[Federal Register Volume 87, Number 162 (Tuesday, August 23, 2022)]
[Proposed Rules]
[Pages 51812-51857]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-17316]
[[Page 51811]]
Vol. 87
Tuesday,
No. 162
August 23, 2022
Part III
Securities and Exchange Commission
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17 CFR Part 240
Clearing Agency Governance and Conflicts of Interest; Proposed Rule
Federal Register / Vol. 87, No. 162 / Tuesday, August 23, 2022 /
Proposed Rules
[[Page 51812]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 242
[Release No. 34-95431; File No. S7-21-22]
RIN 3235-0695
Clearing Agency Governance and Conflicts of Interest
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule; partial withdrawal of proposed rule; withdrawal
of applicability of proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing rules under the Securities Exchange Act of 1934 (``Exchange
Act'') to help improve the governance of clearing agencies registered
with the Commission (``registered clearing agencies'') by reducing the
likelihood that conflicts of interest may influence the board of
directors or equivalent governing body (``board'') of a registered
clearing agency. The proposed rules would identify certain
responsibilities of the board, increase transparency into board
governance, and, more generally, improve the alignment of incentives
among owners and participants of a registered clearing agency. In
support of these objectives, the proposed rules would establish new
requirements for board and committee composition, independent
directors, management of conflicts of interest, and board oversight.
DATES: As of August 23, 2022, SEC withdraws amendatory instructions # 7
and 8 (Sec. Sec. 240.17Ad-25 and 240.17Ad-26 in Release No. 34-64017),
published at 76 FR 14472 on March 16, 2011. Also as of August 23, 2022,
SEC withdraws the applicability of the proposed rule published at 75 FR
65881 on October 26, 2010 (Release No. 34-63107) as it pertained to
clearing agencies.
Comments on this proposal should be received on or before October
7, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
Send an email to [email protected]. Please include
File Number S7-21-22 on the subject line.
Paper Comments
Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-21-22. This file
number should be included on the subject line if email is used. To help
us process and review your comments more efficiently, please use only
one method. The Commission will post all comments on the Commission's
website (https://www.sec.gov/rules/proposed.shtml). Comments are also
available for website viewing and printing in the Commission's Public
Reference Room, 100 F Street NE, Washington, DC 20549, on official
business days between the hours of 10 a.m. and 3 p.m. Operating
conditions may limit access to the Commission's public reference room.
All comments received will be posted without change. Persons submitting
comments are cautioned that we do not redact or edit personal
identifying information from comment submissions. You should submit
only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Matthew Lee, Assistant Director,
Stephanie Park, Senior Special Counsel, Claire Noakes, Special Counsel,
or Tanin Kazemi, Attorney-Adviser, Office of Clearance and Settlement
at (202) 551-5710, Division of Trading and Markets, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is withdrawing the following
proposed rules under the Exchange Act: Regulation MC as proposed for
security-based swap clearing agencies,\1\ and rules proposed for
clearing agencies at 17 CFR 240.17Ad-25 (``Rule 17Ad-25'') and
240.17Ad-26 (``Rule 17Ad-26'').\2\ In their place, the Commission is
proposing a new Rule 17Ad-25 to mitigate conflicts of interest, promote
the fair representation of owners and participants in the governance of
a clearing agency, identify responsibilities of the board, and increase
transparency into clearing agency governance.
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\1\ Exchange Act Release No. 63107 (Oct. 14, 2010), 75 FR 65882
(Oct. 26, 2010) (``Regulation MC Proposing Release'').
\2\ Exchange Act Release No. 64017 (Mar. 3, 2011), 76 FR 14471
(Mar. 16, 2011) (``Clearing Agency Standards Proposing Release'')
(proposing Rules 17Ad-25 and 17Ad-26).
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The Commission is also mindful of the differing perspectives that
exist at registered clearing agencies among stakeholders, including
owners and participants (some of whom also are clearing agency owners),
small and large participants, and direct participants (who are clearing
members) and indirect participants.\3\ Proposed Rule 17Ad-25 would
establish new requirements for clearing agency boards to address and
mitigate conflicts of interest and to help ensure more effective
oversight of the clearing agency by the board. The Commission believes
these requirements would help ensure that a clearing agency's
governance arrangements can more effectively manage these different
perspectives so that the clearing agency can, among other things, help
ensure that the design and implementation of risk management decisions
are effective. Specifically, the proposed rule would: (i) define
independence in the context of a director serving on the board of a
registered clearing agency and require that a majority of directors on
the board be independent, unless a majority of the voting rights
distributed to shareholders of record are directly or indirectly held
by participants of the registered clearing agency, in which case at
least 34 percent of the board must be independent directors; (ii)
establish requirements for a nominating committee, including with
respect to the composition of the nominating committee, fitness
standards for serving on the board, and documenting the process for
evaluating board nominees; (iii) establish requirements for the
function, composition, and reconstitution of the risk management
committee; (iv) require policies and procedures that identify, mitigate
or eliminate, and document the identification and mitigation or
elimination of conflicts of interest; (v) require policies and
procedures that obligate directors to report potential conflicts
promptly; (vi) require policies and procedures for the board to oversee
relationships with service providers for critical services; and (vii)
require policies and procedures to solicit, consider, and document the
registered clearing agency's consideration of the views of its
participants and other
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relevant stakeholders regarding its governance and operations.
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\3\ Examples of indirect participants might be entities such as
customers or clients of direct participants or clearing members
since they rely on services provided by a direct participant to
access the services of the clearing agency.
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Table of Contents
I. Introduction
II. Background
A. Differing Perspectives at Registered Clearing Agencies
B. Regulatory Framework for Registered Clearing Agencies
C. Risks Associated with Clearance and Settlement
III. Proposed Rules
A. Board Composition and Requirements for Independent Directors
B. Nominating Committee
C. Risk Management Committee
D. Conflicts of Interest
E. Board Obligation to Oversee Service Providers for Critical
Services
F. Obligation to Formally Consider Stakeholder Viewpoints
G. Considerations Related to Implementation and Compliance
H. General Request for Comment
IV. Economic Analysis
A. Introduction
B. Economic Baseline
C. Consideration of Benefits and Costs
D. Reasonable Alternatives to the Proposed Rule
E. Request for Comment
V. Paperwork Reduction Act
A. Rule 17Ad-25(b)
B. Rule 17Ad-25(c)
C. Rule 17Ad-25(d)
D. Rule 17Ad-25(g)
E. Rule 17Ad-25(h)
F. Rule 17Ad-25(i)
G. Rule 17Ad-25(j)
H. Chart of Total PRA Burdens
I. Request for Comment
VI. Small Business Regulatory Enforcement Fairness Act
VII. Regulatory Flexibility Act Certification
A. Registered Clearing Agencies
B. Certification
VIII. Statutory Authority and Text of Proposed Rule
I. Introduction
Clearing agencies registered with the Commission play an important
role in the securities markets. They help ensure the prompt and
accurate clearance and settlement of securities transactions, including
the transfer of record ownership and the safeguarding of securities and
related funds, which has the effect of protecting investors and persons
facilitating transactions by and acting on behalf of investors.\4\ As
such, Section 17A of the Exchange Act requires that, before an entity
provides clearing agency services, it must register with the
Commission.\5\ Under the Commission's supervision, registered clearing
agencies, as self-regulatory organizations (``SROs'') under Section 19
of the Exchange Act,\6\ must submit to the Commission changes to their
rules for review and approval or to be deemed immediately effective
upon filing.\7\
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\4\ See 15 U.S.C. 78q-1(a)(1)(A); see, e.g., Committee on
Payment and Settlement Systems and Technical Committee of the
International Organization of Securities Commissions, Principles for
financial market infrastructures (Apr. 16, 2012), at 5 (``PFMI''),
http://www.bis.org/publ/cpss101a.pdf (stating that financial market
infrastructures (``FMIs''), which include clearing agencies like
central counterparties (``CCPs'') and central securities
depositories (``CSDs''), ``[w]hile safe and efficient . . .
contribute to maintaining and promoting financial stability and
economic growth, FMIs also concentrate risk. If not property
managed, FMIs can be sources of financial shocks, such as liquidity
dislocations and credit losses, or a major channel through which
these shocks are transmitted across domestic and international
financial markets'').
