17Ad-22(e)(12)
As proposed, Rule 17Ad-22(e)(12) would require a covered clearing
agency, for transactions that involve the settlement of two linked
obligations, to establish, implement, maintain and enforce written
policies and procedures reasonably designed to eliminate principal risk
by conditioning the final settlement of one obligation upon the final
settlement of the other, regardless of whether the covered clearing
agency settles on a gross or net basis and when finality occurs. The
Commission is adopting Rule 17Ad-22(e)(12) as proposed.\784\
---------------------------------------------------------------------------
\784\ See supra Part II.C.12.
---------------------------------------------------------------------------
The purpose of this information collection is to promote the
elimination of principal risk in transactions with linked obligations.
13. Rule 17Ad-22(e)(13)
As proposed, Rule 17Ad-22(e)(13) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency has the authority and operational capacity to take timely action
to contain losses and liquidity demands and continue to meet its
obligations in the event of a participant default. Proposed rule 17Ad-
22(e)(13)(i) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to address the allocation of credit losses it may
face if its collateral and other resources are insufficient to fully
cover its credit exposures, including the repayment of any funds the
covered clearing agency may borrow from liquidity providers. Proposed
Rule 17Ad-22(e)(13)(ii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to describe its process to replenish any
financial resources it may use following a member default or other
event in which use of such resources is contemplated. Finally, proposed
Rule 17Ad-22(e)(13)(iii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require the covered clearing agency's
participants and, when practicable, other stakeholders to participate
in the testing and review of its default procedures, including any
close-out procedures, at least annually and following material changes
thereto.\785\
---------------------------------------------------------------------------
\785\ See supra Part II.C.13.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(13) with modifications,
as previously discussed in Part II.C.13.c and noted in Part IV.A.4. The
Commission is moving the requirements in proposed Rules 17Ad-
22(e)(13)(i) and (ii) to Rules 17Ad-22(e)(4)(viii) and (ix),
respectively, to consolidate requirements for management of a covered
clearing agency's default waterfall within a single rule. The
Commission believes this modification improves consistency between
Rules 17Ad-22(e)(4) and (7). Specifically, Rule 17Ad-22(e)(4) includes
requirements intended to facilitate the management of credit risk, and
proposed Rules 17Ad-22(e)(13)(i) and (ii) include requirements to
address the allocation of credit losses and the replenishment of funds.
Similarly, Rule 17Ad-22(e)(7) includes requirements intended to
facilitate the management of liquidity risk, and Rules 17Ad-
22(e)(7)(viii) and (ix) include requirements to address liquidity
shortfalls and replenish liquid resources. In contrast, Rule 17Ad-
22(e)(13) is intended to ensure that a covered clearing agency has
policies and procedures addressing its authority and operational
capacity to take timely action to contain losses and liquidity demands,
and proposed Rule 17Ad-22(e)(13)(iii) includes requirements related to
the testing of default procedures.
The purpose of this information collection is to facilitate the
functioning of a covered clearing agency in the event that a
participant fails to meet its obligations, as well as limit the extent
to which a participant's failure can spread to other participants or
the covered clearing agency itself.
14. Rule 17Ad-22(e)(14)
As proposed, Rule 17Ad-22(e)(14) would require a covered clearing
agency that is a security-based swap clearing agency or a complex risk
profile clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to enable the
segregation and portability of positions of a member's customers and
the collateral provided to the covered clearing agency with respect to
those positions, and effectively protect such positions and related
collateral from the default or insolvency of that member. The
Commission is adopting Rule 17Ad-22(e)(14) as proposed.\786\
---------------------------------------------------------------------------
\786\ See supra Part II.C.14.
---------------------------------------------------------------------------
The purpose of this information collection is to facilitate the
safe and effective holding and transfer of customers' positions and
collateral in the event of a participant's default or insolvency.
15. Rule 17Ad-22(e)(15)
As proposed, Rule 17Ad-22(e)(15) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage its
general business risk and hold sufficient liquid net assets funded by
equity to cover potential general business losses so that the covered
clearing agency can continue operations and services as a going concern
if those losses materialize. Proposed Rule 17Ad-22(e)(15)(i) would
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to
determine the amount of liquid net assets funded by equity based upon
its general business risk profile and the length of time required to
achieve a recovery or orderly wind-down, as
[[Page 70888]]
appropriate, of its critical operations and services if such action is
taken. Proposed Rule 17Ad-22(e)(15)(ii) would require a clearing agency
to establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for holding liquid net assets
funded by equity equal to the greater of either six months of its
current operating expenses or the amount determined by the board of
directors to be sufficient to ensure a recovery or orderly wind-down of
critical operations and services of the covered clearing agency, as
contemplated by the plans established under Rule 17Ad-22(e)(3)(ii).
Additionally, proposed Rule 17Ad-22(e)(15)(ii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for monitoring
its business operations and reducing the likelihood of losses. Proposed
Rule 17Ad-22(e)(15)(iii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for maintaining a viable
plan, approved by the board of directors and updated at least annually,
for raising additional equity should its equity fall close to or below
the amount required by the rule, as discussed above. The Commission is
adopting Rule 17Ad-22(e)(15) as proposed.\787\
---------------------------------------------------------------------------
\787\ See supra Part II.C.15.
---------------------------------------------------------------------------
The purpose of this information collection is to mitigate the
potential impairment of a covered clearing agency as a result of a
decline in revenues or increase in expenses.
16. Rule 17Ad-22(e)(16)
As proposed, Rule 17Ad-22(e)(16) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to safeguard its own and its
participants' assets and minimize the risk of loss and delay in access
to these assets. Proposed Rule 17Ad-22(e)(16) would also require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to invest such
assets in instruments with minimal credit, market, and liquidity risks.
The Commission is adopting Rule 17Ad-22(e)(16) as proposed.\788\
---------------------------------------------------------------------------
\788\ See supra Part II.C.16.
---------------------------------------------------------------------------
The purpose of this information collection is to improve the
ability of a covered clearing agency to meet its settlement
obligations.
17. Rule 17Ad-22(e)(17)
As proposed, Rule 17Ad-22(e)(17) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to manage the covered clearing
agency's operational risk. Proposed Rule 17Ad-22(e)(17)(i) would
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to identify
the plausible sources of operational risk, both internal and external,
and mitigate their impact through the use of appropriate systems,
policies, procedures, and controls. Proposed Rule 17Ad-22(e)(17)(ii)
would require a covered clearing agency to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to ensure that systems have a high degree of security,
resiliency, operational reliability, and adequate, scalable capacity.
Finally, proposed Rule 17Ad-22(e)(17)(iii) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for a business
continuity plan that addresses events posing a significant risk of
disrupting operations.
The Commission is adopting Rule 17Ad-22(e)(17) with one
modification: Because the text in Rule 17Ad-22(e)(17)(ii) for
``establishing and maintaining policies and procedures reasonably
designed'' is duplicative of the requirement under Rule 17Ad-22(e) to
have policies and procedures reasonably designed to establish,
maintain, implement, and enforce the requirements thereunder, the
Commission is removing the duplicative text.\789\
---------------------------------------------------------------------------
\789\ See supra Part II.C.17.
---------------------------------------------------------------------------
The purpose of this information collection is to limit operational
disruptions that may impede the proper functioning of a covered
clearing agency.
18. Rule 17Ad-22(e)(18)
As proposed, Rule 17Ad-22(e)(18) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish objective, risk-based,
and publicly disclosed criteria for participation, which permit fair
and open access by direct and, where relevant, indirect participants
and other FMUs. Proposed Rule 17Ad-22(e)(18) would also require that a
covered clearing agency establish, implement, maintain and enforce
written policies and procedures reasonably designed to require
participants to have sufficient financial resources and robust
operational capacity to meet obligations arising from participation in
the clearing agency and to monitor compliance with participation
requirements on an ongoing basis. The Commission is adopting Rule 17Ad-
22(e)(18) as proposed.\790\
---------------------------------------------------------------------------
\790\ See supra Part II.C.18.
---------------------------------------------------------------------------
The purpose of this information collection is to enable a covered
clearing agency to ensure that only entities with sufficient financial
and operational capacity are direct participants in the covered
clearing agency, while still ensuring that all qualified persons can
access a covered clearing agency's services. The purpose of this
information collection is also to enable a covered clearing agency to
monitor that participation requirements are met on an ongoing basis and
to identify a participant experiencing financial difficulties before
the participant fails to meet its settlement obligations.
19. Rule 17Ad-22(e)(19)
As proposed, Rule 17Ad-22(e)(19) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to identify, monitor, and manage the
material risks to the covered clearing agency arising from arrangements
in which firms that are indirect participants in the covered clearing
agency rely on the services provided by direct participants in the
covered clearing agency to access the covered clearing agency's
payment, clearing, or settlement facilities (hereinafter ``tiered
participation arrangements''). In addition, proposed Rule 17Ad-
22(e)(19) would also require that a covered clearing agency establish,
implement, maintain and enforce written policies and procedures
reasonably designed to regularly review the material risks to the
covered clearing agency arising from such tiered participation
arrangements. The Commission is adopting Rule 17Ad-22(e)(19) as
proposed.\791\
---------------------------------------------------------------------------
\791\ See supra Part II.C.19.
---------------------------------------------------------------------------
The purpose of this information collection is to enable a covered
clearing agency to identify and manage risks posed by non-member
entities, such as the customers of clearing members.
20. Rule 17Ad-22(e)(20)
As proposed, Rule 17Ad-22(e)(20) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures
[[Page 70889]]
reasonably designed to identify, monitor, and manage risks related to
any link with one or more other clearing agencies, FMUs, or trading
markets.\792\ The Commission is adopting Rule 17Ad-22(e)(20) as
proposed.
---------------------------------------------------------------------------
\792\ See supra Part II.C.20.
---------------------------------------------------------------------------
The purpose of this information collection is to enable a covered
clearing agency to identify and manage risks posed by linkages to other
entities, such as other clearing agencies, FMUs, or trading markets.
21. Rule 17Ad-22(e)(21)
As proposed, Rule 17Ad-22(e)(21) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it is efficient and
effective in meeting the requirements of its participants and the
markets it serves. Proposed Rule 17Ad-22(e)(21) would also require a
covered clearing agency's management to regularly review the efficiency
and effectiveness of its (i) clearing and settlement arrangements; (ii)
operating structure, including risk management policies, procedures,
and systems; (iii) scope of products cleared, settled, or recorded; and
(iv) use of technology and communication procedures.
The Commission is adopting Rule 17Ad-22(e)(21) with one
modification: the Commission is removing reference to ``recorded''
products under Rule 17Ad-22(e)(21)(iii) because recording products is
not a function of covered clearing agencies.\793\
---------------------------------------------------------------------------
\793\ See supra Part II.C.21.
---------------------------------------------------------------------------
The purpose of this information collection is to ensure that the
services provided by a covered clearing agency do not become
inefficient and to promote the sound operation of a covered clearing
agency.
22. Rule 17Ad-22(e)(22)
As proposed, Rule 17Ad-22(e)(22) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it uses, or at a
minimum accommodates, relevant internationally accepted communication
procedures and standards in order to facilitate efficient payment,
clearing, and settlement. The Commission is adopting Rule 17Ad-
22(e)(22) as proposed.\794\
---------------------------------------------------------------------------
\794\ See supra Part II.C.22.
---------------------------------------------------------------------------
The purpose of this information collection is to ensure the prompt
and accurate clearance and settlement of securities transactions by
enabling participants to communicate with a clearing agency in a
timely, reliable, and accurate manner.
23. Rule 17Ad-22(e)(23)
As proposed, Rule 17Ad-22(e)(23) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for the specific disclosures
enumerated in the rule, as discussed below. Proposed Rule 17Ad-
22(e)(23) would require such policies and procedures to specifically
require a covered clearing agency to (i) publicly disclose all relevant
rules and material procedures, including key aspects of its default
rules and procedures; (ii) provide sufficient information to enable
participants to identify and evaluate the risks, fees, and other
material costs they incur by participating in the covered clearing
agency; and (iii) publicly disclose relevant basic data on transaction
volume and values.
Rule 17Ad-22(e)(23)(iv) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to maintain clear and comprehensive
rules and procedures that provide for a comprehensive public disclosure
of its material rules, policies, and procedures regarding governance
arrangements and legal, financial, and operational risk management,
accurate in all material respects at the time of publication, including
(i) a general background of the covered clearing agency, including its
function and the market it serves, basic data and performance
statistics on its services and operations, such as basic volume and
value statistics by product type, average aggregate intraday exposures
to its participants, and statistics on the covered clearing agency's
operational reliability, and a description of its general organization,
legal and regulatory framework, and system design and operations; (ii)
a standard-by-standard summary narrative for each applicable standard
set forth in proposed Rules 17Ad-22(e)(1) through (22) with sufficient
detail and context to enable the reader to understand its approach to
controlling the risks and addressing the requirements in each standard;
(iii) a summary of material changes since the last update of the
disclosure; and (iv) an executive summary of the key points regarding
each. Rule 17Ad-22(e)(23)(v) would also require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure the comprehensive public
disclosure required under proposed Rule 17Ad-22(e)(23)(iv) is updated
not less than every two years, or more frequently following changes to
its system or the environment in which it operates to the extent
necessary, to ensure statements previously provided remain accurate in
all material respects.\795\
---------------------------------------------------------------------------
\795\ See supra Part II.C.23.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ad-22(e)(23) with three
modifications, as previously discussed in Part II.C.23.c. First, the
Commission is striking the language ``maintain clear and comprehensive
rules and procedures'' under Rule 17Ad-22(e)(23) because Rule 17Ad-
22(e) already requires that a covered clearing agency have written
policies and procedures reasonably designed to establish, implement,
maintain and enforce the requirements thereunder. Consistent with this
change, the Commission is also striking ``providing'' from Rule 17Ad-
22(e)(23)(iv). Second, the Commission is modifying Rule 17Ad-
22(e)(23)(iv) so that the language more closely tracks the categories
of requirements in Rule 17Ad-22(e). The purpose of this modification is
to make clear that the comprehensive public disclosure is intended to
describe the material rules, policies and procedures of the covered
clearing agency related to compliance with Rule 17Ad-22(e), rather than
require a complete disclosure of all rules, policies, and procedures.