\5\ See 15 U.S.C. 78q-1(a)(2); see also 17 CFR 240.17Ab2-1.
\6\ Upon registration, registered clearing agencies are SROs
under Section 3(a)(26) of the Exchange Act. See 15 U.S.C.
78c(a)(26).
\7\ Except for certain rule changes that do not need approval,
set forth in 17 CFR 240.19b-4(f), 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.
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Given the important role of clearing agencies in the U.S. financial
system, the governance framework of each clearing agency is an integral
part in helping to ensure that the clearing agency is resilient and
strong. A transparent and reliable governance framework has a positive
and lasting cascading effect: Through the decision-making of the
clearing agency and to its effective and efficient supervision. From
the outset, an ideal governance framework that establishes a clear and
deliberative process would have the clearing agency consider a range of
stakeholder views as part of its rules and risk management practices,
resulting in more thorough and robust SRO rule proposals for the
Commission to consider in supervising the clearing agency. In essence,
improved governance would help promote optimum practices for all
registered clearing agencies to follow to help ensure that their
processes and decisions are clear, transparent, and reliable, that
risks are appropriately monitored, addressed, and managed, and that
their leadership is competent and accountable. When these fundamental
guiding principles on governance influence and permeate a clearing
agency's culture and operations, the clearing agency will instill
confidence in its participants, the markets, and the investing public,
thereby meeting and promoting the policy objectives in Section 17A of
the Exchange Act regarding the prompt and accurate clearance and
settlement of securities transactions, among other objectives.\8\
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\8\ See 15 U.S.C. 78q-1(a)(1)(A)-(D); see also Exchange Act
Release No. 68080 (Oct. 22, 2012), 77 FR 66219, 66252 (Nov. 2, 2012)
(``Clearing Agency Standards Adopting Release'') (noting that
``[g]overnance arrangements have the potential to play an important
role in making sure that clearing agencies fulfill the Exchange Act
requirements that the rules of a clearing agency be designed to
protect investors and the public interest and to support the
objectives of owners and participants. Similarly, governance
arrangements may promote the effectiveness of a clearing agency's
risk management procedures by creating an oversight framework that
fosters a focus on the critical role that risk management plays in
promoting prompt and accurate clearance and settlement'').
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The Commission has previously stated that clear and transparent
governance arrangements help promote accountability and reliability in
the decisions, rules and procedures of the clearing agency because they
provide interested parties (such as owners, direct and indirect
participants, and general members of the public) with information about
how such decisions are made and what the rules and procedures are
designed to accomplish.\9\ In turn, clear and transparent governance
arrangements help optimize the clearing agency's decisions, rules and
procedures that the Commission considers in the SRO rule filing process
because clearing agency transparency improves the quality of the
information shared with stakeholders, which in turn improves the public
comments submitted in response to rule filings. While the business
models of clearing agencies vary and include entities that are
affiliates of publicly traded companies and entities that function as
participant-owned utilities, the key components of a clearing agency's
governance arrangements include the
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clearing agency's ownership structure, the composition and role of its
board, the structure and role of board committees, reporting lines
between management and the board, and the processes that help ensure
management is held accountable for the clearing agency's
performance.\10\ Regardless of the business model, the clearing agency
is more effective when it has governance arrangements that accomplish
the following: (1) help ensure that the clearing agency satisfies the
Exchange Act requirements and Commission rules that are designed to
protect investors and the public interest; and (2) support the
objectives of the clearing agency's owners, direct participants, and
indirect participants.\11\
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\9\ See Clearing Agency Standards Proposing Release, supra note
2, at 14488 (``Clear and transparent governance arrangements promote
accountability and reliability in the decisions, rules and
procedures of the clearing agency because they provide interested
parties (such as owners, participants, and general members of the
public) with information about how such decisions are made and what
the rules and procedures are designed to accomplish. The key
components of a clearing agency's governance arrangements include
the clearing agency's ownership structure, the composition and role
of its board, the structure and role of board committees, reporting
lines between management and the board, and the processes that
ensure management is held accountable for the clearing agency's
performance. Governance arrangements have the potential to play an
important role in making sure that clearing agencies fulfill the
Exchange Act requirements that the rules of a clearing agency be
designed to protect investors and the public interest and to support
the objectives of owners and participants. Similarly, governance
arrangements may promote the effectiveness of a clearing agency's
risk management procedures by creating an oversight framework that
fosters a focus on the critical role that risk management plays in
promoting prompt and accurate clearance and settlement.'').
\10\ See id. at 66269.
\11\ See id. at 66252.
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In recognizing the implications that a robust governance framework
has on the operations of clearing agencies, the Commission adopted a
series of clearing agency governance requirements. In 2012, the
Commission adopted a general governance rule for all registered
clearing agencies (that are not covered clearing agencies) under Rule
17Ad-22(d).\12\ In 2016, the Commission adopted a governance rule under
Rule 17Ad-22(e) as part of its heightened standards for covered
clearing agencies, defined as a registered clearing agency that
provides the services of a central counterparty or central securities
depository.\13\ The Commission took a broad, principles-based approach
in the design of both rules, and emphasized that governance remains an
area of continued consideration and interest, with the goal of
establishing an evolving regulatory framework for clearing
agencies.\14\
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\12\ See 17 CFR 240.17Ad-22(d)(8) (requiring that all registered
clearing agencies aside from covered clearing agencies 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, to support the objectives of owners
and participants, and to promote the effectiveness of the clearing
agency's risk management procedures).
\13\ See 17 CFR 240.17Ad-22(e)(2) (requiring 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,
establish that the board of directors and senior management have
appropriate experience and skills to discharge their duties and
responsibilities, specify clear and direct lines of responsibility,
and consider the interests of participants' customers, securities
issuers and holders, and other relevant stakeholders of the covered
clearing agency); see also Exchange Act Release No. 78961 (Sept. 28,
2016), 81 FR 70786 (Oct. 13, 2016) (``CCA Standards Adopting
Release'').
\14\ See Clearing Agency Standards Adopting Release, supra note
8, at 66252 (stating that ``[w]e continue to perform a careful
review and evaluation of the comments that the Commission received
on proposed Rules 17Ad-25, 17Ad-26 and Regulation MC, which
commenters rightly observed represent separate, and in some cases
more prescriptive, proposed requirements related to clearing agency
governance and mitigation of conflicts of interest . . . .We believe
it is more appropriate to consider those issues in connection with
the Commission's ongoing consideration of those rules'').
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During the ensuing years since the adoption of the 2016 covered
clearing agency governance rule, the Commission has observed and
learned from recurring tensions among incentive structures in the area
of clearing agency governance. The Commission understands that
differing views among clearing agency stakeholders can have a ripple
effect on the decisions that clearing agencies make, including risk
management decisions that, in turn, affect clearing members and the
larger financial community. Accordingly and for the reasons described
throughout this release, the Commission is proposing rules that would
build upon and strengthen the existing governance requirements adopted
by the Commission in the Clearing Agency Standards Adopting Release in
2012 and the CCA Standards Adopting Release in 2016.\15\ Specifically,
the Commission believes that the existing clearing agency governance
rules should be enhanced to help balance the differing incentives of
the registered clearing agencies, clearing members, and other key
stakeholders. While the governance requirements adopted by the
Commission at that time are broad and principles-based, the rules
proposed today would set more specific and defined parameters and
requirements for governance for all registered clearing agencies--both
covered clearing agencies under Rule 17Ad-22(e) under the Exchange Act
and all registered clearing agencies other than covered clearing
agencies that are subject to Rule 17Ad-22(d) under the Exchange Act.