As adopted, Rule 17Ad-22(e)(23)(iv) will require policies and
procedures providing for a comprehensive public disclosure that
describes the covered clearing agency's material rules, policies, and
procedures regarding its legal, governance, risk management, and
operating framework, accurate in all material respects at the time of
publication. Third, the Commission is also modifying paragraph (iv)(D)
to correct technical errors in the proposed rule text so that it refers
to the standards set forth in paragraphs (e)(1) through (23) (rather
than (e)(1) through (22)). The Commission believes that providing a
summary narrative for Rule 17Ad-22(e)(23) is appropriate because Rule
17Ad-22(e)(23) requires policies and procedures to (i) publicly
disclose all relevant rules and material procedures, including key
aspects of its default rules and procedures; (ii) provide sufficient
information to enable participants to identify and evaluate the risks,
fees, and other material costs they incur by participating in the
covered clearing agency; and (iii) publicly disclose relevant basic
data on transaction
[[Page 70890]]
volume and values, in addition to requiring the standard-by-standard
summary narrative required by Rule 17Ad-22(e)(23)(iv)(D).
The purpose of this information collection is to ensure that
participants and prospective participants in a covered clearing agency
are provided with a complete picture of the covered clearing agency's
operations and risk management so that they can understand the risks
and responsibilities of participation in the covered clearing agency.
24. Rule 17Ab2-2
Proposed Rule 17Ab2-2 would establish procedures for the Commission
to make determinations affecting covered clearing agencies in three
cases:
Pursuant to proposed Rule 17Ab2-2(a), the Commission may,
if it deems appropriate, upon application by any registered clearing
agency or member thereof or on its own initiative, determine whether a
registered clearing agency should be considered a covered clearing
agency.
Pursuant to proposed Rule 17Ab2-2(b), the Commission may,
if it deems appropriate, upon application by any clearing agency or
member thereof, or on its own initiative, determine whether a covered
clearing agency meets the definition of ``systemically important in
multiple jurisdictions.''
Pursuant to proposed Rule 17Ab2-2(c), the Commission may,
if it deems appropriate, determine whether any of the activities of a
clearing agency providing central counterparty services, in addition to
clearing agencies registered with the Commission for the purpose of
clearing security-based swaps, have a more complex risk profile.
Under proposed Rule 17Ab2-2(e), in each of the above cases, the
Commission would publish notice of its intention to consider such
determinations, together with a brief statement of the grounds under
consideration, and provide at least a 30-day public comment period
prior to any determination. The Commission may also provide the
clearing agency subject to the proposed determination opportunity for
hearing regarding the proposed determination. Under proposed Rule
17Ab2-2(f), in each of the above cases, notice of determinations would
be given by prompt publication thereof, together with a statement of
written reasons supporting the determination.\796\
---------------------------------------------------------------------------
\796\ See supra Part II.D.
---------------------------------------------------------------------------
The Commission is adopting Rule 17Ab2-2 with modifications. First
the Commission has determined not to adopt proposed Rule 17Ab2-2(a).
Second, with respect to proposed Rules 17Ab2-2(b) and (c),\797\ the
Commission is removing the factors that reference such other
characteristics or factors that the Commission deems appropriate in the
circumstances. Third, the Commission is adopting a new paragraph to
provide for a process to rescind any determination made pursuant to
Rule 17Ab2-2. This new rule includes the same procedural elements as
for determinations for application of covered clearing agency status,
including publication with a 30-day comment period. Because the
Commission is not adopting Rule 17Ab2-2(a), the Commission is also
renumbering the remaining paragraphs accordingly.
---------------------------------------------------------------------------
\797\ Because the Commission has determined not to adopt
proposed Rule 17Ab2-2(a), the Commission is renumbering Rule 17Ab2-2
accordingly, and proposed Rules 17Ab2-2(b) and (c) will therefore
appear in Rules 17Ab2-2(a) and (b) respectively. See infra Part VI.
---------------------------------------------------------------------------
The purpose of this information collection is to enable
determinations by the Commission regarding the status of a registered
clearing agency or a covered clearing agency, as applicable and as
described above.
25. Rule 17Ad-22(c)(1)
Rule 17Ad-22(c)(1) requires that, each fiscal quarter (based on
calculations made as of the last business day of the clearing agency's
fiscal quarter), or at any time upon Commission request, a registered
clearing agency that performs CCP services shall calculate and maintain
a record, in accordance with Rule 17a-1 under the Exchange Act,\798\ of
the financial resources necessary to meet the requirements of paragraph
(b)(3) of Rule 17Ad-22, and sufficient documentation to explain the
methodology it uses to compute such financial resource requirement.
---------------------------------------------------------------------------
\798\ See 17 CFR 240.17a-1.
---------------------------------------------------------------------------
In response to the comments received,\799\ the Commission is
modifying Rule 17Ad-22(c)(1) to require a registered clearing agency
that performs CCP services to calculate and maintain a record of
financial and qualifying liquid resources necessary to also meet
paragraphs (e)(4) and (e)(7), as applicable, in addition to paragraph
(b)(3). Because calculations under Rule 17Ad-22(b)(3) and (e)(4) would
refer to the same financial resources at a covered clearing agency, the
Commission anticipates that the calculations for each would be the same
and would involve adjustments needed to synthesize and format existing
information in a manner sufficient to explain the methodology the
clearing agency uses to meet the requirements of the rule.
---------------------------------------------------------------------------
\799\ See supra Part I.C.3.
---------------------------------------------------------------------------
The purpose of this information collection is to require a CCP to
calculate and document its financial and qualifying liquid resources
necessary under Rules 17Ad-22.
B. Respondents
In the CCA Standards proposing release, the Commission estimated
that the majority of the requirements in Rule 17Ad-22(e) would have
then applied to five registered clearing agencies, each of which met
the definition of ``covered clearing agency.'' \800\ The Commission
estimated that two additional entities might seek to register with the
Commission and that, of those, one might be a security-based swap
clearing agency. The Commission also noted that the number of covered
clearing agencies subject to Rule 17Ad-22(e) could increase further if
either (i) the FSOC were to designate additional clearing agencies as
systemically important or (ii) Commission determinations under Rule
17Ab2-2 found additional clearing agencies to be covered clearing
agencies. The Commission noted, however, that it could not predict
whether the FSOC might exercise such authority or whether such
determinations under Rule 17Ab2-2 would be appropriate, and therefore
estimated, for PRA purposes, that a majority of the requirements under
Rule 17Ad-22(e) would have seven respondents, of which (i) six would be
CCPs and one would be a CSD and (ii) two would be security-based swap
clearing agencies. The Commission then further clarified that Rule
17Ad-22(e)(6) would only have six respondents because it only applies
to CCPs, Rule 17Ad-22(e)(11) would only have one respondent because it
only applies to CSDs, and Rule 17Ad-22(e)(14) would only have two
respondents because it only applies to security-based swap clearing
agencies.
---------------------------------------------------------------------------
\800\ See CCA Standards, supra note 5, at 29566. Specifically,
under the definition, four registered clearing agencies would have
been designated clearing agencies for which the Commission is the
supervisory agency, and one registered clearing agency would have
been a security-based swap clearing agency. Because of modifications
to Rule 17Ad-22(a), the definition of ``covered clearing agency'' is
being moved to Rule 17Ad-22(a)(5). See infra Part VI.
---------------------------------------------------------------------------
With regard to Rule 17Ab2-2, the Commission estimated, for PRA
purposes, that two registered clearing agencies or their members on
their behalf might apply for a Commission determination or be subject
to a Commission-initiated determination
[[Page 70891]]
regarding whether the registered clearing agency is a covered clearing
agency, whether the registered clearing agency is involved in
activities with a more complex risk profile, or whether the registered
clearing agency, as a covered clearing agency, is systemically
important in multiple jurisdictions.\801\
---------------------------------------------------------------------------
\801\ See id. at 29567.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(c)(1), which the Commission is
modifying in response to comments received,\802\ the affected
respondents would only be covered clearing agencies because the
modifications to Rule 17Ad-22(c)(1) refer to requirements that only
apply to covered clearing agencies subject to Rule 17Ad-22(e).
Accordingly, the affected respondents are the same as under Rule 17Ad-
22(e).
---------------------------------------------------------------------------
\802\ See supra Part I.C.3.
---------------------------------------------------------------------------
The Commission received no comment regarding the estimates for
Rules 17Ad-22(e) and 17Ab2-2 and continues to believe that the above
estimates are appropriate for the below discussion of total annual
reporting and recordkeeping burdens.
C. Total Annual Reporting and Recordkeeping Burdens
As described in the CCA Standards proposing release, the Commission
believes the information collected pursuant to Rule 17Ad-22(e)
reflects, to a degree, existing policies and procedures at covered
clearing agencies, but in some instances a covered clearing agency will
be required to develop new policies and procedures. Thus, when a
covered clearing agency reviews and updates its policies and procedures
pursuant to Rule 17Ad-22(e), the Commission believes that the PRA
burden may vary across the requirements under Rule 17Ad-22(e),
depending on the complexity of the requirement in question and the
extent to which a covered clearing agency already has policies and
procedures consistent with the requirement. As a general matter, the
portions of Rule 17Ad-22(e) for which the Commission expects a higher
PRA burden are those provisions including requirements not comparable
to any existing requirements under Rule 17Ad-22(d). Where the
requirements do not reflect existing practices or the normal course of
a covered clearing agency's activity, the PRA burden may entail, in
addition to ongoing burdens, initial one-time burdens to develop new
policies and procedures. The Commission received no comments regarding
the accuracy of the estimated annual reporting and recordkeeping
burdens for Rules 17Ad-22(e) or 17Ab2-2.
As described in the CCA Standards proposing release,\803\ the
Commission continues to believe that Rules 17Ad-22(e)(1), (8) through
(10), (12), (14), (16), and (22) contain requirements either
substantially similar to those in Rule 17Ad-22(d) or reflect current
practices at covered clearing agencies. The Commission believes that a
covered clearing agency may need to make only limited changes to its
policies and procedures pursuant to the requirements in these rules.
For example, a covered clearing agency may need to conduct a comparison
of its existing policies and procedures against each rule to confirm
that its policies and procedures are consistent with the requirements
therein.
---------------------------------------------------------------------------
\803\ See CCA Standards proposing release, supra note 5, at
29567 & nn.440-443.
---------------------------------------------------------------------------
The Commission also continues to believe that Rules 17Ad-22(e)(2),
(3), (5), (11), (13), (17), (18), (20), and (21) contain provisions
that are similar to those in Rule 17Ad-22(d) but would also impose
additional requirements not found in Rule 17Ad-22(d). The Commission
believes that a covered clearing agency may need to make changes to
update its policies and procedures pursuant to the requirements in
these rules. For example, a covered clearing agency may need to review
and amend its existing rules, policies, and procedures but may not need
to develop, design, or implement new operations or practices pursuant
to these rules.
For Rules 17Ad-22(e)(4), (6), (7), (15), (19), and (23), for which
no comparable pre-existing requirements under Rule 17Ad-22 have been
identified, the Commission continues to believe that a covered clearing
agency may need to make more extensive changes to its policies and
procedures, may need to implement new policies and procedures, and may
need to take other steps pursuant to the requirements in these rules.
For example, a covered clearing agency may need to develop, design, and
implement new operations and practices. In these cases, the PRA burden
is greater since these requirements may not reflect established
practices or the normal course of a covered clearing agency's
activities. Further, the PRA burden for these rules may entail both
initial one-time burdens, such as create new policies and procedures,
as well as ongoing burdens, such as requirements to make certain
disclosures or perform certain types of review, on a periodic basis.
1. Rule 17Ad-22(e)(1)
As described in Part IV.A.1, the Commission is adopting Rule 17Ad-
22(e)(1) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\804\
---------------------------------------------------------------------------
\804\ See CCA Standards proposing release, supra note 5, at
29567-68.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(1) contains substantially similar provisions to
Rule 17Ad-22(d)(1).\805\ The Commission therefore expects that a
respondent clearing agency has written rules, policies, and procedures
substantially similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing current policies
and procedures and revising them, where appropriate, pursuant to the
rule. Accordingly, based on the similar provisions and the
corresponding burden estimates previously made by the Commission for
Rule 17Ad-22(d)(1),\806\ the Commission estimates that respondent
clearing agencies will incur an aggregate one-time burden of
approximately 56 hours to review and revise existing policies and
procedures.\807\
---------------------------------------------------------------------------
\805\ See 17 CFR 240.17Ad-22(d)(1); see also supra Part II.C.1.
\806\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\807\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours)) = 8 hours
x 7 respondent clearing agencies = 56 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(1) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to Rule 17Ad-22,\808\ the Commission
estimates that the ongoing activities required by Rule 17Ad-22(e)(1)
impose an aggregate annual burden on respondent clearing agencies of 21
hours.\809\
---------------------------------------------------------------------------
\808\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\809\ This figure was calculated as follows: (Compliance
Attorney for 3 hours) x 7 respondent clearing agencies = 21 hours.
---------------------------------------------------------------------------
2. Rule 17Ad-22(e)(2)
As described in Part IV.A.2, the Commission is adopting Rule 17Ad-
22(e)(2) with modifications. In consideration of these modifications,
the burden estimates for the rule have been modified from the
preliminary estimates in the CCA Standards proposing release, as
described below.