Because all clearing agencies would face these tensions, the Commission
believes it is appropriate to have this governance proposal apply to
all registered clearing agencies. In this regard, the rules would
establish new governance requirements on board composition for
independent directors, nominating committees, risk management
committees, conflicts of interest, board obligations to oversee service
providers for critical services, and an obligation to formally consider
stakeholder viewpoints. The proposed rules are designed to address
governance issues specific to registered clearing agencies, due to
their distinct ownership structures and organizational forms. Moreover,
the rules are designed to take a multi-layered approach to governance
in that one rule alone would not necessarily capture and address an
issue relating to governance; each of the different rules proposed
today would provide one additional mitigation layer to help ensure that
registered clearing agencies are designed, managed, and operated under
a robust governance framework to protect investors and the public
interest and help promote the prompt and accurate clearance and
settlement of securities transactions. Each mitigation layer improves
the robustness of the governance framework by itself, with each
additional mitigation layer having a cumulative effect on robustness.
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\15\ See 17 CFR 240.17Ad-22; see also Clearing Agency Standards
Adopting Release, supra note 8; CCA Standards Adopting Release,
supra note 13.
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In Part II below, the Commission provides context for the rule
proposal by (i) discussing the different perspectives that exist among
various stakeholders at registered clearing agencies, (ii) briefly
summarizing changes to the regulatory framework for registered clearing
agencies following passage of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (``Dodd-Frank Act''),\16\ and (iii)
describing recent events that have increased focus among market
participants on the governance arrangements that direct risk management
policies and procedures at registered clearing agencies.
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\16\ Public Law 111-203, 124 Stat. 1376 (2010).
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II. Background
Rule 17Ad-22 under the Exchange Act provides for two categories of
registered clearing agencies and contains a set of rules that apply to
each category. The first category is covered clearing agencies, which
are registered clearing agencies that provide CCP \17\ or
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CSD \18\ services.\19\ Rule 17Ad-22(e) applies to covered clearing
agencies and includes requirements 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.\20\ The
second category includes registered clearing agencies other than
covered clearing agencies; such clearing agencies must comply with Rule
17Ad-22(d).\21\ Rule 17Ad-22(d) establishes a regulatory regime to
govern registered clearing agencies that do not provide CCP or CSD
services.\22\ Currently, all clearing agencies registered with the
Commission that are actively providing clearance and settlement
services are covered clearing agencies.\23\ Although all currently
registered and active clearing agencies meet the definition of a
covered clearing agency, thereby making Rule 17Ad-22(d) not applicable
to any registered and active clearing agencies at present, clearing
agencies that are not covered clearing agencies may register with the
Commission in the future and would be subject to Rule 17Ad-22(d).\24\
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\17\ A CCP is a type of registered clearing agency that acts as
the buyer to every seller and the seller to every buyer, providing a
trade guaranty with respect to transactions submitted for clearing
by the CCP's participants. See 17 CFR 240.17Ad-22(a)(2); Exchange
Act Release No. 88616 (Apr. 9, 2020), 85 FR 28853, 28855 (May 14,
2020) (``CCA Definition Adopting Release''). A CCP may perform a
variety of risk management functions to manage the market, credit,
and liquidity risks associated with transactions submitted for
clearing. For example, CCPs help manage the effects of a participant
default by closing out the defaulting participant's open positions
and using financial resources available to the CCP to absorb any
losses. In this way, the CCP can prevent the onward transmission of
financial risk. See, e.g., Exchange Act Release No. 94196 (Feb. 9,
2022), 87 FR 10436, 10448 (Feb. 24, 2022) (``T+1 Proposing
Release''). If a CCP is unable to perform its risk management
functions effectively, however, it can transmit risk throughout the
financial system.
\18\ A CSD is a type of registered clearing agency that acts as
a depository for handling securities, whereby all securities of a
particular class or series of any issuer deposited within the system
are treated as fungible. Through use of a CSD, securities may be
transferred, loaned, or pledged by bookkeeping entry without the
physical delivery of certificates. A CSD also may permit or
facilitate the settlement of securities transactions more generally.
See 15 U.S.C. 78c(a)(23)(A); 17 CFR 240.17Ad-22(a)(3); CCA
Definition Adopting Release, supra note 17, at 28856. If a CSD is
unable to perform these functions, market participants may be unable
to settle their transactions, transmitting risk through the
financial system.
\19\ See 17 CFR 240.17Ad-22(a)(5).
\20\ See CCA Standards Adopting Release, supra note 13, at
70793. The Financial Stability Oversight Council (``FSOC'') has
designated certain financial market utilities (``FMUs'')--which
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--as systemically important or likely to become systemically
important (``SIFMUs''). 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).
\21\ See 17 CFR 240.17Ad-22(d).
\22\ See CCA Standards Adopting Release, supra note 13, at
70793.
\23\ They are The Depository Trust Company (``DTC''), FICC,
NSCC, ICE Clear Credit (``ICC''), ICE Clear Europe (``ICEEU''), The
Options Clearing Corporation (``OCC''), and LCH SA.
\24\ The Boston Stock Exchange Clearing Corporation (``BSECC'')
and Stock Clearing Corporation of Philadelphia (``SCCP'') are
currently registered with the Commission as clearing agencies but
conduct no clearance or settlement operations; both inactive
clearing agencies are subject to Rule 17Ad-22(d). See Exchange Act
Release No. 63629 (Jan. 3, 2011), 76 FR 1473, 1474 (Jan. 10, 2011)
(``BSECC Notice''); Exchange Act Release No. 63268 (Nov. 8, 2010),
75 FR 69730, 69731 (Nov. 15, 2010) (``SCCP Notice'').
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In establishing these regimes under Rule 17Ad-22 under the Exchange
Act, the Commission stated that the approach under Rules 17Ad-22(d) and
(e) takes into account clearing agency activities and the risks they
pose, while promoting robust risk management practices and the general
safety and soundness of registered clearing agencies and addressing
concerns relating to the level of concentration in the provision of
clearing agency services.\25\ The Commission recognized that Rule 17Ad-
22(d) 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.\26\ Notwithstanding their
different risk profiles, all registered clearing agencies--whether
covered clearing agencies under Rule 17Ad-22(e) or registered clearing
agencies under Rule 17Ad-22(d)--are important to the U.S. financial
system, as evident in their obligations under Section 17A of the
Exchange Act. Effective governance--the primary way by which a clearing
agency develops and oversees the provision of its clearance and
settlement services--is the lynchpin to ensuring a well-functioning and
resilient clearing agency that can withstand periods of market
stress.\27\ In this regard, the Commission believes that the governance
requirements in proposed Rule 17Ad-25 should apply to all registered
clearing agencies. The Commission's intent with respect to proposed
Rule 17Ad-25 is, in part, to take another incremental step to help
ensure that risks posed by registered clearing agencies are
appropriately managed consistent with the purposes of the Exchange Act.
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\25\ See CCA Standards Adopting Release, supra note 13, at
70793.
\26\ See id.
\27\ See SEC Division of Trading and Markets and Office of
Compliance Inspections and Examinations, Staff Report on the
Regulation of Clearing Agencies (Oct. 1, 2020) (``Staff Report on
Clearing Agencies''), https://www.sec.gov/files/regulation-clearing-agencies-100120.pdf.
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A. Differing Perspectives at Registered Clearing Agencies
The Exchange Act requires each registered clearing agency to be so
organized and have the capacity to facilitate prompt and accurate
clearance and settlement.\28\ It also requires each registered clearing
agency to have rules that assure the fair representation of
shareholders and participants in the selection of directors and the
administration of its affairs.\29\ These requirements highlight the
importance of a clearing agency's organization in facilitating prompt
and accurate clearance and settlement, and of the need for a clearing
agency to have rules that help ensure that both owners and participants
participate in the selection of directors and the administration of its
affairs, including board governance. Moreover, the Commission's recent
experience has revealed that differing perspectives among other
categories of stakeholders may influence the ways risk management
decisions and practices develop and are implemented by the registered
clearing agency. These differing views--whether between small and large
clearing members or between direct and indirect participants of the
clearing agency--warrant attention as they may manifest themselves in a
clearing agency's decision-making to benefit one category of
stakeholders at the expense of another category of stakeholders.
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\28\ 15 U.S.C. 78q-1(b)(3)(A).
\29\ 15 U.S.C. 78q-1(b)(3)(C). The Exchange Act specifically
states the ``fair representation of . . . shareholders (or members)
and participants'' in the selection of directors and the
administration of affairs, reflecting the fact that a clearing
agency could be either a for-profit or not-for-profit entity. See
Regulation of Clearing Agencies, Exchange Act Release No. 16900, 20
SEC Docket 415, 420 n.15 (June 17, 1980) (explaining that ``[t]he
fair representation requirement was adopted verbatim from S. 249,
the Senate bill that preceded the Securities Acts Amendments of
1975. The report of the Senate Committee on Banking, Housing and
Urban Affairs to accompany S. 249 states: `The rules of the clearing
agency must assure fair representation of its shareholders (or
members) and participants in the decision making process of the
clearing agency . . . . The reference to shareholders of [sic]
members makes it clear that the bill establishes no norm as to
whether clearing agencies should or should not be operated for
profit. The bill makes no attempt to set up particular standards of
representation or participation. Rather, it provides that the
Commission must assure itself that the rules of the clearing agency
regarding the manner in which decisions are made give fair voice to
participants as well as to shareholders or members. Fair
representation of participants may be found if they are afforded an
opportunity to acquire voting stock of the clearing agency in
proportion to their use of its facilities''). ``Members,'' however,
is a term often used to describe the participants of a clearing
agency. This release refers to ``shareholders (or members)''
collectively as ``owners'' of the registered clearing agency. In
some instances, owners and shareholders may differ in certain
respects, such as the nature and extent of their voting rights on
the board. To avoid confusion, in this release the Commission uses
only ``participants'' to refer to the direct users of a clearing
agency, which have met the standards for participation and have
executed a participation agreement.
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First, based on its supervisory experiences, the Commission has
observed that owners and participants may have structural incentives
that differ from one another, leading to differing views as to the
efficacy of certain risk management tools and the potential for
divergent interests in the risk management of the clearing agency. For
example, owners and participants may have differing views as to the
scope of products cleared by the clearing agency, the minimum standards
required for participation in the clearing agency, and the size,
timing, and nature of financial resource requirements applied as part
of the risk management framework.
Fundamentally, an owner's interest in protecting the equity and
continued operation of the clearing agency diverges from a
participant's interest in avoiding the allocation of losses from a
defaulting participant. Diverging interests and incentives among owners
and participants with respect to loss allocation or scope of products--
such as in the event that some participants may want to limit access to
a market by limiting access to clearing, while owners would like to
expand the scope of products to collect fees-could limit the benefits
of a clearing agency, and even potentially cause harm to the market it
serves as well as the broader financial system to the extent that they
might undermine the risk mitigating purpose of the clearing agency by
failing to achieve the right balance among competing interests.\30\
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\30\ For a discussion of the importance of aligning clearing
agency governance with the interests of those who bear the financial
risk, see infra note 167 and accompanying text.
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When a clearing agency chooses to mutualize the risk it faces among
its owners and participants, it may find a closer alignment of
incentives among owners and participants because both owners and
participants would bear losses associated with a failure of the
clearing agency.\31\ In considering how to mutualize the risk it faces,
a clearing agency may choose from a number of different approaches. For
example, a clearing agency may be organized so that the participants
are owners of the clearing agency,\32\ which may eliminate diverging
incentives between owners and participants. Regardless of the approach,
as stated above, the Exchange Act requires that a clearing agency be so
organized and have the capacity to facilitate prompt and accurate
clearance and settlement. In addition, the Exchange Act requires that
the rules of the clearing agency assure a fair representation of its
shareholders (or members) and participants in the selection of its
directors and administration of its affairs.\33\
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\31\ See Jorge Cruz Lopez & Mark Manning, Who Pays? CCP Resource
Provision in the Post-Pittsburgh World (Dec. 2017), https://www.bankofcanada.ca/wp-content/uploads/2017/12/sdp2017-17.pdf.
\32\ See, e.g., Exchange Act Release No. 52922 (Dec. 7, 2005),
70 FR 74070 (Dec. 14, 2005) (explaining that participants of DTC,
FICC, and NSCC that make full use of the services of one or more of
these clearing agency subsidiaries of DTCC are required to purchase
DTCC common shares).
\33\ See 15 U.S.C. 78q-1(b)(3)(C).
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Second, the Commission has observed differing views between large
and small participants in a registered clearing agency about risk
management practices. Consolidation among market participants in recent
years has resulted in the increased concentration of clearance and
settlement activity among a smaller set of firms. For example, over 90
percent of the total notional amount of the U.S. market in credit
derivatives is concentrated in four U.S. commercial banks.\34\ Large
clearing agency participants, especially participant-owners, often have
different incentives from smaller participants. When a small number of
dominant participants exercise control or influence over a registered
clearing agency with respect to the services provided by the registered
clearing agency or the rules applicable to its participants, these
participants may promote margin requirements that are not commensurate
with the risks and particular attributes of each participant's specific
products, portfolio, and market, thereby indirectly limiting
competition and increasing their ability to maintain higher profit
margins. Given such incentives, a registered clearing agency that is
dominated by a small number of large participants might make decisions
that are designed to provide them with a competitive advantage.
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\34\ See Staff Report on Clearing Agencies, supra note 27, at 21
(citing the Office of the Comptroller of the Currency, Quarterly
Report on Bank Trading and Derivatives Activities, Third Quarter
2019, graph 4 (Dec. 2019), https://www.occ.gov/publications-andresources/publications/quarterly-report-on-bank-trading-and-derivatives-activities/files/pub-derivativesquarterly-qtr3-2019.pdf).
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Third, the Commission's proposal is informed, in part, by its
experience overseeing registered clearing agencies with regard to the
concerns raised by certain participants that access criteria and risk
management standards may impose disproportionate costs relative to the
value of access to clearing agencies. In addition, when the Commission
proposed Regulation MC, the Commission identified a potential area
where a conflict of interest of participants that exercise undue
control or influence over a security-based swap clearing agency could
adversely affect the central clearing of security-based swaps by
limiting access to the security-based swap clearing agency, either by
restricting direct participation in the security-based swap clearing
agency or restricting indirect access by controlling the ability of
non-participants to enter into correspondent clearing arrangements.\35\
The resulting conflicts of interest could limit the benefits of a
registered security-based swap clearing agency in the securities market
to indirect participants. As a result, the Commission believes it
should continue to implement measures that help ensure the decisions of
a registered clearing agency reflect the interests and perspectives of
the broadest cross-section of stakeholders as possible.
---------------------------------------------------------------------------
\35\ See Regulation MC Proposing Release, supra note 1, at
65885.
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This proposal is intended to help ensure that a registered clearing
agency's governance arrangements can manage these differing
perspectives and interests more effectively. As discussed in detail
below, the Commission believes that the proposed rules would help
ensure that a registered clearing agency's governance arrangements can
more effectively manage the divergent interests between and among
clearing agency owners and participants, small and large participants,
and direct and indirect participants of a clearing agency, which, in
turn, would improve a clearing agency's risk management practices to be
fair and more effective. Imposing these requirements on all registered
clearing agencies would have the effect of building upon existing
governance requirements with consistent, more defined and robust
governance standards across all registered clearing agencies.