Rule 17Ad-22(e)(2) contains similar provisions to Rule 17Ad-
22(d)(8) but also adds additional requirements that
[[Page 70892]]
do not appear in Rule 17Ad-22(d).\810\ The Commission therefore expects
that a respondent clearing agency may have written rules, policies, and
procedures similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing and revising
current policies and procedures and creating new policies and
procedures, as necessary, pursuant to the rule. Accordingly, based on
the similar provisions and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(8),\811\ the
Commission preliminarily estimated that respondent clearing agencies
would incur an aggregate one-time burden of approximately 154 hours to
review and revise existing policies and procedures and to create new
policies and procedures, as necessary.\812\ Because the modifications
to Rule 17Ad-22(e)(2) noted above will require updating current
policies and procedures or establishing new policies and procedures to
ensure compliance, the Commission estimates that respondent clearing
agencies will incur an aggregate one-time burden of approximately 175
hours to review and revise existing policies and procedures and to
create new policies and procedures, as necessary.\813\
---------------------------------------------------------------------------
\810\ See 17 CFR 204.17Ad-22(d)(8); see also supra Part II.C.2.
\811\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\812\ See CCA Standards proposing release, supra note 5, at
29568. This figure was calculated as follows: ((Assistant General
Counsel for 12 hours) + (Compliance Attorney for 10 hours)) = 22
hours x 7 respondent clearing agencies = 154 hours.
The Commission notes that the CCA Standards proposing release
correctly identified the number of initial burden hours as 154 hours
but incorrectly stated the burden estimate for Assistant General
Counsel as 24 rather than 12 hours. See id.
\813\ This figure was calculated as follows: ((Assistant General
Counsel for 14 hours) + (Compliance Attorney for 11 hours)) = 25
hours x 7 respondent clearing agencies = 175 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(2) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to Rule 17Ad-22,\814\ the Commission
preliminarily estimated that the ongoing activities required by Rule
17Ad-22(e)(2) would impose an aggregate annual burden on respondent
clearing agencies of 28 hours.\815\ Because the modifications to Rule
17Ad-22(e)(2) noted above will require updating current policies and
procedures or establishing new policies and procedures to ensure
compliance, the Commission estimates that the ongoing activities
required by Rule 17Ad-22(e)(2) will impose an aggregate annual burden
on respondent clearing agencies of 35 hours.\816\
---------------------------------------------------------------------------
\814\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\815\ See CCA Standards proposing release, supra note 5, at
29568. This figure was calculated as follows: (Compliance Attorney
for 4 hours) x 7 respondent clearing agencies = 28 hours.
\816\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
3. Rule 17Ad-22(e)(3)
As described in Part IV.A.3, the Commission is adopting Rule 17Ad-
22(e)(3) with one modification. Because this modification is only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. The burden estimates below are unchanged from the CCA
Standards proposing release.\817\
---------------------------------------------------------------------------
\817\ See CCA Standards proposing release, supra note 5, at
29568.
---------------------------------------------------------------------------
While Rule 17Ad-22(d) requires registered clearing agencies to have
policies and procedures to manage certain risks,\818\ Rule 17Ad-
22(e)(3) requires a comprehensive framework for risk management, under
which policies and procedures for risk management are designed
holistically, are consistent with each other, and work effectively
together. Accordingly, the PRA burden requires a respondent clearing
agency to revise its written rules, policies, and procedures to
include, among other things, periodic review and plans for the recovery
and orderly wind-down of the covered clearing agency. As a result, the
Commission estimates that respondent clearing agencies will incur an
aggregate one-time burden of 399 hours to review and revise existing
policies and procedures and to create new policies and procedures, as
necessary.\819\
---------------------------------------------------------------------------
\818\ See 17 CFR 240.17Ad-22(d).
\819\ This figure was calculated as follows: ((Assistant General
Counsel for 25 hours) + (Compliance Attorney for 18 hours) + (Senior
Risk Management Specialist for 7 hours) + (Computer Operations
Manager for 7 hours)) = 57 hours x 7 respondent clearing agencies =
399 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(3) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures created in
response to the rule and activities related to facilitating a periodic
review of the risk management framework. Based on the Commission's
previous estimates for ongoing monitoring and compliance burdens with
respect to Rule 17Ad-22,\820\ the Commission estimates that the ongoing
activities required by Rule 17Ad(22)(e)(3) impose an aggregate annual
burden on respondent clearing agencies of 343 hours.\821\ Additionally,
the Commission notes that the estimated ongoing burden for Rule 17Ad-
22(e)(3) is similar to the initial one-time burden because the rule
requires policies and procedures for review on a specified periodic
basis and approval by the board of directors annually.
---------------------------------------------------------------------------
\820\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\821\ This figure was calculated as follows: ((Compliance
Attorney for 8 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 5 hours) + (Risk Management Specialist
for 33 hours)) = 49 hours x 7 respondent clearing agencies = 343
hours.
---------------------------------------------------------------------------
4. Rule 17Ad-22(e)(4)
As described in Part IV.A.4, the Commission is adopting Rule 17Ad-
22(e)(4) with modifications. While some of these modifications are only
technical or clarifying in nature, the burden estimates for the rule,
as described below, have been modified from the preliminary estimates
in the CCA Standards proposing release to reflect that Rules 17Ad-
22(e)(13)(i) and (ii) are being adopted under Rule 17Ad-22(e)(4) as new
Rules 17Ad-22(e)(4)(viii) and (ix).\822\
---------------------------------------------------------------------------
\822\ The Commission notes that because the modifications to
Rules 17Ad-22(e)(4) and (13) reflect only the moving of requirements
from Rule 17Ad-22(e)(13) to Rule 17Ad-22(e)(4), the burden hours
across the two rules remains unchanged.
---------------------------------------------------------------------------
The Commission estimates that the PRA burdens for Rule 17Ad-
22(e)(4) are more significant than in other cases under Rule 17Ad-22(e)
and may require a respondent clearing agency to make substantial
changes to its written rules, policies, and procedures pursuant to the
rule.\823\ In addition, Rule 17Ad-22(e)(4) will require a respondent
clearing agency to make one-time systems adjustments so that it has the
capability to test the sufficiency of its financial resources and to
perform an annual model validation. As a result, the Commission
preliminarily estimated that respondent clearing agencies would incur
an aggregate one-time burden of 1,400 hours.\824\ Because the
modifications to Rule 17Ad-22(e)(4) noted above will require updating
current policies and procedures or establishing new policies and
[[Page 70893]]
procedures to ensure compliance, the Commission estimates that
respondent clearing agencies will incur an aggregate one-time burden of
approximately 1,533 hours to review and revise existing policies and
procedures and to create new policies and procedures, as
necessary.\825\
---------------------------------------------------------------------------
\823\ See supra Part II.C.4.
\824\ See CCA Standards proposing release, supra note 5, at
29568. This figure was calculated as follows: ((Assistant General
Counsel for 60 hours) + (Compliance Attorney for 40 hours) + (Senior
Risk Management Specialist for 30 hours) + (Computer Operations
Manager for 45 hours) + (Chief Compliance Officer for 15 hours) +
(Senior Programmer for 10 hours)) = 200 hours x 7 respondent
clearing agencies = 1,400 hours.
\825\ This figure was calculated as follows: ((Assistant General
Counsel for 74 hours) + (Compliance Attorney for 45 hours) + (Senior
Risk Management Specialist for 30 hours) + (Computer Operations
Manager for 45 hours) + (Chief Compliance Officer for 15 hours) +
(Senior Programmer for 10 hours)) = 219 hours x 7 respondent
clearing agencies = 1,533 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(4) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures developed in
response to the rule and ongoing activities with respect to testing the
sufficiency of its financial resources and performing the annual model
validation. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to Rule 17Ad-22,\826\
the Commission preliminarily estimated that the ongoing activities
required by proposed Rule 17Ad-22(e)(4) would impose an aggregate
annual burden on respondent clearing agencies of 420 hours.\827\
Because the modifications to Rule 17Ad-22(e)(4) noted above will
require updating current policies and procedures or establishing new
policies and procedures to ensure compliance, the Commission estimates
that the ongoing activities required by Rule 17Ad-22(e)(4) will impose
an aggregate annual burden on respondent clearing agencies of 434
hours.\828\
---------------------------------------------------------------------------
\826\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\827\ See CCA Standards proposing release, supra note 5, at
29569. This figure was calculated as follows: ((Compliance Attorney
for 24 hours) + (Administrative Assistant for 3 hours) + (Senior
Business Analyst for 3 hours) + (Risk Management Specialist for 30
hours)) = 60 hours x 7 respondent clearing agencies = 420 hours.
\828\ This figure was calculated as follows: ((Compliance
Attorney for 26 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours) + (Risk Management Specialist
for 30 hours)) = 62 hours x 7 respondent clearing agencies = 434
hours.
---------------------------------------------------------------------------
5. Rule 17Ad-22(e)(5)
As described in Part IV.A.5, the Commission is adopting Rule 17Ad-
22(e)(5) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\829\
---------------------------------------------------------------------------
\829\ See CCA Standards proposing release, supra note 5, at
29569.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(5) contains similar provisions to Rule 17Ad-
22(d)(3).\830\ The Commission therefore expects that a respondent
clearing agency has written rules, policies, and procedures
substantially similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing current policies
and procedures and revising them, where appropriate, pursuant to the
rule. For example, a respondent clearing agency may need to develop new
policies and procedures for an annual review of the sufficiency of its
collateral haircuts and concentration limits. Accordingly, based on the
similar policies and procedures requirements in and the Commission's
previous corresponding burden estimates for Rule 17Ad-22(d)(3),\831\
the Commission estimates that respondent clearing agencies will incur
an aggregate one-time burden of approximately 294 hours to review and
revise existing policies and procedures and to create new policies and
procedures, as necessary.\832\
---------------------------------------------------------------------------
\830\ See 17 CFR 240.17Ad-22(d)(3); see also supra Part II.C.5.
\831\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\832\ This figure was calculated as follows: ((Assistant General
Counsel for 16 hours) + (Compliance Attorney for 12 hours) + (Senior
Risk Management Specialist for 7 hours) + (Computer Operations
Manager for 7 hours)) = 42 hours x 7 respondent clearing agencies =
294 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(5) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to the written policies and procedures created
in response to the rule and also requires an annual review of
collateral haircuts and concentration limits. Based on the Commission's
previous estimates for ongoing monitoring and compliance burdens with
respect to Rule 17Ad-22,\833\ the Commission estimates that the ongoing
activities required by the rule imposes an aggregate annual burden on
respondent clearing agencies of 252 hours.\834\ The Commission notes
that the estimated ongoing burden for Rule 17Ad-22(e)(5) is similar to
the initial one-time burden because the rule requires policies and
procedures for a not-less-than-annual review of the sufficiency of a
covered clearing agency's collateral haircuts and concentration limits.
---------------------------------------------------------------------------
\833\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\834\ This figure was calculated as follows: ((Compliance
Attorney for 6 hours) + (Risk Management Specialist for 30 hours)) =
36 hours x 7 respondent clearing agencies = 252 hours.
---------------------------------------------------------------------------
6. Rule 17Ad-22(e)(6)
As described in Part IV.A.6, the Commission is adopting Rule 17Ad-
22(e)(6) with modifications. Because these modifications are only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. Therefore, the burden estimates described below are unchanged
from the CCA Standards proposing release.\835\
---------------------------------------------------------------------------
\835\ See CCA Standards proposing release, supra note 5, at
29569.
---------------------------------------------------------------------------
The Commission estimates that the PRA burdens for Rule 17Ad-
22(e)(6) are more significant than in other cases under Rule 17Ad-22(e)
and may require a respondent clearing agency to make substantial
changes to its written rules, policies, and procedures pursuant to the
rule.\836\ For example, Rule 17Ad-22(e)(6) requires one-time systems
adjustments to perform daily backtesting and monthly (or more frequent)
sensitivity analyses. As a result, the Commission preliminarily
estimated that respondent clearing agencies would incur an aggregate
one-time burden of 1,080 hours to review and revise existing policies
and procedures and to create new policies and procedures, as
necessary.\837\
---------------------------------------------------------------------------
\836\ See id. at 29569 & n.469; see also supra Part II.C.6.
\837\ This figure was calculated as follows: ((Assistant General
Counsel for 50 hours) + (Compliance Attorney for 40 hours) + (Senior
Risk Management Specialist for 25 hours) + (Computer Operations
Manager for 40 hours) + (Chief Compliance Officer for 15 hours) +
(Senior Programmer for 10 hours)) = 180 hours x 6 respondent
clearing agencies = 1,080 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(6) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to the written policies and procedures created
in response to the rule and activities associated with daily
backtesting, monthly (or more frequent) sensitivity analyses, and
annual model validation. Based on the Commission's previous estimates
for ongoing monitoring and compliance burdens with respect to Rule
17Ad-22,\838\ the Commission estimates that the ongoing activities
required by Rule 17Ad-22(e)(6) impose an aggregate annual burden on
respondent clearing agencies of 360 hours.\839\
---------------------------------------------------------------------------
\838\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\839\ This figure was calculated as follows: ((Compliance
Attorney for 24 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours) + (Risk Management Specialist
for 30 hours)) = 60 hours x 6 respondent clearing agencies = 360
hours.
---------------------------------------------------------------------------
[[Page 70894]]
7. Rule 17Ad-22(e)(7)
As described in Part IV.A.7, the Commission is adopting Rule 17Ad-
22(e)(7) with modifications. Because these modifications are only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. Therefore, the burden estimates described below are unchanged
from the CCA Standards proposing release.\840\
---------------------------------------------------------------------------
\840\ See CCA Standards proposing release, supra note 5, at
29569-70.
---------------------------------------------------------------------------
The Commission estimates that the PRA burdens for Rule 17Ad-
22(e)(7) are more significant than in other cases under Rule 17Ad-22(e)
and may require a respondent clearing agency to make substantial
changes to its written rules, policies, and procedures pursuant to the
rule.\841\ For example, Rule 17Ad-22(e)(7) requires one-time systems
adjustments to test the sufficiency of its liquid resources, test its
access to liquidity providers, and perform an annual model validation.
As a result, the Commission estimates that respondent clearing agencies
will incur an aggregate one-time burden of 2,310 hours to review and
revise existing policies and procedures and to create new policies and
procedures, as necessary.\842\
---------------------------------------------------------------------------
\841\ See id. at 29569 & n.473; see also supra Part II.C.7.
\842\ This figure was calculated as follows: ((Assistant General
Counsel for 95 hours) + (Compliance Attorney for 85 hours) + (Senior
Risk Management Specialist for 45 hours) + (Computer Operations
Manager for 60 hours) + (Chief Compliance Officer for 30 hours) +
(Senior Programmer for 15 hours)) = 330 hours x 7 respondent
clearing agencies = 2,310 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(7) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to policies and procedures created in response
to the rule as well as activities related to testing the sufficiency of
its liquidity resources, testing access to its liquidity providers, and
performing an annual model validation. Based on the Commission's
previous estimates for ongoing monitoring and compliance burdens with
respect to existing Rule 17Ad-22,\843\ the Commission estimates that
the ongoing activities required by Rule 17Ad-22(e)(7) impose an
aggregate annual burden on respondent clearing agencies of 896
hours.\844\
---------------------------------------------------------------------------
\843\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\844\ This figure was calculated as follows: ((Compliance
Attorney for 48 hours) + (Administrative Assistant for 5 hours) +
(Senior Business Analyst for 5 hours) + (Risk Management Specialist
for 60 hours) + (Senior Risk Management Specialist for 10 hours)) =
128 hours x 7 respondent clearing agencies = 896 hours.
---------------------------------------------------------------------------
8. Rule 17Ad-22(e)(8)
As described in Part IV.A.8, the Commission is adopting Rule 17Ad-
22(e)(8) with one modification. Because these modifications are only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. Therefore, the burden estimates described below are unchanged
from the CCA Standards proposing release.\845\
---------------------------------------------------------------------------
\845\ See CCA Standards proposing release, supra note 5, at
29570.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(8) contains substantially similar provisions to
Rule 17Ad-22(d)(12).\846\ The Commission therefore expects that a
respondent clearing agency has written rules, policies, and procedures
substantially similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing current policies
and procedures and revising them, where appropriate, pursuant to the
rule. Accordingly, based on the similar provisions and the
corresponding burden estimates previously made by the Commission for
Rule 17Ad-22(d)(12),\847\ the Commission estimates that respondent
clearing agencies will incur an aggregate one-time burden of
approximately 84 hours to review and revise existing policies and
procedures.\848\
---------------------------------------------------------------------------
\846\ See 17 CFR 240.17Ad-22(d)(12); see also supra Part II.C.8.
\847\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\848\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(8) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\849\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(8) impose an aggregate annual burden on respondent clearing
agencies of approximately 35 hours.\850\
---------------------------------------------------------------------------
\849\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\850\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
9. Rule 17Ad-22(e)(9)
As described in Part IV.A.9, the Commission is adopting Rule 17Ad-
22(e)(9) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\851\
---------------------------------------------------------------------------
\851\ See CCA Standards proposing release, supra note 5, at
29570.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(9) contains substantially similar provisions to
Rule 17Ad-22(d)(5).\852\ The Commission therefore expects that a
respondent clearing agency has written rules, policies, and procedures
substantially similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing current policies
and procedures and revising them, where appropriate, pursuant to the
rule. Accordingly, based on the similar provisions and the
corresponding burden estimates previously made by the Commission for
Rule 17Ad-22(d)(5),\853\ the Commission estimates that respondent
clearing agencies will incur an aggregate one-time burden of
approximately 84 hours to review and revise existing policies and
procedures.\854\
---------------------------------------------------------------------------
\852\ See 17 CFR 240.17Ad-22(d)(5); see also supra Part II.C.9.
\853\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\854\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(9) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\855\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(9) impose an aggregate annual burden on respondent clearing
agencies of approximately 35 hours.\856\
---------------------------------------------------------------------------
\855\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\856\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
10. Rule 17Ad-22(e)(10)
As described in Part IV.A.10, the Commission is adopting Rule 17Ad-
22(e)(10) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\857\
---------------------------------------------------------------------------
\857\ See CCA Standards proposing release, supra note 5, at
29570.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(10) contains substantially similar provisions to
Rule 17Ad-22(d)(15).\858\ The Commission
[[Page 70895]]
therefore expects that a respondent clearing agency has written rules,
policies, and procedures substantially similar to the requirements in
the rule and that the PRA burden includes the incremental burdens of
reviewing current policies and procedures and revising them, where
appropriate, pursuant to the rule. Accordingly, based on the similar
provisions and the corresponding burden estimates previously made by
the Commission for Rule 17Ad-22(d)(15),\859\ the Commission estimates
that respondent clearing agencies will incur an aggregate one-time
burden of approximately 84 hours to review and revise existing policies
and procedures.\860\
---------------------------------------------------------------------------
\858\ See 17 CFR 240.17Ad-22(d)(15); see also supra Part
II.C.10.
\859\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\860\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(10) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\861\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(10) impose an aggregate annual burden on respondent clearing
agencies of approximately 35 hours.\862\
---------------------------------------------------------------------------
\861\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\862\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
11. Rule 17Ad-22(e)(11)
As described in Part IV.A.11, the Commission is adopting Rule 17Ad-
22(e)(11) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\863\
---------------------------------------------------------------------------
\863\ See CCA Standards proposing release, supra note 5, at
29570-71.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(e)(11), a respondent clearing agency
is a registered clearing agencies that provides CSD services. Because
Rule 17Ad-22(e)(11) contains similar provisions to Rule 17Ad-
22(d)(10),\864\ the Commission expects that such clearing agencies
generally have written rules, policies, and procedures similar to the
requirements imposed under the rule. Rule 17Ad-22(e)(11) also imposes
additional requirements that do not appear in Rule 17Ad-22, and
accordingly a covered clearing agency providing CSD services may need
to review and revise its policies and procedures or create new policies
and procedures, as necessary, as necessary, pursuant to the rule. Based
on the similar policies and procedures requirements and the
corresponding burden estimates made by the Commission for Rule 17Ad-
22(d)(10),\865\ the Commission estimates that the respondent clearing
agency will incur a one-time burden of approximately 55 hours to review
and revise existing policies and procedures and create new policies and
procedures, as necessary.\866\
---------------------------------------------------------------------------
\864\ See 17 CFR 240.17Ad-22(d)(10); see also supra Part
II.B.11.
\865\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\866\ This figure was calculated as follows: ((Assistant General
Counsel for 20 hours) + (Compliance Attorney for 10 hours) +
(Intermediate Accountant for 15 hours) + (Senior Business Analyst
for 5 hours) + (Computer Operations Manager for 5 hours)) = 55 hours
x 1 respondent clearing agency = 55 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(11) also imposes ongoing burdens on the respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\867\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(11) impose a total annual burden on the respondent clearing
agency of approximately 8 hours.\868\
---------------------------------------------------------------------------
\867\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\868\ This figure was calculated as follows: (Compliance
Attorney for 8 hours) x 1 respondent clearing agency = 8 hours.
---------------------------------------------------------------------------
12. Rule 17Ad-22(e)(12)
As described in Part IV.A.12, the Commission is adopting Rule 17Ad-
22(e)(12) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\869\
---------------------------------------------------------------------------
\869\ See CCA Standards proposing release, supra note 5, at
29571.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(12) contains substantially similar provisions to
Rule 17Ad-22(d)(13).\870\ The Commission therefore expects that a
respondent clearing agency has written rules, policies, and procedures
substantially similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing current policies
and procedures and revising them, where appropriate, pursuant to the
rule. Accordingly, based on the similar provisions and the
corresponding burden estimates previously made by the Commission for
Rule 17Ad-22(d)(13),\871\ the Commission estimates that respondent
clearing agencies will incur an aggregate one-time burden of
approximately 84 hours to review and revise existing policies and
procedures.\872\
---------------------------------------------------------------------------
\870\ See 17 CFR 240.17Ad-22(d)(13); see also supra Part
II.C.12.
\871\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\872\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Senior
Business Analyst for 2 hours) + (Computer Operations Manager for 2
hours)) = 12 hours x 7 respondent clearing agencies = 84 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(12) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\873\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(12) impose an aggregate annual burden on respondent clearing
agencies of approximately 35 hours.\874\
---------------------------------------------------------------------------
\873\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\874\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
13. Rule 17Ad-22(e)(13)
As described in Part IV.A.13, the Commission is adopting Rule 17Ad-
22(e)(13) with modifications. The burden estimates for the rule, as
described below, have been modified from the preliminary estimates in
the CCA Standards proposing release to reflect that Rules 17Ad-
22(e)(13)(i) and (ii) are being adopted under Rule 17Ad-22(e)(4) as new
Rules 17Ad-22(e)(4)(viii) and (ix).\875\
---------------------------------------------------------------------------
\875\ See supra note 822.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(13) requires a respondent clearing agency to have
written policies and procedures reasonably designed to address
participant default and ensure that the clearing agency can contain
losses and liquidity demands and continue to meet its obligations. Rule
17Ad-22(e)(13) contains similar provisions to Rule 17Ad-22(d)(11) but
also imposes additional requirements that do not appear in Rule 17Ad-
22.\876\ The Commission therefore expects that a respondent clearing
agency may have written rules, policies, and procedures similar to some
requirements in the rule and that the PRA burden includes the
incremental burdens of reviewing and
[[Page 70896]]
revising existing policies and procedures pursuant to Rule 17Ad-
22(e)(13) and creating new policies and procedures, as necessary.
Accordingly, based on the similar policies and procedures requirements
and the corresponding burden estimates previously made by the
Commission for Rule 17Ad-22(d)(11),\877\ the Commission preliminarily
estimated that respondent clearing agencies would incur an aggregate
one-time burden of approximately 420 hours to review and update
existing policies and procedures and to create new policies and
procedures, as necessary.\878\ Because the modifications to Rule 17Ad-
22(e)(13) noted above will require updating current policies and
procedures or establishing new policies and procedures to ensure
compliance, the Commission estimates that respondent clearing agencies
will incur an aggregate one-time burden of approximately 287 hours to
review and revise existing policies and procedures and to create new
policies and procedures, as necessary.\879\
---------------------------------------------------------------------------
\876\ See 17 CFT 240.17Ad-22(d)(11); see also supra Part
II.C.13.
\877\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\878\ See CCA Standards proposing release, supra note 5, at
29571. This figure was calculated as follows: ((Assistant General
Counsel for 20 hours) + (Compliance Attorney for 16 hours) + (Senior
Business Analyst for 12 hours) + (Computer Operations Manager for 12
hours)) = 60 hours x 7 respondent clearing agencies = 420 hours.
\879\ This figure was calculated as follows: ((Assistant General
Counsel for 6 hours) + (Compliance Attorney for 11 hours) + (Senior
Business Analyst for 12 hours) + (Computer Operations Manager for 12
hours)) = 41 hours x 7 respondent clearing agencies = 287 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(13) also imposes ongoing burdens on a respondent
clearing agency. The rule requires policies and procedures for the
annual review and testing of a clearing agency's default policies and
procedures. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to Rule 17Ad-22,\880\
the Commission preliminarily estimated that the ongoing activities
required by Rule 17Ad-22(e)(13) would impose an aggregate annual burden
on respondent clearing agencies of approximately 63 hours.\881\ Because
the modifications to Rule 17Ad-22(e)(13) noted above will require
updating current policies and procedures or establishing new policies
and procedures to ensure compliance, the Commission estimates that the
ongoing activities required by Rule 17Ad-22(e)(13) will impose an
aggregate annual burden on respondent clearing agencies of 49
hours.\882\
---------------------------------------------------------------------------
\880\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\881\ See CCA Standards proposing release, supra note 5, at
29571. This figure was calculated as follows: (Compliance Attorney
for 9 hours) x 7 respondent clearing agencies = 63 hours.
\882\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
14. Rule 17Ad-22(e)(14)
As described in Part IV.A.14, the Commission is adopting Rule 17Ad-
22(e)(14) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\883\
---------------------------------------------------------------------------
\883\ See CCA Standards proposing release, supra note 5, at
29571-72.
---------------------------------------------------------------------------
With respect to Rule 17Ad-22(e)(14), a respondent clearing agency
is a registered clearing agency that provides CCP services for
security-based swaps. Such clearing agencies generally have written
policies and procedures regarding the segregation and portability of
customer positions and collateral as a result of applicable rules and
regulations notwithstanding Rule 17Ad-22.\884\ The Commission therefore
expects that a respondent clearing agency has written rules, policies,
and procedures substantially similar to the requirements in the rule
and that the PRA burden includes the incremental burdens of reviewing
current policies and procedures and revising them, where appropriate,
pursuant to the rule. Accordingly, the Commission estimates that Rule
17Ad-22(e)(14) imposes on respondent clearing agencies an aggregate
one-time burden of 72 hours to review and revise existing policies and
procedures.\885\
---------------------------------------------------------------------------
\884\ See, e.g., 77 FR 6336 (Feb. 7, 2012) (CFTC adopting rules
imposing LSOC on DCOs for cleared swaps); see also supra Part
II.C.14. Because the respondent clearing agencies are subject to the
CFTC's segregation and portability requirements for cleared swaps,
the Commission expects that the burden imposed by Rule 17Ad-
22(e)(14) will be limited.
\885\ This figure was calculated as follows: ((Assistant General
Counsel for 12 hours) + (Compliance Attorney for 10 hours) +
(Computer Operations Manager for 7 hours) + (Senior Business Analyst
for 7 hours)) = 36 hours x 2 respondent clearing agency that
provide, or would potentially provide, CCP services with respect to
security-based swaps = 72 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(14) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\886\ the
Commission believes that the ongoing activities required by Rule 17Ad-
22(e)(14) impose an aggregate annual burden on respondent clearing
agencies of approximately 12 hours.\887\
---------------------------------------------------------------------------
\886\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\887\ This figure was calculated as follows: (Compliance
Attorney for 6 hours) x 2 respondent clearing agencies = 12 hours
---------------------------------------------------------------------------
15. Rule 17Ad-22(e)(15)
As described in Part IV.A.15, the Commission is adopting Rule 17Ad-
22(e)(15) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\888\
---------------------------------------------------------------------------
\888\ See CCA Standards proposing release, supra note 5, at
29571.