B. Regulatory Framework for Registered Clearing Agencies
The regulatory framework for registered clearing agencies has
evolved over the last decade. Existing elements of the regulatory
framework establish policies and procedures requirements for minimum
standards to help promote participation in registered clearing
agencies.\36\ Other rules require that certain clearing agencies have
policies and procedures for governance arrangements that support the
objectives of owners and participants and consider the interests of
participants' customers, securities issuers and holders, and other
relevant stakeholders.\37\
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\36\ See, e.g., 17 CFR 240.17Ad-22(b)(5)-(7).
\37\ See, e.g., 17 CFR 240.17Ad-22(e)(2)(iii), (vi).
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[[Page 51817]]
Following the enactment of the Dodd-Frank Act, the Commission has
taken multiple steps to strengthen its regulatory framework for
clearing agencies by: (i) establishing minimum requirements for
governance, operations, and risk management practices of registered
clearing agencies; \38\ (ii) enhancing the Commission's oversight and
enforcement of the technology and systems infrastructure that supports
clearing agencies; \39\ (iii) establishing an enhanced regulatory
framework for systemically important clearing agencies and clearing
agencies for security-based swaps; \40\ and (iv) expanding the enhanced
regulatory framework from systemically important clearing agencies to
all registered clearing agencies that provide CCP or CSD services so
that the set of covered clearing agencies includes the seven active
clearing agencies registered with the Commission.\41\ In addition, the
Commission has adopted rules to help promote access to registered
clearing agencies, including rules that require a registered clearing
agency that performs CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to: (i)
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; (ii) have membership standards that do
not require that participants maintain a minimum portfolio size or
minimum transaction volume; and (iii) provide that a person maintaining
net capital equal to or greater than $50 million may obtain membership
at the clearing agency, provided that such person is able to comply
with other reasonable membership standards.\42\
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\38\ See 17 CFR 240.17Ad-22; see also Clearing Agency Standards
Adopting Release, supra note 8; CCA Standards Adopting Release,
supra note 13; CCA Definition Adopting Release, supra note 17.
\39\ See 17 CFR 242.1000 et seq.; see also Exchange Act Release
No. 73639 (Nov. 19, 2014), 79 FR 72251 (Dec. 5, 2014) (``Regulation
SCI Adopting Release'').
\40\ See 17 CFR 240.17Ad-22(e); CCA Standards Adopting Release,
supra note 13.
\41\ See CCA Definition Adopting Release, supra note 17.
\42\ 17 CFR 240.17Ad-22(b)(5)-(7).
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1. Current Requirements and Past Proposals on Clearing Agency
Governance
In the recent past, the Commission addressed clearing agency
governance with the adoption of two rules. In 2016, the Commission
adopted a rule that requires 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, establish that the board of directors and senior
management have appropriate experience and skills to discharge their
duties and responsibilities, specify clear and direct lines of
responsibility, and consider the interests of participants' customers,
securities issuers and holders, and other relevant stakeholders of the
covered clearing agency.\43\ In 2012, the Commission adopted a rule
that requires all registered clearing agencies aside from covered
clearing agencies 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, to support
the objectives of owners and participants, and to help promote the
effectiveness of the clearing agency's risk management procedures.\44\
The Commission took a broad, principles-based approach to these
governance rules to give a clearing agency the discretion 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, while at the same time, largely being subject to the
requirements of the SRO rule filing process, which requires public
notice and comment and consideration by the Commission.\45\
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\43\ See 17 CFR 240.17Ad-22(e)(2); see also CCA Standards
Adopting Release, supra note 13, at 70802. The Commission also
issued guidance on Rule 17Ad-22(e)(2) ``because . . . [as] there may
be a number of ways to address compliance with Rule 17Ad-22(e)(2),
the Commission . . . provid[ed] the following guidance that a
covered clearing agency generally should consider in establishing
and maintaining its policies and procedures: . . . 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.'' CCA Standards
Adopting Release, supra note 13, at 70806-07.
\44\ See 17 CFR 240.17Ad-22(d)(8); see also Clearing Agency
Standards Adopting Release, supra note 8, at 66251-52.
\45\ See generally CCA Standards Adopting Release, supra note
13, at 70800 (``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.''); Clearing Agency Standards Adopting
Release, supra note 8, at 66252 (``We appreciate the perspective of
commenters who prefer the more general policies and procedures
design of Rule 17Ad-22(d)(8) to any more prescriptive rulemaking by
the Commission in the area of clearing agency governance.'').
---------------------------------------------------------------------------
The Commission also proposed, but did not adopt, other rules
directed to clearing agency governance: proposed Regulation MC, which
contemplated limitations on ownership and minimum requirements for
independent directors intended to satisfy a requirement for Commission
rulemaking set forth in Section 765 of the Dodd-Frank Act (``Section
765''); \46\ proposed Rule 17Ad-25, which included additional
requirements for a clearing agency to mitigate conflicts of interest;
\47\ and proposed Rule 17Ad-26, which included requirements for a
clearing agency to establish standards for directors on the board and
committees thereof.\48\ The Commission did not adopt those proposals,
which were issued in 2010 and 2011, and is now withdrawing them because
of the multiple changes that the Commission has made to its regulatory
framework for clearing agencies as stated above.
---------------------------------------------------------------------------
\46\ See Regulation MC Proposing Release, supra note 1, at
65893-904.
\47\ See Clearing Agency Standards Proposing Release, supra note
2, at 14497-98.
\48\ See id. at 14498-99.
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As part of the incremental evolution of the Commission's clearing
agency regulatory framework that has occurred over the past decade, the
Commission now believes that updated rules are warranted to build upon
and strengthen the existing clearing agency governance framework, given
the trends the Commission has observed in the securities markets and
during its supervisory processes.\49\ Specifically,
[[Page 51818]]
the Commission believes that addressing the composition of a board and
its committees will help ensure effective governance, help promote
transparency into decision-making processes, facilitate fair
representation of owners and participants, and mitigate the potential
effects of conflicts of interest between owners and participants, large
and small participants, and direct and indirect participants. For these
reasons, proposed Rule 17Ad-25 includes provisions directed to all
registered clearing agencies.
---------------------------------------------------------------------------
\49\ As discussed further below, the Commission believes that
the targeted set of proposed rules for governance included in this
release can help ensure that the framework effectively addresses the
considerations set forth in Section 765 with respect to clearing of
security-based swaps. Although Section 765 directed the Commission
to focus on conflicts of interest specifically with respect to
security-based swap clearing agencies, the Commission believes that
conflicts of interest concerns can arise across all registered
clearing agencies regardless of the asset classes served.
---------------------------------------------------------------------------
2. Commodity Futures Trading Commission's Governance Framework for
Derivatives Clearing Organizations
Three clearing agencies registered with the Commission are also
registered as derivatives clearing organizations (``DCOs'') with the
Commodity Futures Trading Commission (``CFTC''). The Commission
acknowledges that, while other agency rules and regulations on
governance may apply to a clearing agency registered with the
Commission that are similar in scope or purpose to proposed Rule 17Ad-
25, the Commission remains obligated to ensure that risk in the U.S.
securities markets is appropriately managed--including through
promulgation of its own rules and regulations--consistent with the
purposes of the Exchange Act. Additionally, because Rule 17Ad-22(e)
under the Exchange Act and other comparable regulations--including DCO
governance rules adopted by the CFTC in January 2020 \50\--are based on
the same international standards, namely the PFMI, the potential for
inconsistent regulation is low. In this regard, the Commission believes
its existing governance rules for covered clearing agencies and
registered clearing agencies other than covered clearing agencies are
consistent with the CFTC's governance rule for DCOs.\51\ Certain
proposed requirements in this rulemaking are also consistent with the
requirements in the CFTC's DCO regime, which provides conflicts of
interest and board composition rules.\52\ Further, in developing these
rules, Commission staff has consulted with the CFTC and the Board of
Governors of the Federal Reserve System (``FRB'').