---------------------------------------------------------------------------
Because Rule 17Ad-22(d) does not include requirements related to
general business risk, the Commission estimates that the PRA burdens
for Rule 17Ad-22(e)(15) are more significant than in other cases under
Rule 17Ad-22(e) and may require a respondent clearing agency to make
substantial changes to its written rules, policies, and procedures
pursuant to the rule.\889\ The Commission estimates that Rule 17Ad-
22(e)(15) will impose an aggregate one-time burden on respondent
covered clearing agencies of 1,470 hours to review and revise existing
policies and procedures and to create new policies and procedures, as
necessary.\890\
---------------------------------------------------------------------------
\889\ See 17 CFR 240.17Ad-22(d); see also supra Part II.C.15.
\890\ This figure was calculated as follows: ((Assistant General
Counsel for 40 hours) + (Compliance Attorney for 30 hours) +
(Computer Operations Manager for 10 hours) + (Senior Business
Analyst for 10 hours) + (Financial Analyst for 70 hours) + (Chief
Financial Officer for 50 hours)) = 210 hours x 7 respondent clearing
agencies = 1,470 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(15) also imposes ongoing burdens on a respondent
clearing agency. Rule 17Ad-22(e)(15) requires a respondent clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to maintain a viable plan, approved
by its board of directors and updated at least annually, for raising
additional equity in the event that the covered clearing agency's
liquid net assets fall below the level required by the rule. Based on
the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\891\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(15) impose an aggregate annual burden on respondent clearing
agencies of 336 hours.\892\
---------------------------------------------------------------------------
\891\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\892\ This figure was calculated as follows: ((Compliance
Attorney for 42 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours)) = 48 hours x 7 respondents
clearing agencies = 336 hours.
---------------------------------------------------------------------------
[[Page 70897]]
16. Rule 17Ad-22(e)(16)
As described in Part IV.A.16, the Commission is adopting Rule 17Ad-
22(e)(16) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\893\
---------------------------------------------------------------------------
\893\ See CCA Standards proposing release, supra note 5, at
29572.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(16) contains substantially similar provisions to
Rule 17Ad-22(d)(3).\894\ The Commission therefore expects that a
respondent clearing agency has written rules, policies, and procedures
substantially similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing current policies
and procedures and revising them, where appropriate, pursuant to the
rule. Accordingly, based on the similar provisions and the
corresponding burden estimates previously made by the Commission for
Rule 17Ad-22(d)(3),\895\ the Commission estimates that respondent
clearing agencies will incur an aggregate one-time burden of
approximately 140 hours to review and revise existing policies and
procedures.\896\
---------------------------------------------------------------------------
\894\ See 17 CFR 240.17Ad-22(d)(3); see also supra Part II.C.16.
\895\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\896\ This figure was calculated as follows: ((Assistant General
Counsel for 4 hours) + (Compliance Attorney for 8 hours) + (Senior
Business Analyst for 4 hours) + (Computer Operations Manager for 4
hours)) = 20 hours x 7 respondent clearing agencies = 140 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(16) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\897\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(16) impose an aggregate annual burden on respondent clearing
agencies of 42 hours.\898\
---------------------------------------------------------------------------
\897\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\898\ This figure was calculated as follows: (Compliance
Attorney for 6 hours) x 7 respondent clearing agencies = 42 hours.
---------------------------------------------------------------------------
17. Rule 17Ad-22(e)(17)
As described in Part IV.A.17, the Commission is adopting Rule 17Ad-
22(e)(17) with one modification. Because this modification is only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. The burden estimates for the rule are unchanged from the CCA
Standards proposing release.\899\
---------------------------------------------------------------------------
\899\ See CCA Standards proposing release, supra note 5, at
29572-73.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(17) contains similar provisions to Rule 17Ad-
22(d)(4) but also imposes additional requirements that do not appear in
Rule 17Ad-22.\900\ The Commission therefore expects that a respondent
clearing agency may have written rules, policies, and procedures
similar to the requirements in the rule and that the PRA burden
includes the incremental burdens of reviewing and revising current
policies and procedures and creating new policies and procedures, as
necessary, pursuant to the rule. Accordingly, based on the similar
policies and procedures requirements and the corresponding burden
estimates previously made by the Commission for Rule 17Ad-
22(d)(4),\901\ the Commission estimates that respondent clearing
agencies will incur an aggregate one-time burden of 196 hours to review
and revise existing policies and procedures and to create new policies
and procedures, as necessary.\902\
---------------------------------------------------------------------------
\900\ See 17 CFR 240.17Ad-22(d)(4); see also supra Part II.C.17.
\901\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\902\ This figure was calculated as follows: ((Assistant General
Counsel for 4 hours) + (Compliance Attorney for 8 hours) + (Computer
Operations Manager for 6 hours) + (Senior Business Analyst for 4
hours) + (Chief Compliance Officer for 4 hours) + (Senior Programmer
for 2 hours)) = 28 hours x 7 respondent clearing agency = 196 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(17) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to Rule 17Ad-22,\903\ the Commission
estimates that the ongoing activities required by Rule 17Ad-22(e)(17)
impose an aggregate annual burden on respondent clearing agencies of
112 hours.\904\
---------------------------------------------------------------------------
\903\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\904\ This figure was calculated as follows: (Compliance
Attorney for 6 hours) x 7 respondent clearing agencies = 42 hours.
---------------------------------------------------------------------------
18. Rule 17Ad-22(e)(18)
As described in Part IV.A.18, the Commission is adopting Rule 17Ad-
22(e)(18) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\905\
---------------------------------------------------------------------------
\905\ See CCA Standards proposing release, supra note 5, at
29573.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(18) contains similar provisions to Rules 17Ad-
22(b)(5) through (7) and (d)(2).\906\ The Commission therefore expects
that a respondent clearing agency may have written rules, policies, and
procedures similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing and revising
current policies and procedures and creating new policies and
procedures, as necessary, pursuant to the rule. Accordingly, based on
the similar policies and procedures requirements and the corresponding
burden estimates previously made by the Commission for Rules 17Ad-
22(b)(5) through (7) and (d)(2),\907\ the Commission estimates that
respondent clearing agencies will incur an aggregate one-time burden of
308 hours to review and revise existing policies and procedures and to
create new policies and procedures, as necessary.\908\
---------------------------------------------------------------------------
\906\ See 17 CFR 240.17Ad-22(b)(5)-(7), (d)(2); see also supra
Part II.C.18.
\907\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\908\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) + Computer
Operations Manager for 15 hours) + (Senior Business Analyst for 5
hours) + (Chief Compliance Officer for 5 hours) + (Senior Programmer
for 2 hours)) = 44 hours x 7 respondent clearing agencies = 308
hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(18) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\909\ the
Commission estimates that the ongoing activities required by the rule
impose an aggregate annual burden on respondent clearing agencies of 49
hours.\910\
---------------------------------------------------------------------------
\909\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\910\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
19. Rule 17Ad-22(e)(19)
As described in Part IV.A.19, the Commission is adopting Rule 17Ad-
22(e)(19) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\911\
---------------------------------------------------------------------------
\911\ See CCA Standards proposing release, supra note 5, at
29573.
---------------------------------------------------------------------------
Tiered participation arrangements are not addressed by Rule 17Ad-
22(d). The Commission therefore expects that a respondent clearing
agency may need to create policies and procedures pursuant to Rule
17Ad-22(e)(19).\912\ The
[[Page 70898]]
Commission estimates that Rule 17Ad-22(e)(19) imposes an aggregate one-
time burden on respondent clearing agencies of 308 hours to review and
revise existing policies and procedures and to create new policies and
procedures, as necessary.\913\
---------------------------------------------------------------------------
\912\ See 17 CFR 240.17Ad-22(d); see also supra Part II.C.19.
\913\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) +
(Computer Operations Manager for 15 hours) + (Senior Business
Analyst for 5 hours) + (Chief Compliance Officer for 5 hours) +
(Senior Programmer for 2 hours)) = 44 hours x 7 respondent clearing
agencies = 308 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(19) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to Rule 17Ad-22,\914\ the Commission
estimates that the ongoing activities required by the rule impose an
annual aggregate burden on respondent clearing agencies of 49
hours.\915\
---------------------------------------------------------------------------
\914\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\915\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
20. Rule 17Ad-22(e)(20)
As described in Part IV.A.13, the Commission is adopting Rule 17Ad-
22(e)(20) with one modification. The burden estimates for the rule are
unchanged from the CCA Standards proposing release.\916\
---------------------------------------------------------------------------
\916\ See Clearing Agency Standards adopting release, supra note
5, at 29573-74.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(20) contains similar provisions to Rule 17Ad-
22(d)(7) but also adds additional requirements that do not appear in
Rule 17Ad-22(d).\917\ The Commission therefore expects that a
respondent clearing agency may have written rules, policies, and
procedures similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing and revising
current policies and procedures and creating new policies and
procedures, as necessary, pursuant to the rule. Accordingly, based on
the similar policies and procedures requirements and compliance burdens
associated with Rule 17Ad-22(d)(7),\918\ the Commission estimates that
respondent clearing agencies will incur an aggregate one-time burden of
approximately 308 hours to review and update existing policies and
procedures.\919\ Rule 17Ad-22(e)(20) also imposes ongoing burdens on a
respondent clearing agency. The rule requires ongoing monitoring and
compliance activities with respect to its policies and procedures under
the rule. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to Rule 17Ad-22,\920\
the Commission estimates that the ongoing activities required by the
rule impose an aggregate annual burden on respondent clearing agencies
of 49 hours.\921\
---------------------------------------------------------------------------
\917\ See17 CFR 240.17Ad-22(d)(7); see also supra Part II.C.20.
\918\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\919\ See CCA Standards proposing release, supra note 5, at
29573. This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) + (Senior
Business Analyst for 5 hours) + (Computer Operations Manager for 15
hours) + (Chief Compliance Officer for 5 hours) + (Senior Programmer
for 2 hours) = 44 hours x 7 respondent clearing agencies = 308
hours.
\920\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\921\ This figure was calculated as follows: (Compliance
Attorney for 7 hours) x 7 respondent clearing agencies = 49 hours.
---------------------------------------------------------------------------
21. Rule 17Ad-22(e)(21)
As described in Part IV.A.21, the Commission is adopting Rule 17Ad-
22(e)(21) with one modification. Because this modification is only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. The burden estimates for the rule are unchanged from the CCA
Standards proposing release.\922\
---------------------------------------------------------------------------
\922\ See CCA Standards proposing release, supra note 5, at
29574.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(21) contains similar provisions to Rule 17Ad-
22(d)(6) but also adds additional requirements that do not appear in
Rule 17Ad-22(d).\923\ The Commission therefore expects that a
respondent clearing agency may have written rules, policies, and
procedures similar to the requirements in the rule and that the PRA
burden includes the incremental burdens of reviewing and revising
current policies and procedures and creating new policies and
procedures, as necessary, pursuant to the rule. Accordingly, based on
the similar policies and procedures requirements and the corresponding
burden estimates previously made by the Commission for Rule 17Ad-
22(d)(6),\924\ the Commission estimates that respondent clearing
agencies will incur an aggregate one-time burden of approximately 224
hours to review and revise existing policies and procedures.\925\
---------------------------------------------------------------------------
\923\ See 17 CFR 240.17Ad-22(d)(6); see also supra Part II.C.21.
\924\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\925\ This figure was calculated as follows: ((Assistant General
Counsel for 10 hours) + (Compliance Attorney for 7 hours) + (Senior
Business Analyst for 5 hours) + (Computer Operations Manager for 10
hours)) = 32 hours x 7 respondent clearing agencies = 224 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(21) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to existing Rule 17Ad-22,\926\ the
Commission estimates that the ongoing activities required by Rule 17Ad-
22(e)(21) impose an aggregate annual burden on respondent clearing
agencies of 77 hours.\927\
---------------------------------------------------------------------------
\926\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\927\ This figure was calculated as follows: ((Compliance
Attorney for 5 hours) + (Administrative Assistant for 3 hours) +
(Senior Business Analyst for 3 hours) = 11 hours x 7 respondent
clearing agencies = 77 hours.
---------------------------------------------------------------------------
22. Rule 17Ad-22(e)(22)
As described in Part IV.A.22, the Commission is adopting Rule 17Ad-
22(e)(22) as proposed. The burden estimates for the rule are unchanged
from the CCA Standards proposing release.\928\
---------------------------------------------------------------------------
\928\ See CCA Standards proposing release, supra note 5, at
29574.
---------------------------------------------------------------------------
Although Rule 17Ad-22(d) does not include any requirements with
provisions similar to Rule 17Ad-22(e)(22), the Commission understands
that covered clearing agencies currently use the relevant
internationally accepted communication procedures and standards and
therefore expects that a respondent clearing agency may need to make
only limited changes to its policies and procedures under the
rule.\929\ Accordingly, the Commission estimates that the rule imposes
an aggregate one-time burden on respondent clearing agencies of 168
hours to review and revise existing policies and procedures.\930\
---------------------------------------------------------------------------
\929\ See 17 CFR 240.17Ad-22(d); see also supra Part II.C.22.
\930\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Compliance Attorney for 6 hours) + (Computer
Operations Manager for 7 hours) + (Senior Business Analyst for 2
hours) + (Chief Compliance Officer for 5 hours) + (Senior Programmer
for 2 hours)) = 24 hours x 7 respondent clearing agencies = 168
hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(22) also imposes ongoing burdens on a respondent
clearing agency. It requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for
[[Page 70899]]
ongoing monitoring and compliance burdens with respect to existing Rule
17Ad-22,\931\ the Commission estimates that the ongoing activities
required by Rule 17Ad-22(e)(22) impose an aggregate annual burden on
respondent clearing agencies of 35 hours.\932\
---------------------------------------------------------------------------
\931\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\932\ This figure was calculated as follows: (Compliance
Attorney for 5 hours) x 7 respondent clearing agencies = 35 hours.
---------------------------------------------------------------------------
23. Rule 17Ad-22(e)(23)
As described in Part IV.A.23, the Commission is adopting Rule 17Ad-
22(e)(23) with modifications. Because these modifications are only
technical or clarifying in nature, the Commission does not believe they
will alter the PRA burdens described in the CCA Standards proposing
release. Therefore, the burden estimates described below are unchanged
from the CCA Standards proposing release.\933\
---------------------------------------------------------------------------
\933\ See CCA Standards proposing release, supra note 5, at
29574.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(23) contains similar requirements to Rule 17Ad-
22(d)(9) but also imposes substantial new requirements.\934\ The
Commission therefore expects that, although a respondent clearing
agency may have written rules, policies and procedures similar to those
required by some provisions under the rule, a respondent clearing
agency will need to create new policies and procedures to address the
other provisions. Accordingly, based on the similar policies and
procedures requirements and the corresponding burden estimates
previously made by the Commission for Rule 17Ad-22(d)(9),\935\ the
Commission estimates that respondent clearing agencies will incur an
aggregate one-time burden of 966 hours to review and revise existing
policies and procedures and to create policies and procedures, as
necessary.\936\
---------------------------------------------------------------------------
\934\ See 17 CFR 240.17Ad-22(d)(9); see also supra Part II.C.23.
\935\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\936\ This figure was calculated as follows: ((Assistant General
Counsel for 38 hours) + (Compliance Attorney for 24 hours) +
(Computer Operations Manager for 32 hours) + (Senior Business
Analyst for 18 hours) + (Chief Compliance Officer for 18 hours) +
(Senior Programmer for 8 hours)) = 138 hours x 7 respondent clearing
agencies = 966 hours.
---------------------------------------------------------------------------
Rule 17Ad-22(e)(23) also imposes ongoing burdens on a respondent
clearing agency. The rule requires ongoing monitoring and compliance
activities with respect to its policies and procedures under the rule.
Based on the Commission's previous estimates for ongoing monitoring and
compliance burdens with respect to Rule 17Ad-22,\937\ the Commission
estimates that the ongoing activities required by Rule 17Ad-22(e)(23)
impose an aggregate annual burden on respondent clearing agencies of
238 hours.\938\
---------------------------------------------------------------------------
\937\ See Clearing Agency Standards adopting release, supra note
5, at 66260-63.
\938\ This figure was calculated as follows: (Compliance
Attorney for 34 hours) x 7 respondent clearing agencies = 238 hours.
---------------------------------------------------------------------------
24. Total Burden for Rule 17Ad-22(e)
The Commission preliminarily estimated that respondent clearing
agencies would incur an aggregate initial burden under Rule 17Ad-22(e)
of 10,664 hours and an aggregate ongoing burden of 3,460 hours.\939\ In
light of the modifications made by the Commission in adopting Rule
17Ad-22(e) described above that will require updating current policies
and procedures or establishing new policies and procedures to ensure
compliance with the rule, the Commission estimates that respondent
clearing agencies will incur an aggregate initial burden of 10,776
hours under Rule 17Ad-22(e) and an aggregate ongoing burden of 3,537
hours.
---------------------------------------------------------------------------
\939\ See CCA Standards proposing release, supra note 5, at
29574.
---------------------------------------------------------------------------
25. Total Burden for Rule 17Ab2-2
As discussed in Part IV.A.24, Rule 17Ab2-2 establishes procedures
for the Commission to make determinations affecting covered clearing
agencies in certain circumstances.\940\ Because such determinations may
be made upon request of a clearing agency or its members, the
respondents would have the burdens of preparing such requests for
submission to the Commission. To the extent such determinations are
carried out by the Commission on its own initiative under Rule 17Ab2-2,
the Commission expects that the PRA burdens on a respondent clearing
agency would be limited. Accordingly, based on the Commission's
previous estimates for ongoing monitoring and compliance burdens with
respect to existing Rule 17Ad-22,\941\ the Commission preliminarily
estimated that respondent clearing agencies would incur an aggregate
one-time burden of approximately 24 hours to draft and review a
determination request to the Commission.\942\ In consideration of the
modifications made by the Commission in adopting Rule 17Ab2-2 as
described above, the Commission estimates that respondent clearing
agencies will incur an aggregate one-time burden of approximately 20
hours to draft and review a determination request to the
Commission.\943\
---------------------------------------------------------------------------
\940\ See supra Part II.D.
\941\ See Clearing Agency Standards adopting release, supra note
5, at 66260.
\942\ See CCA Standards proposing release, supra note 5, at
29575. This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Staff Attorney for 4 hours) + (Outside
Counsel for 6 hours)) = 12 hours x 2 respondent clearing agencies =
24 hours.
\943\ This figure was calculated as follows: ((Assistant General
Counsel for 2 hours) + (Staff Attorney for 3 hours) + (Outside
Counsel for 5 hours)) = 10 hours x 2 respondent clearing agencies =
20 hours.
---------------------------------------------------------------------------
26. Total Burden for Rule 17Ad-22(c)(1)
As discussed in Part IV.A.25, the modifications to Rule 17Ad-
22(c)(1) impose a recordkeeping requirement on registered clearing
agencies that are covered clearing agencies. With respect to Rule 17Ad-
22(c)(1), a respondent clearing agency is a registered clearing agency
that provides CCP services. In the Clearing Agency Standards release,
the Commission estimated that respondent clearing agencies would incur
both initial and ongoing burdens under Rule 17Ad-22(c)(1).
Specifically, the Commission estimated that Rule 17Ad-22(c)(1) would
impose on a respondent clearing agency a one-time burden of 100
hours.\944\ In light of the modifications to Rule 17Ad-22(c)(1) that
affect covered clearing agencies, the Commission believes that
respondent clearing agencies would incur an aggregate one-time burden
of 660 hours to perform adjustments needed to synthesize and format
existing information in a manner sufficient to explain the methodology
used to meet the requirements of Rule 17Ad-22(c)(1).\945\
---------------------------------------------------------------------------
\944\ See Clearing Agency Standards adopting release, supra note
5, 66261-62. This figure was calculated as follows: ((Chief
Compliance Officer at 40 hours) + (Computer Operations Department
Manager at 40 hours) + (Senior Programmer at 20 hours)) = 100 hours.
\945\ This figure was calculated as follows: ((Chief Compliance
Officer at 44 hours) + (Computer Operations Department Manager at 44
hours) + (Senior Programmer at 22 hours)) = 110 hours x 6 respondent
clearing agencies = 660 hours.
---------------------------------------------------------------------------
In addition, the Commission estimated that Rule 17Ad-22(c)(1) would
impose ongoing burdens on a respondent clearing agency of three hours
per respondent clearing agency per quarter, amounting to an aggregate
annual burden of 12 hours.\946\ In light of the modifications to Rule
17Ad-22(c)(1) that affect covered clearing agencies, the Commission
believes that the ongoing activities required by Rule 17Ad-22(c)(1)
will impose an aggregate annual burden on respondent clearing agencies
of 120 hours to perform adjustments
[[Page 70900]]
needed to synthesize and format existing information in a manner
sufficient to explain the methodology used to meet the requirements of
the rule.\947\
---------------------------------------------------------------------------
\946\ See Clearing Agency Standards adopting release, supra note
5, 66262. This figure was calculated as follows: ((Compliance
Attorney at 1 hour) + (Computer Operations Department Manager at 2
hours)) = 3 hours per quarter x 4 quarters per year = 12 hours.
\947\ This figure was calculated as follows: ((Compliance
Attorney at 2 hours) + (Computer Operations Department Manager at 3
hours)) = 5 hours per quarter x 4 quarters per year = 20 hours x 6
respondent clearing agencies = 120 hours.
---------------------------------------------------------------------------
D. Collection of Information Is Mandatory
The collection of information requirement for Rule 17Ad-22(e) is
mandatory. The collection of information requirement for Rule 17Ab2-2
is voluntary.
E. Confidentiality
The Commission expects that the policies and procedures developed
pursuant to Rule 17Ad-22(e) would be communicated to the participants,
as applicable, of each respondent clearing agency and, as applicable,
the public. A respondent clearing agency would be required to preserve
such policies and procedures in accordance with, and for the periods
specified in, Rules 17a-1 and 17a-4(e)(7) under the Exchange Act.\948\
To the extent that the Commission receives confidential information
pursuant to this collection of information, such information would be
kept confidential subject to the provisions of applicable law.\949\
---------------------------------------------------------------------------
\948\ 17 CFR 240.17a-1 and 17a-4(e)(7).
\949\ See, e.g., 5 U.S.C. 552. Exemption 4 of the Freedom of
Information Act provides an exemption for trade secrets and
commercial or financial information obtained from a person and
privileged or confidential. See 5 U.S.C. 552(b)(4). Exemption 8 of
the Freedom of Information Act provides an exemption for matters
that are contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions. See 5 U.S.C. 552(b)(8).
---------------------------------------------------------------------------
To the extent that the Commission receives confidential information
pursuant to the collection of information under Rule 17Ab2-2, the
Commission also expects such information would be kept confidential
subject to the provisions of applicable law.\950\
---------------------------------------------------------------------------
\950\ See id.
---------------------------------------------------------------------------
V. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires the Commission,
in promulgating rules, to consider the impact of those rules on small
entities.\951\ Section 603(a) of the Administrative Procedure Act,\952\
as amended by the RFA, generally requires the Commission to undertake a
regulatory flexibility analysis of all proposed rules to determine the
impact of such rulemaking on ``small entities.'' \953\ The Commission
certified in the CCA Standards proposing release, pursuant to Section
605(b) of the RFA,\954\ that the proposed rules would not, if adopted,
have a significant impact on a substantial number of small entities.
The Commission received no comments on this certification.
---------------------------------------------------------------------------
\951\ See 5 U.S.C. 601 et seq.
\952\ See 5 U.S.C. 603(a).
\953\ Section 601(b) of the RFA permits agencies to formulate
their own definitions of ``small entities.'' See 5 U.S.C. 601(b).
The Commission has adopted definitions for the term ``small entity''
for the purposes of rulemaking in accordance with the RFA. These
definitions are set forth in Rule 0-10, 17 CFR 240.0-10.
\954\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------
A. Registered Clearing Agencies
The amendments to Rule 17Ad-22 and Rule 17Ab2-2 apply to covered
clearing agencies, which would include registered clearing agencies
that are designated clearing agencies, complex risk profile clearing
agencies, or clearing agencies that otherwise have been determined to
be covered clearing agencies by the Commission. For the purposes of
Commission rulemaking and as applicable to the amendments to Rule 17Ad-
22 and new Rule 17Ab2-2, a small entity includes, when used with
reference to a clearing agency, a clearing agency that (i) compared,
cleared, and settled less than $500 million in securities transactions
during the preceding fiscal year, (ii) had less than $200 million of
funds and securities in its custody or control at all times during the
preceding fiscal year (or at any time that it has been in business, if
shorter), and (iii) is not affiliated with any person (other than a
natural person) that is not a small business or small
organization.\955\
---------------------------------------------------------------------------
\955\ See 17 CFR 240.0-10(d).
---------------------------------------------------------------------------
Based on the Commission's existing information about the clearing
agencies currently registered with the Commission,\956\ the Commission
believes that such registered clearing agencies exceed the thresholds
defining ``small entities'' set out above. While other clearing
agencies may seek to register as clearing agencies with the Commission,
the Commission does not believe that any such entities would be ``small
entities'' as defined in Exchange Act Rule 0-10.\957\ Further,
registered clearing agencies are only subject to the requirements of
Rule 17Ad-22(e) if they meet the definition of a covered clearing
agency, as described in Part II.A. Accordingly, the Commission believes
that any such registered clearing agencies will exceed the thresholds
for ``small entities'' set forth in Exchange Act Rule 0-10.
---------------------------------------------------------------------------
\956\ In 2015, DTCC processed $1.508 quadrillion in financial
transactions. Within DTCC, DTC settled $112.3 trillion of securities
and held securities valued at $45.4 trillion, NSCC processed an
average daily value of $976.6 billion in equity securities, and FICC
cleared $917.1 trillion of transactions in government securities and
$48.2 trillion of transactions in agency mortgage-backed securities.
See DTCC, 2015 Annual Report, available at http://www.dtcc.com/annuals/2015/index.php. OCC cleared more than 4.1 billion contracts
and held margin of $98.3 billion at the end of 2015. See OCC, 2015
Annual Report, available at http://www.theocc.com/components/docs/about/annual-reports/occ-2015-annual-report.pdf. In addition,
Intercontinental Exchange (``ICE'') averaged daily trade volume of
9.3 million and revenues of $3.3 billion in 2015. See ICE at a
glance, available at https://www.theice.com/publicdocs/ICE_at_a_glance.pdf.
\957\ See 17 CFR 240.0-10(d). The Commission based this
determination on its review of public sources of financial
information about registered clearing agencies.
---------------------------------------------------------------------------
B. Certification
For the reasons described above, the Commission certifies that the
amendments to Rule 17Ad-22 and new Rule 17Ab2-2 will not have a
significant economic impact on a substantial number of small entities.
VI. Statutory Authority
Pursuant to the Exchange Act, particularly Section 17A thereof, 15
U.S.C. 78q-1, and Section 805 of the Clearing Supervision Act, 12
U.S.C. 5464, the Commission is adopting amendments to Rule 17Ad-22 and
new Rule 17Ab2-2.
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Text of Amendment
In accordance with the foregoing, title 17, chapter II of the Code
of Federal Regulations is amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE
0
1. The general authority citation for part 240 continues to read, and
the sectional authority for Sec. 240.17Ad-22 is revised to read, as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78ov-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et. seq.; and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350;
Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-106,
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
[[Page 70901]]
Section 240.17Ad-22 is also issued under 12 U.S.C. 5461 et seq.
* * * * *
0
2. Section 240.17Ab2-2 is added to read as follows:
Sec. 240.17Ab2-2 Determinations affecting covered clearing agencies.
(a) The Commission may, if it deems appropriate, upon application
by any clearing agency or member of a clearing agency, or on its own
initiative, determine whether a covered clearing agency is systemically
important in multiple jurisdictions. In determining whether a covered
clearing agency is systemically important in multiple jurisdictions,
the Commission may consider:
(1) Whether the covered clearing agency is a designated clearing
agency; and
(2) Whether the clearing agency has been determined to be
systemically important by one or more jurisdictions other than the
United States through a process that includes consideration of whether
the foreseeable effects of a failure or disruption of the designated
clearing agency could threaten the stability of each relevant
jurisdiction's financial system.