---------------------------------------------------------------------------
\50\ See DCO General Provisions and Core Principles, 85 FR 4800
(Jan. 27, 2020), https://www.cftc.gov/sites/default/files/2020/01/2020-01065a.pdf.
\51\ See 17 CFR 39.24 (requiring DCOs to, among other things,
have governance arrangements that are written, clear and
transparent, place a high priority on the safety and efficiency of
the derivatives clearing organization, and explicitly support the
stability of the broader financial system and other relevant public
interest considerations of clearing members, customers of clearing
members, and other relevant stakeholders; the board of directors
shall make certain that the DCO's design, rules, overall strategy,
and major decisions appropriately reflect the legitimate interests
of clearing members, customers of clearing members, and other
relevant stakeholders).
\52\ See 17 CFR 39.25 (requiring DCOs to establish and enforce
rules to minimize conflicts of interest in the decision-making
process of the derivatives clearing organization, establish a
process for resolving such conflicts of interest, and describe
procedures for identifying, addressing, and managing conflicts of
interest involving members of the board of directors); 17 CFR 39.26
(requiring DCOs to ensure that the composition of the governing
board or board-level committee of the DCO includes market
participants and individuals who are not executives, officers, or
employees of the derivatives clearing organization or an affiliate
thereof). We note that the CFTC recently proposed amendments to its
DCO governance framework relating to risk management committee
requirements. See Governance Requirements for Derivatives Clearing
Organizations, Release Number 8565-22 (July 27, 2022), https://www.cftc.gov/PressRoom/PressReleases/8565-22.
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C. Risks Associated With Clearance and Settlement
The Commission also believes that the proposed governance rules
would help ensure that registered clearing agencies make more effective
risk management decisions that take into account relevant stakeholder
perspectives and concerns. Recent episodes of increased market
volatility--in March 2020 following the outbreak of the COVID-19
pandemic, and in January 2021 following heightened interest in certain
``meme'' stocks--have revealed potential vulnerabilities in the U.S.
securities market and highlight the essential role of registered
clearing agencies in managing the risk that securities transactions may
fail to clear or settle.\53\ These events underscore the importance of
a strong regulatory framework to oversee registered clearing agencies
that clear or settle securities transactions and provide transparency
to the markets.
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\53\ See, e.g., SEC, Staff Report on Equity and Options Market
Structure Conditions in Early 2021 (Oct. 14, 2021) (``2021 Staff
Report''), https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf. Staff reports, Investor
Bulletins, and other staff documents (including those cited herein)
represent the views of Commission staff and are not a rule,
regulation, or statement of the Commission. The Commission has
neither approved nor disapproved the content of these staff
documents and, like all staff statements, they have no legal force
or effect, do not alter or amend applicable law, and create no new
or additional obligations for any person.
---------------------------------------------------------------------------
Among other things, the rules of a registered clearing agency
generally require its participants to transfer collateral to the
clearing agency, which may include different types of collateral, such
as margin payments, funds, or other assets, and the requirements
associated with these rules may change in response to changes in market
volatility. The terms of these rules, and the related policies and
procedures of the registered clearing agency that implement them, are
generally approved by the board as part of the clearing agency's
governance arrangements. These rules, policies, and procedures are also
subject to Commission review as proposed rule changes under Section 19
of the Exchange Act and Rule 19b-4 thereunder.\54\ The potential for
sudden and large increases in the margin required by a registered
clearing agency of its participants, as evidenced in the March 2020 and
January 2021 events stated above, have increased scrutiny by a wide
variety of market participants into the way a registered clearing
agency establishes, implements, maintains, and enforces its rules that
impose margin requirements.\55\ Some market participants have suggested
that such margin requirements are too conservative; \56\ others have
suggested that margin requirements do not sufficiently consider the
range of participants in a clearing agency and the downstream effect
such requirements may have on other types of investors.\57\ In response
to this increased attention, the Basel Committee on Banking Supervision
(``BCBS''), the Committee on Payments and Market Infrastructure
(``CPMI''), and the International Organization of Securities
Commissions (``IOSCO'') jointly released a consultative paper on CCP
margin practices, focused on, among other things, recent market
volatility and the apparent drivers of the size and composition of
margin calls.\58\
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\54\ 15 U.S.C. 78s; 17 CFR 240.19b-4.
\55\ See, e.g., Fitch Ratings, Margin Call Disparity, Breaches
Could Drive Clearinghouse Scrutiny (July 20, 2020), https://www.fitchratings.com/research/non-bank-financial-institutions/margin-call-disparity-breaches-could-drive-clearinghouse-scrutiny-20-07-2020.
\56\ See Alexander Campbell, CCP Margin Buffers Too Big,
Research Suggests (July 9, 2019), https://www.risk.net/risk-management/6783941/ccp-margin-buffers-too-big-research-suggests.
\57\ See Glenn Hubbard et al., Report of the Task Force on
Financial Stability, Brookings Institution (June 2021), https://www.brookings.edu/wp-content/uploads/2021/06/financial-stability_report.pdf.
\58\ See BCBS-CPMI-IOSCO, Consultative Report, Review of
Margining Practices (Oct. 2021), https://www.bis.org/bcbs/publ/d526.pdf.
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Concerns about the size and timing of margin requirements are only
one example of an area in which direct and indirect participants that
rely on the clearance and settlement process have expressed concerns
about clearing
[[Page 51819]]
agency governance and, in particular, the way that such governance
would oversee or employ risk management tools under stressed market
conditions. Two other areas of heightened attention concern a clearing
agency's process for loss allocation in the event of a participant
default and an event other than a participant default (hereinafter a
``non-default loss''), such as an operational failure, cyber-attack, or
theft. For example, participants and others have expressed concerns
about the extent to which existing governance structures at registered
clearing agencies would function during a potential recovery or
resolution scenario, which would occur in the event that a clearing
agency's prefunded financial resources available to absorb any loss--
sometimes referred to as the ``clearing fund'' or ``guaranty fund''--
are insufficient to close out a defaulting participant's portfolio
without allocating losses among the non-defaulting participants of the
clearing agency.\59\ Based on its supervisory experience, the
Commission believes that this loss allocation process could thus have
significant implications for the risk management of its non-defaulting
participants.
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\59\ In 2018, a default at a European CCP increased scrutiny of
the auction process through which a CCP may choose to close out a
defaulted portfolio. CPMI-IOSCO issued a report on issues for
consideration in 2020. See Bank for International Settlements,
Central Counterparty Default Management Auctions--Issues for
Consideration (June 2020), https://www.bis.org/cpmi/publ/d192.pdf.
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Further, although concerns about the size and timing of margin
requirements are, at one level, concerns about the risk management
practices of a clearing agency, they also implicate clearing agency
governance because the governance arrangements of a registered clearing
agency will determine the process for developing and approving policies
and procedures for imposing margin requirements, and the governance and
management of the registered clearing agency will also implement these
policies and procedures, whether during normal market conditions or
periods of increased market volatility.
In this regard, proposed Rule 17Ad-25 is intended to help ensure
that in periods of market stress or stress on the registered clearing
agency, the governance process of all registered clearing agencies is
transparent, objective, and addresses conflicts of interest. Trust
among market participants in the national system for clearance and
settlement, particularly in times of market stress, necessarily depends
on trust in the ability of registered clearing agencies to more
effectively manage the risk flowing from that market stress and, when
necessary, transparently and objectively impose increased margin
requirements or employ loss allocation mechanisms.