(b) The Commission may, if it deems appropriate, determine whether
any of the activities of a clearing agency providing central
counterparty services, in addition to clearing agencies registered with
the Commission for the purpose of clearing security-based swaps, have a
more complex risk profile. In determining whether a clearing agency's
activity has a more complex risk profile, the Commission may consider
whether the clearing agency clears financial instruments that are
characterized by discrete jump-to-default price changes or that are
highly correlated with potential participant defaults.
(c) The Commission may, if it deems appropriate, upon application
by any clearing agency or member of a clearing agency, or on its own
initiative, determine whether to rescind any determination made
pursuant to paragraph (a) or (b) of this section. In determining
whether to rescind any such determination, the Commission may consider
a change in circumstances such that the covered clearing agency no
longer meets the criteria supporting the determination in effect.
(d) The Commission shall publish notice of its intention to
consider making a determination under paragraph (a), (b), or (c) of
this section, together with a brief statement of the grounds under
consideration therefor, and provide at least a 30-day public comment
period prior to any such determination, giving all interested persons
an opportunity to submit written data, views, and arguments concerning
such proposed determination. The Commission may provide the clearing
agency subject to the proposed determination opportunity for hearing
regarding the proposed determination.
(e) Notice of determinations under paragraph (a), (b), or (c) of
this section shall be given by prompt publication thereof, together
with a statement of written reasons therefor.
(f) For purposes of this rule, the terms covered clearing agency,
designated clearing agency, and systemically important in multiple
jurisdictions shall have the meanings set forth in Sec. 240.17Ad-
22(a).
0
3. Amend Sec. 240.17Ad-22 by revising paragraphs (a) and (c)(1), and
(d) introductory text and adding paragraphs (e) and (f) to read as
follows:
Sec. 240.17Ad-22 Standards for clearing agencies.
(a) Definitions. For purposes of this section:
(1) Backtesting means an ex-post comparison of actual outcomes with
expected outcomes derived from the use of margin models.
(2) Central counterparty means a clearing agency that interposes
itself between the counterparties to securities transactions, acting
functionally as the buyer to every seller and the seller to every
buyer.
(3) Central securities depository services means services of a
clearing agency that is a securities depository as described in Section
3(a)(23)(A) of the Act (15 U.S.C. 78c(a)(23)(A)).
(4) Clearing agency involved in activities with a more complex risk
profile means a clearing agency registered with the Commission under
Section 17A of the Act (15 U.S.C. 78q-1) that:
(i) Provides central counterparty services for security-based
swaps;
(ii) Has been determined by the Commission to be involved in
activities with a more complex risk profile at the time of its initial
registration; or
(iii) Is subsequently determined by the Commission to be involved
in activities with a more complex risk profile pursuant to Sec.
240.17Ab2-2(b).
(5) Covered clearing agency means a designated clearing agency or a
clearing agency involved in activities with a more complex risk profile
for which the Commodity Futures Trading Commission is not the
Supervisory Agency as defined in Section 803(8) of the Payment,
Clearing, and Settlement Supervision Act of 2010 (12 U.S.C. 5461 et
seq.).
(6) Designated clearing agency means a clearing agency registered
with the Commission under Section 17A of the Exchange Act (15 U.S.C.
78q-1) that is designated systemically important by the Financial
Stability Oversight Council pursuant to the Payment, Clearing, and
Settlement Supervision Act of 2010 (12 U.S.C. 5461 et seq.) and for
which the Commission is the supervisory agency as defined in Section
803(8) of the Payment, Clearing, and Settlement Supervision Act of 2010
(12 U.S.C. 5461 et seq.).
(7) Financial market utility has the same meaning as defined in
Section 803(6) of the Payment, Clearing, and Settlement Supervision Act
of 2010 (12 U.S.C. 5462(6)).
(8) Link means, for purposes of paragraph (e)(20) of this section,
a set of contractual and operational arrangements between two or more
clearing agencies, financial market utilities, or trading markets that
connect them directly or indirectly for the purposes of participating
in settlement, cross margining, expanding their services to additional
instruments or participants, or for any other purposes material to
their business.
(9) Model validation means an evaluation of the performance of each
material risk management model used by a covered clearing agency (and
the related parameters and assumptions associated with such models),
including initial margin models, liquidity risk models, and models used
to generate clearing or guaranty fund requirements, performed by a
qualified person who is free from influence from the persons
responsible for the development or operation of the models or policies
being validated.
(10) Net capital as used in paragraph (b)(7) of this section means
net capital as defined in Sec. 240.15c3-1 for broker-dealers or any
similar risk adjusted capital calculation for all other prospective
clearing members.
(11) Normal market conditions as used in paragraphs (b)(1) and (2)
of this section means conditions in which the expected movement of the
price of cleared securities would produce changes in a clearing
agency's exposures to its participants that would be expected to breach
margin requirements or other risk control mechanisms only one percent
of the time.
(12) Participant family means that if a participant directly, or
indirectly through one or more intermediaries, controls, is controlled
by, or is under common control with, another participant then the
affiliated
[[Page 70902]]
participants shall be collectively deemed to be a single participant
family for purposes of paragraphs (b)(3), (d)(14), (e)(4), and (e)(7)
of this section.
(13) Potential future exposure means the maximum exposure estimated
to occur at a future point in time with an established single-tailed
confidence level of at least 99 percent with respect to the estimated
distribution of future exposure.
(14) Qualifying liquid resources means, for any covered clearing
agency, the following, in each relevant currency:
(i) Cash held either at the central bank of issue or at
creditworthy commercial banks;
(ii) Assets that are readily available and convertible into cash
through prearranged funding arrangements, such as:
(A) Committed arrangements without material adverse change
provisions, including:
(1) Lines of credit;
(2) Foreign exchange swaps; and
(3) Repurchase agreements; or
(B) Other prearranged funding arrangements determined to be highly
reliable even in extreme but plausible market conditions by the board
of directors of the covered clearing agency following a review
conducted for this purpose not less than annually; and
(iii) Other assets that are readily available and eligible for
pledging to (or conducting other appropriate forms of transactions
with) a relevant central bank, if the covered clearing agency has
access to routine credit at such central bank in a jurisdiction that
permits said pledges or other transactions by the covered clearing
agency.
(15) Security-based swap means a security-based swap as defined in
Section 3(a)(68) of the Act (15 U.S.C. 78c(a)(68)).
(16) Sensitivity analysis means an analysis that involves analyzing
the sensitivity of a model to its assumptions, parameters, and inputs
that:
(i) Considers the impact on the model of both moderate and extreme
changes in a wide range of inputs, parameters, and assumptions,
including correlations of price movements or returns if relevant, which
reflect a variety of historical and hypothetical market conditions.
Sensitivity analysis must use actual portfolios and, where applicable,
hypothetical portfolios that reflect the characteristics of proprietary
positions and customer positions;
(ii) When performed by or on behalf of a covered clearing agency
involved in activities with a more complex risk profile, considers the
most volatile relevant periods, where practical, that have been
experienced by the markets served by the clearing agency; and
(iii) Tests the sensitivity of the model to stressed market
conditions, including the market conditions that may ensue after the
default of a member and other extreme but plausible conditions as
defined in a covered clearing agency's risk policies.
(17) Stress testing 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, or changes
in other valuation inputs and assumptions.
(18) Systemically important in multiple jurisdictions means, with
respect to a covered clearing agency, a covered clearing agency that
has been determined by the Commission to be systemically important in
more than one jurisdiction pursuant to Sec. 240.17Ab2-2.
(19) Transparent means, for the purposes of paragraphs (e)(1), (2),
and (10) of this section, to the extent consistent with other statutory
and Commission requirements on confidentiality and disclosure, that
documentation required under paragraphs (e)(1), (2), and (10) is
disclosed to the Commission and, as appropriate, to other relevant
authorities, to clearing members and to customers of clearing members,
to the owners of the covered clearing agency, and to the public.
* * * * *
(c) Record of financial resources and annual audited financial
statements. (1) Each fiscal quarter (based on calculations made as of
the last business day of the clearing agency's fiscal quarter), or at
any time upon Commission request, a registered clearing agency that
performs central counterparty services shall calculate and maintain a
record, in accordance with Sec. 240.17a-1 of this chapter, of the
financial and qualifying liquid resources necessary to meet the
requirements, as applicable, of paragraphs (b)(3), (e)(4), and (e)(7)
of this section, and sufficient documentation to explain the
methodology it uses to compute such financial resources or qualifying
liquid resources requirement.
* * * * *
(d) Each registered clearing agency that is not a covered clearing
agency shall establish, implement, maintain and enforce written
policies and procedures reasonably designed to, as applicable:
* * * * *
(e) Each covered clearing agency shall establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable:
(1) Provide for a well-founded, clear, transparent, and enforceable
legal basis for each aspect of its activities in all relevant
jurisdictions.
(2) Provide for governance arrangements that:
(i) Are clear and transparent;
(ii) Clearly prioritize the safety and efficiency of the covered
clearing agency;
(iii) Support the public interest requirements in Section 17A of
the Act (15 U.S.C. 78q-1) applicable to clearing agencies, and the
objectives of owners and participants;
(iv) Establish that the board of directors and senior management
have appropriate experience and skills to discharge their duties and
responsibilities;
(v) Specify clear and direct lines of responsibility; and
(vi) Consider the interests of participants' customers, securities
issuers and holders, and other relevant stakeholders of the covered
clearing agency.
(3) Maintain a sound risk management framework for comprehensively
managing legal, credit, liquidity, operational, general business,
investment, custody, and other risks that arise in or are borne by the
covered clearing agency, which:
(i) Includes risk management policies, procedures, and systems
designed to identify, measure, monitor, and manage the range of risks
that arise in or are borne by the covered clearing agency, that are
subject to review on a specified periodic basis and approved by the
board of directors annually;
(ii) Includes plans for the recovery and orderly wind-down of the
covered clearing agency necessitated by credit losses, liquidity
shortfalls, losses from general business risk, or any other losses;
(iii) Provides risk management and internal audit personnel with
sufficient authority, resources, independence from management, and
access to the board of directors;
(iv) Provides risk management and internal audit personnel with a
direct reporting line to, and oversight by, a risk management committee
and an independent audit committee of the board of directors,
respectively; and
(v) Provides for an independent audit committee.
(4) Effectively identify, measure, monitor, and manage its credit
exposures to participants and those arising from its payment, clearing,
and settlement processes, including by:
(i) Maintaining sufficient financial resources to cover its credit
exposure to
[[Page 70903]]
each participant fully with a high degree of confidence;
(ii) To the extent not already maintained pursuant to paragraph
(e)(4)(i) of this section, for a covered clearing agency providing
central counterparty services that is either systemically important in
multiple jurisdictions or a clearing agency involved in activities with
a more complex risk profile, maintaining additional financial resources
at the minimum to enable it to cover a wide range of foreseeable stress
scenarios that include, but are not limited to, the default of the two
participant families that would potentially cause the largest aggregate
credit exposure for the covered clearing agency in extreme but
plausible market conditions;
(iii) To the extent not already maintained pursuant to paragraph
(e)(4)(i) of this section, for a covered clearing agency not subject to
paragraph (e)(4)(ii) of this section, maintaining additional financial
resources at the minimum to enable it to cover a wide range of
foreseeable stress scenarios that include, but are not limited to, the
default of the participant family that would potentially cause the
largest aggregate credit exposure for the covered clearing agency in
extreme but plausible market conditions;
(iv) Including prefunded financial resources, exclusive of
assessments for additional guaranty fund contributions or other
resources that are not prefunded, when calculating the financial
resources available to meet the standards under paragraphs (e)(4)(i)
through (iii) of this section, as applicable;
(v) Maintaining the financial resources required under paragraphs
(e)(4)(ii) and (iii) of this section, as applicable, in combined or
separately maintained clearing or guaranty funds;
(vi) Testing the sufficiency of its total financial resources
available to meet the minimum financial resource requirements under
paragraphs (e)(4)(i) through (iii) of this section, as applicable, by:
(A) Conducting stress testing of its total financial resources once
each day using standard predetermined parameters and assumptions;
(B) Conducting a comprehensive analysis on at least a monthly basis
of the existing stress testing scenarios, models, and underlying
parameters and assumptions, and considering modifications to ensure
they are appropriate for determining the covered clearing agency's
required level of default protection in light of current and evolving
market conditions;
(C) Conducting a comprehensive analysis of stress testing
scenarios, models, and underlying parameters and assumptions more
frequently than monthly when the products cleared or markets served
display high volatility or become less liquid, or when the size or
concentration of positions held by the covered clearing agency's
participants increases significantly; and
(D) Reporting the results of its analyses under paragraphs
(e)(4)(vi)(B) and (C) of this section to appropriate decision makers at
the covered clearing agency, including but not limited to, its risk
management committee or board of directors, and using these results to
evaluate the adequacy of and adjust its margin methodology, model
parameters, models used to generate clearing or guaranty fund
requirements, and any other relevant aspects of its credit risk
management framework, in supporting compliance with the minimum
financial resources requirements set forth in paragraphs (e)(4)(i)
through (iii) of this section;
(vii) Performing a model validation for its credit risk models not
less than annually or more frequently as may be contemplated by the
covered clearing agency's risk management framework established
pursuant to paragraph (e)(3) of this section;
(viii) Addressing allocation of credit losses the covered clearing
agency may face if its collateral and other resources are insufficient
to fully cover its credit exposures, including the repayment of any
funds the covered clearing agency may borrow from liquidity providers;
and
(ix) Describing the covered clearing agency's process to replenish
any financial resources it may use following a default or other event
in which use of such resources is contemplated.
(5) Limit the assets it accepts as collateral to those with low
credit, liquidity, and market risks, and set and enforce appropriately
conservative haircuts and concentration limits if the covered clearing
agency requires collateral to manage its or its participants' credit
exposure; and require a review of the sufficiency of its collateral
haircuts and concentration limits to be performed not less than
annually.