III. Proposed Rules
The Commission is proposing rules under the Exchange Act and to
address the considerations set forth in Section 765 of the Dodd-Frank
Act. Section 17(a) of the Exchange Act directs registered clearing
agencies to make and keep for prescribed periods such records, furnish
such copies, and make and disseminate such reports as the Commission,
by rule, prescribes as necessary or appropriate in the public interest,
for the protection of investors, or in furtherance of the Exchange
Act.\60\ Section 17A of the Exchange Act directs the Commission to
facilitate the establishment of a national system for the prompt and
accurate clearance and settlement of securities transactions and
provides the Commission with the authority to regulate those entities
critical to the clearance and settlement process.\61\ Section 23(a) of
the Exchange Act authorizes the Commission to make rules and
regulations as necessary or appropriate to implement the provisions of
the Exchange Act.\62\ The enactment of the Payment, Clearing, and
Settlement Supervision Act (``Clearing Supervision Act'') in 2010
(Title VIII of the Dodd-Frank Act) reaffirmed the importance of the
national system for clearance and settlement.\63\ Specifically,
Congress found that the ``proper functioning of the financial markets
is dependent upon safe and efficient arrangements for the clearing and
settlement of payments, securities, and other financial transactions.''
\64\ In addition, Section 765 of the Dodd-Frank Act specifically
directs the Commission to adopt rules to mitigate conflicts of interest
for security-based swap clearing agencies.\65\ Accordingly, the
Commission is proposing these rules pursuant to overlapping statutory
authorities, because although the Commission is able to propose these
rules pursuant to Section 17A of the Exchange Act, the Commission is
also meeting the mandatory rulemaking requirements of Section 765. The
Commission preliminarily has determined that these proposed rules are
necessary and appropriate to improve the governance of a clearing
agency that clears security-based swaps and in which a major security-
based swap participant has a material debt or equity investment.
---------------------------------------------------------------------------
\60\ See 15 U.S.C. 78q(a).
\61\ See 15 U.S.C. 78q-1(a)(2)(A).
\62\ See 15 U.S.C. 78w(a).
\63\ See 12 U.S.C. 5461-5472.
\64\ 12 U.S.C. 5461(a)(1).
\65\ See 15 U.S.C. 8343.
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The Commission had previously reviewed the potential for conflicts
of interest at security-based swap clearing agencies in accordance with
Section 765 of the Dodd-Frank Act when it proposed Regulation MC, and
had identified those conflicts that could affect access to clearing
agency services, products eligible for clearing, and risk management
practices of the clearing agencies.\66\ The Commission had identified
three key areas where it believed a conflict of interest of
participants who exercise undue control or influence over a security-
based swap clearing agency could adversely affect the central clearing
of security-based swaps.\67\ First, participants could limit access to
the security-based swap clearing agency, either by restricting direct
participation in the security-based swap clearing agency or restricting
indirect access by controlling the ability of non-participants to enter
into correspondent clearing arrangements. Second, participants could
limit the scope of products eligible for clearing at the security-based
swap clearing agency, particularly if there is a strong economic
incentive to keep a product traded in the over-the-counter (``OTC'')
market for security-based swaps. Third, participants could use their
influence to reduce the amount of collateral they would be required to
contribute and liquidity resources they would have to expend as margin
or guaranty fund to the security-based swap clearing agency. Although
the Commission does not believe that the participants of security-based
swap clearing agencies are engaged in these types of activities, the
Commission recognizes that these three potential conflicts of interest
could limit the benefits of a security-based swap clearing agency in
the security-based swaps market, and even potentially cause substantial
harm to that market and the broader financial markets.
---------------------------------------------------------------------------
\66\ See Regulation MC Proposing Release, supra note 1, at
65885.
\67\ See id.
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Nevertheless, there are benefits to having participant incentives
known and reflected in the decision making activity of a board of
directors. Employees of participants--in particular, chief risk
officers or their equivalent--are likely to bring technical expertise
to a board of directors. Participants are often exposed to enormous
financial liability in the event of a default, and so they have strong
[[Page 51820]]
incentives to have sound risk management at the clearing agencies. In
order to promote the utility of having directors who are familiar with
participant operations, the proposed rule does not prohibit directors
who, among other things, receive compensation from participants from
meeting the definition of independent director (provided all other
requirements of the proposed rules are met).\68\
---------------------------------------------------------------------------
\68\ Other jurisdictions have chosen a different approach, as
discussed below. See infra Part IV.B.2.
---------------------------------------------------------------------------
For the reasons discussed throughout this release, the Commission
is proposing rules for all registered clearing agencies to establish
requirements for governance, including requirements for the composition
of the board of directors, to mitigate conflicts of interest, to
establish certain obligations of the board to oversee service provider
relationships, and to establish an obligation of the board to consider
the views of participants and other relevant stakeholders. Each of
these proposed rules are discussed further below.
A. Board Composition and Requirements for Independent Directors
1. Proposed Rules 17Ad-25(b), (e) and (f)
Proposed Rules 17Ad-25(b), (e), and (f) would establish
requirements related to independent directors. First, proposed Rule
17Ad-25(b)(1) would require that a majority of the directors of a
registered clearing agency must be independent directors, as defined in
proposed Rule 17Ad-25(a). The proposed rule would also provide that, if
a majority of the voting interests issued as of the immediately prior
record date are directly or indirectly held by participants, then at
least 34 percent of the members of the board of directors must be
independent directors. Proposed Rule 17Ad-25(a) would define an
``independent director'' to mean a director that has no material
relationship with the registered clearing agency, or any affiliate
thereof. Proposed Rule 17Ad-25(a) also would define ``material
relationship'' to mean a relationship, whether compensatory or
otherwise, that reasonably could affect the independent judgment or
decision-making of the director, and includes relationships during a
lookback period of one year counting back from making the initial
determination in proposed Rule 17Ad-25(b)(2). In addition, proposed
Rule 17Ad-25(a) would define ``affiliate'' to mean a person that
directly or indirectly controls, is controlled by, or is under common
control with the registered clearing agency. Proposed Rule 17Ad-
25(b)(2) would require each registered clearing agency to broadly
consider all the relevant facts and circumstances, including under
proposed Rule 17Ad-25(g), on an ongoing basis, to affirmatively
determine that a director does not have a material relationship with
the registered clearing agency or an affiliate of the registered
clearing agency to qualify as an independent director. In making such
determination, a registered clearing agency must (i) identify the
relationships between a director, the registered clearing agency, any
affiliate thereof, along with the circumstances set forth in proposed
Rule 17Ad-25(f); (ii) evaluate whether any relationship is likely to
impair the independence of the director in performing the duties of
director; and (iii) document this determination in writing. Such
documentation requirements would be subject to the recordkeeping and
retention requirements that apply to all SROs under Section 17(a)(2) of
the Exchange Act.\69\
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\69\ See 15 U.S.C. 78q(a)(2).
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The Commission believes that proposed Rules 17Ad-25(a) and 17Ad-
25(b)(2) could provide registered clearing agencies with a broad pool
of potential candidates to serve as independent directors. For example,
an employee of a participant of the registered clearing agency, a
professional in the securities or financial services industries, an
academic, and other such qualified persons would be eligible for
consideration as an independent director as long as the candidate meets
the other criteria under the definition of material relationship and
proposed Rule 17Ad-25(f).
Proposed Rule 17Ad-25(e) would require that, if any committee has
the authority to act on behalf of the board of directors, the
composition of that committee must have at least the same percentage of
independent directors as is required under these rules for the board of
directors, as set forth in proposed paragraph (b)(1).
Proposed Rule 17Ad-25(f) would describe certain circumstances that
would always exclude a director from being an independent director.