(6) Cover, if the covered clearing agency provides central
counterparty services, its credit exposures to its participants by
establishing a risk-based margin system that, at a minimum:
(i) Considers, and produces margin levels commensurate with, the
risks and particular attributes of each relevant product, portfolio,
and market;
(ii) Marks participant positions to market and collects margin,
including variation margin or equivalent charges if relevant, at least
daily and includes the authority and operational capacity to make
intraday margin calls in defined circumstances;
(iii) Calculates margin sufficient to cover its potential future
exposure to participants in the interval between the last margin
collection and the close out of positions following a participant
default;
(iv) Uses reliable sources of timely price data and uses procedures
and sound valuation models for addressing circumstances in which
pricing data are not readily available or reliable;
(v) Uses an appropriate method for measuring credit exposure that
accounts for relevant product risk factors and portfolio effects across
products;
(vi) Is monitored by management on an ongoing basis and is
regularly reviewed, tested, and verified by:
(A) Conducting backtests of its margin model at least once each day
using standard predetermined parameters and assumptions;
(B) Conducting a sensitivity analysis of its margin model and a
review of its parameters and assumptions for backtesting on at least a
monthly basis, and considering modifications to ensure the backtesting
practices are appropriate for determining the adequacy of the covered
clearing agency's margin resources;
(C) Conducting a sensitivity analysis of its margin model and a
review of its parameters and assumptions for backtesting more
frequently than monthly during periods of time when the products
cleared or markets served display high volatility or become less
liquid, or when the size or concentration of positions held by the
covered clearing agency's participants increases or decreases
significantly; and
(D) Reporting the results of its analyses under paragraphs
(e)(6)(vi)(B) and (C) of this section to appropriate decision makers at
the covered clearing agency, including but not limited to, its risk
management committee or board of directors, and using these results to
evaluate the adequacy of and adjust its margin methodology, model
parameters, and any other relevant aspects of its credit risk
management framework; and
(vii) Requires a model validation for the covered clearing agency's
margin system and related models to be performed not less than
annually, or more frequently as may be contemplated by the covered
clearing agency's risk management framework established pursuant to
paragraph (e)(3) of this section.
[[Page 70904]]
(7) Effectively measure, monitor, and manage the liquidity risk
that arises in or is borne by the covered clearing agency, including
measuring, monitoring, and managing its settlement and funding flows on
an ongoing and timely basis, and its use of intraday liquidity by, at a
minimum, doing the following:
(i) Maintaining sufficient liquid resources at the minimum in all
relevant currencies to effect same-day and, where appropriate, intraday
and multiday settlement of payment obligations with a high degree of
confidence under a wide range of foreseeable stress scenarios that
includes, but is not limited to, the default of the participant family
that would generate the largest aggregate payment obligation for the
covered clearing agency in extreme but plausible market conditions;
(ii) Holding qualifying liquid resources sufficient to meet the
minimum liquidity resource requirement under paragraph (e)(7)(i) of
this section in each relevant currency for which the covered clearing
agency has payment obligations owed to clearing members;
(iii) Using the access to accounts and services at a Federal
Reserve Bank, pursuant to Section 806(a) of the Payment, Clearing, and
Settlement Supervision Act of 2010 (12 U.S.C. 5465(a)), or other
relevant central bank, when available and where determined to be
practical by the board of directors of the covered clearing agency, to
enhance its management of liquidity risk;
(iv) Undertaking due diligence to confirm that it has a reasonable
basis to believe each of its liquidity providers, whether or not such
liquidity provider is a clearing member, has:
(A) Sufficient information to understand and manage the liquidity
provider's liquidity risks; and
(B) The capacity to perform as required under its commitments to
provide liquidity to the covered clearing agency;
(v) Maintaining and testing with each liquidity provider, to the
extent practicable, the covered clearing agency's procedures and
operational capacity for accessing each type of relevant liquidity
resource under paragraph (e)(7)(i) of this section at least annually;
(vi) Determining the amount and regularly testing the sufficiency
of the liquid resources held for purposes of meeting the minimum liquid
resource requirement under paragraph (e)(7)(i) of this section by, at a
minimum:
(A) Conducting stress testing of its liquidity resources at least
once each day using standard and predetermined parameters and
assumptions;
(B) Conducting a comprehensive analysis on at least a monthly basis
of the existing stress testing scenarios, models, and underlying
parameters and assumptions used in evaluating liquidity needs and
resources, and considering modifications to ensure they are appropriate
for determining the clearing agency's identified liquidity needs and
resources in light of current and evolving market conditions;
(C) Conducting a comprehensive analysis of the scenarios, models,
and underlying parameters and assumptions used in evaluating liquidity
needs and resources more frequently than monthly when the products
cleared or markets served display high volatility or become less
liquid, when the size or concentration of positions held by the
clearing agency's participants increases significantly, or in other
appropriate circumstances described in such policies and procedures;
and
(D) Reporting the results of its analyses under paragraphs
(e)(7)(vi)(B) and (C) of this section to appropriate decision makers at
the covered clearing agency, including but not limited to, its risk
management committee or board of directors, and using these results to
evaluate the adequacy of and adjust its liquidity risk management
methodology, model parameters, and any other relevant aspects of its
liquidity risk management framework;
(vii) Performing a model validation of its liquidity risk models
not less than annually or more frequently as may be contemplated by the
covered clearing agency's risk management framework established
pursuant to paragraph (e)(3) of this section;
(viii) Addressing foreseeable liquidity shortfalls that would not
be covered by the covered clearing agency's liquid resources and seek
to avoid unwinding, revoking, or delaying the same-day settlement of
payment obligations;
(ix) Describing the covered clearing agency's process to replenish
any liquid resources that the clearing agency may employ during a
stress event; and
(x) Undertaking an analysis at least once a year that evaluates the
feasibility of maintaining sufficient liquid resources at a minimum in
all relevant currencies to effect same-day and, where appropriate,
intraday and multiday settlement of payment obligations with a high
degree of confidence under a wide range of foreseeable stress scenarios
that includes, but is not limited to, the default of the two
participant families that would potentially cause the largest aggregate
payment obligation for the covered clearing agency in extreme but
plausible market conditions if the covered clearing agency provides
central counterparty services and is either systemically important in
multiple jurisdictions or a clearing agency involved in activities with
a more complex risk profile.
(8) Define the point at which settlement is final to be no later
than the end of the day on which the payment or obligation is due and,
where necessary or appropriate, intraday or in real time.
(9) Conduct its money settlements in central bank money, where
available and determined to be practical by the board of directors of
the covered clearing agency, and minimize and manage credit and
liquidity risk arising from conducting its money settlements in
commercial bank money if central bank money is not used by the covered
clearing agency.
(10) Establish and maintain transparent written standards that
state its obligations with respect to the delivery of physical
instruments, and establish and maintain operational practices that
identify, monitor, and manage the risks associated with such physical
deliveries.
(11) When the covered clearing agency provides central securities
depository services:
(i) Maintain securities in an immobilized or dematerialized form
for their transfer by book entry, ensure the integrity of securities
issues, and minimize and manage the risks associated with the
safekeeping and transfer of securities;
(ii) Implement internal auditing and other controls to safeguard
the rights of securities issuers and holders and prevent the
unauthorized creation or deletion of securities, and conduct periodic
and at least daily reconciliation of securities issues it maintains;
and
(iii) Protect assets against custody risk through appropriate rules
and procedures consistent with relevant laws, rules, and regulations in
jurisdictions where it operates.
(12) Eliminate principal risk by conditioning the final settlement
of one obligation upon the final settlement of the other, regardless of
whether the covered clearing agency settles on a gross or net basis and
when finality occurs if the covered clearing agency settles
transactions that involve the settlement of two linked obligations.
(13) Ensure the covered clearing agency has the authority and
operational capacity to take timely action to contain losses and
liquidity
[[Page 70905]]
demands and continue to meet its obligations by, at a minimum,
requiring the covered clearing agency's participants and, when
practicable, other stakeholders to participate in the testing and
review of its default procedures, including any close-out procedures,
at least annually and following material changes thereto.
(14) Enable, when the covered clearing agency provides central
counterparty services for security-based swaps or engages in activities
that the Commission has determined to have a more complex risk profile,
the segregation and portability of positions of a participant's
customers and the collateral provided to the covered clearing agency
with respect to those positions and effectively protect such positions
and related collateral from the default or insolvency of that
participant.
(15) Identify, monitor, and manage the covered clearing agency's
general business risk and hold sufficient liquid net assets funded by
equity to cover potential general business losses so that the covered
clearing agency can continue operations and services as a going concern
if those losses materialize, including by:
(i) Determining the amount of liquid net assets funded by equity
based upon its general business risk profile and the length of time
required to achieve a recovery or orderly wind-down, as appropriate, of
its critical operations and services if such action is taken;
(ii) Holding liquid net assets funded by equity equal to the
greater of either (x) six months of the covered clearing agency's
current operating expenses, or (y) the amount determined by the board
of directors to be sufficient to ensure a recovery or orderly wind-down
of critical operations and services of the covered clearing agency, as
contemplated by the plans established under paragraph (e)(3)(ii) of
this section, and which:
(A) Shall be in addition to resources held to cover participant
defaults or other risks covered under the credit risk standard in
paragraph (b)(3) or paragraphs (e)(4)(i) through (iii) of this section,
as applicable, and the liquidity risk standard in paragraphs (e)(7)(i)
and (ii) of this section; and
(B) Shall be of high quality and sufficiently liquid to allow the
covered clearing agency to meet its current and projected operating
expenses under a range of scenarios, including in adverse market
conditions; and
(iii) Maintaining a viable plan, approved by the board of directors
and updated at least annually, for raising additional equity should its
equity fall close to or below the amount required under paragraph
(e)(15)(ii) of this section.
(16) Safeguard the covered clearing agency's own and its
participants' assets, minimize the risk of loss and delay in access to
these assets, and invest such assets in instruments with minimal
credit, market, and liquidity risks.
(17) Manage the covered clearing agency's operational risks by:
(i) Identifying the plausible sources of operational risk, both
internal and external, and mitigating their impact through the use of
appropriate systems, policies, procedures, and controls;
(ii) Ensuring that systems have a high degree of security,
resiliency, operational reliability, and adequate, scalable capacity;
and
(iii) Establishing and maintaining a business continuity plan that
addresses events posing a significant risk of disrupting operations.
(18) Establish objective, risk-based, and publicly disclosed
criteria for participation, which permit fair and open access by direct
and, where relevant, indirect participants and other financial market
utilities, require participants to have sufficient financial resources
and robust operational capacity to meet obligations arising from
participation in the clearing agency, and monitor compliance with such
participation requirements on an ongoing basis.
(19) Identify, monitor, and manage the material risks to the
covered clearing agency arising from arrangements in which firms that
are indirect participants in the covered clearing agency rely on the
services provided by direct participants to access the covered clearing
agency's payment, clearing, or settlement facilities.
(20) Identify, monitor, and manage risks related to any link the
covered clearing agency establishes with one or more other clearing
agencies, financial market utilities, or trading markets.
(21) Be efficient and effective in meeting the requirements of its
participants and the markets it serves, and have the covered clearing
agency's management regularly review the efficiency and effectiveness
of its:
(i) Clearing and settlement arrangements;
(ii) Operating structure, including risk management policies,
procedures, and systems;
(iii) Scope of products cleared or settled; and
(iv) Use of technology and communication procedures.
(22) Use, or at a minimum accommodate, relevant internationally
accepted communication procedures and standards in order to facilitate
efficient payment, clearing, and settlement.
(23) Provide for the following:
(i) Publicly disclosing all relevant rules and material procedures,
including key aspects of its default rules and procedures;
(ii) Providing sufficient information to enable participants to
identify and evaluate the risks, fees, and other material costs they
incur by participating in the covered clearing agency;
(iii) Publicly disclosing relevant basic data on transaction volume
and values;
(iv) A comprehensive public disclosure that describes its material
rules, policies, and procedures regarding its legal, governance, risk
management, and operating framework, accurate in all material respects
at the time of publication, that includes:
(A) Executive summary. An executive summary of the key points from
paragraphs (e)(23)(iv)(B), (C), and (D) of this section;
(B) Summary of material changes since the last update of the
disclosure. A summary of the material changes since the last update of
paragraph (e)(23)(iv)(C) or (D) of this section;
(C) General background on the covered clearing agency. A
description of:
(1) The covered clearing agency's function and the markets it
serves;
(2) Basic data and performance statistics on the covered clearing
agency's services and operations, such as basic volume and value
statistics by product type, average aggregate intraday exposures to its
participants, and statistics on the covered clearing agency's
operational reliability; and
(3) The covered clearing agency's general organization, legal and
regulatory framework, and system design and operations; and
(D) Standard-by-standard summary narrative. A comprehensive
narrative disclosure for each applicable standard set forth in
paragraphs (e)(1) through (23) of this section with sufficient detail
and context to enable a reader to understand the covered clearing
agency's approach to controlling the risks and addressing the
requirements in each standard; and
(v) Updating the public disclosure under paragraph (e)(23)(iv) of
this section every two years, or more frequently following changes to
its system or the environment in which it operates to the extent
necessary to ensure statements previously provided under paragraph
(e)(23)(iv) of this section remain accurate in all material respects.
[[Page 70906]]
(f) For purposes of enforcing the Payment, Clearing, and Settlement
Supervision Act of 2010 (12 U.S.C. 5461 et seq.), a designated clearing
agency for which the Commission acts as supervisory agency shall be
subject to, and the Commission shall have the authority under, the
provisions of paragraphs (b) through (n) of Section 8 of the Federal
Deposit Insurance Act (12 U.S.C. 1818) in the same manner and to the
same extent as if such designated clearing agency were an insured
depository institution and the Commission were the appropriate Federal
banking agency for such insured depository institution.
By the Commission.
Dated: September 28, 2016.
Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-23891 Filed 10-12-16; 8:45 am]
BILLING CODE 8011-01-P