These circumstances would include: (1) the director is subject to
rules, policies, and procedures by the registered clearing agency that
may undermine the director's ability to operate unimpeded, such as
removal by less than a majority vote of shares that are entitled to
vote in such director's election; (2) the director, or a family member,
has an employment relationship with or otherwise receives compensation,
other than as a director, from the registered clearing agency or any
affiliate thereof, or the holder of a controlling voting interest of
the registered clearing agency; (3) the director, or a family member,
is receiving payments from the registered clearing agency, or any
affiliate thereof, or the holder of a controlling voting interest of
the registered clearing agency that reasonably could affect the
independent judgment or decision-making of the director, other than the
following: (i) compensation for services as a director to the board of
directors or a committee thereof; or (ii) pension and other forms of
deferred compensation for prior services not contingent on continued
service; (4) the director, or a family member, is a partner in, or
controlling shareholder of, any organization to or from which the
registered clearing agency, or any affiliate thereof, or the holder of
a controlling voting interest of the registered clearing agency, is
making or receiving payments for property or service, other than the
following: (i) payments arising solely from investments in the
securities of the registered clearing agency, or affiliate thereof; or
(ii) payments under non-discretionary charitable contribution matching
programs; (5) the director, or a family member is employed as an
executive officer of another entity where any executive officers of the
registered clearing agency serve on that entity's compensation
committee; or (6) the director, or a family member, is a partner of the
outside auditor of the registered clearing agency, or an employee of
the outside auditor who is working on the audit of the registered
clearing agency, or any affiliate thereof. Proposed Rules 17Ad-
25(f)(2)-(6) would be subject to a lookback period of one year
(counting back from making the initial determination in proposed Rule
17Ad-25(b)(2)). Family member would be defined to include any child,
stepchild, grandchild, parent, stepparent, grandparent, spouse,
sibling, niece, nephew, mother-in-law, father-in-law, son-in-law,
daughter-in-law, brother-in-law, or sister-in-law, including adoptive
relationships, any person (other than a tenant or employee) sharing a
household with the director or a nominee for director, a trust in which
these persons (or the director or a nominee for director) have more
than fifty percent of the beneficial interest, a foundation in which
these persons (or the director or a nominee for director) control the
management of assets, and
[[Page 51821]]
any other entity in which these persons (or the director or a nominee
for director) own more than fifty percent of the voting interests.
At the time of the 2016 CCA Standards Adopting Release, the
Commission declined to incorporate more prescriptive governance
elements into the rule as urged by commenters, including specific
requirements on independent representation on the board or risk
committee or governance relating to business relationships and
affiliates,\70\ based on the premise that the requirements in Section
17A of the Exchange Act relating to fair representation and the public
interest provided sufficient grounds to hold covered clearing agencies
accountable to these concerns.\71\ Similarly, with regard to the 2012
governance rule for all registered clearing agencies that are not
covered clearing agencies, the Commission declined to adopt more
prescriptive elements to its approach on governance with regard to
board composition.\72\ However, given the growing concentration of
clearing and settlement participants among a small number of firms \73\
and the concentration of differing perspectives into distinct groups of
clearing agency stakeholders, the Commission believes it is appropriate
to propose requirements on independent representation to facilitate the
consideration and management of diverse stakeholder interests in the
decision-making of the clearing agency.
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\70\ See CCA Standards Adopting Release, supra note 13, at 70804
(stating that ``[a]fter 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 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 . . . . 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'').
\71\ See 15 U.S.C. 78q-1(b)(3)(C).
\72\ See Clearing Agency Standards Adopting Release, supra note
8, at 66251 (adopting the rule largely as proposed and declining to
incorporate prescriptive requirements as suggested by commenters,
including ``[o]ne commenter [who] urged the Commission to ensure
that Rule 17Ad-22(d)(8) as well as any requirements adopted from the
Commission's proposed Regulation MC pertaining to the mitigation of
conflicts of interest are designed to ensure that buy-side market
participants have a meaningful voice in the operating committees of
clearing agencies because that representation is critical to
promoting robust governance arrangements at clearing agencies and
serving the best interests of the U.S. financial system. Another
commenter stated that proposed Rules 17Ad-22(d)(8), 17Ad-25, and
17Ad-26 reflect a better approach to governance, conflicts of
interest, and board and committee composition than the Commission's
proposed requirements for clearing agencies under Regulation MC. One
commenter urged the Commission to consider complementing proposed
Rule 17Ad-22(d)(8) with a minimum board independence requirement so
that at least two-thirds of all board directors would be required to
be independent'').
\73\ See Staff Report on Clearing Agencies, supra note 27, at
21.
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2. Discussion
(a) Board of Director Oversight of Management
Several current requirements under the Exchange Act and regulations
are applicable to a clearing agency's board of directors. Section 17A
of the Exchange Act requires that the rules of a clearing agency assure
the fair representation of owners and participants in the selection of
directors and the administration of the clearing agency's affairs.\74\
Rule 17Ad-22(e)(2) \75\ under the Exchange Act requires a covered
clearing agency to establish, implement, maintain, and enforce written
policies and procedures reasonably designed to provide for governance
arrangements that, in relevant part, (i) support the public interest
requirements in Section 17A of the Exchange Act applicable to clearing
agencies, and the objectives of owners and participants; (ii) establish
that the board of directors and senior management have appropriate
experience and skills to discharge their duties and responsibilities;
and (iii) consider the interests of participants' customers, securities
issuers and holders, and other relevant stakeholders of the covered
clearing agency.
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\74\ See 15 U.S.C. 78q-1(b)(3)(C).
\75\ See 17 CFR 240.17Ad-22(e)(2)(iii)-(iv), (vi).
---------------------------------------------------------------------------
Given the importance of the board oversight function,\76\ CPMI-
IOSCO has issued guidance regarding the board's obligations with
respect to oversight of management.\77\ This guidance provides several
examples of effective oversight of management by clearing agency
boards. For example, the guidance highlights the board's responsibility
for: (i) carefully overseeing, monitoring and evaluating management's
implementation of the risk-management framework; (ii) taking
appropriate steps to help ensure that management is performing risk-
management tasks properly and effectively; (iii) ensuring that
processes are in place for effective and timely communication,
reporting and information flow between management and the board; (iv)
communicating with management about risk management processes; and (v)
when assessing the risk-management framework, appropriately challenging
management to demonstrate the effectiveness of risk-management
processes.\78\ Likewise, the report stated that while a board may not
delegate its ultimate responsibilities regarding risk management, it
may assign certain tasks, so long as the board clearly defines the
assigned tasks and retains ultimate responsibility over such tasks.\79\
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\76\ As a foundational principle of U.S. state corporate law, a
board of directors of a corporation has ultimate responsibility for
the oversight of management, consistent with a director's fiduciary
duties of loyalty and care to a company. See, e.g., Del. Code tit.
8, sec. 141 (2022) (establishing that the board is ultimately
responsible for the corporation's management). In the context of a
registered clearing agency incorporated under such principles, this
means that the board has ultimate responsibility for ensuring an
effective framework for the management of risk by the registered
clearing agency, so that the clearing agency can facilitate the
prompt and accurate clearance and settlement of securities
transactions. To discharge this duty effectively, the board must
necessarily work closely with management, but also effectively
oversee it.
\77\ See CPMI-IOSCO, Final Report, Resilience of central
counterparties (CCPs): Further guidance on the PFMI (July 2017)
(``CCP Resilience Guidance''), https://www.bis.org/cpmi/publ/d163.pdf.
\78\ See id. at 5.
\79\ See id.
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(b) Requirement for Independent Directors
Corporate governance tools exist to help ensure that the board
performs more effective oversight of the management of the company. One
such tool is the independent director, which could bolster the board's
ability to perform effectively by reducing the potential for financial
or other relationships between directors and those persons who are
overseen by directors, such as management.\80\ The Commission is
proposing a definition of ``independent director'' that retains
elements of the definition used in Regulation MC, but with
modifications.\81\ The Commission continues to believe that as part of
the definition, the key operating elements are the concepts of material
relationships and affiliates, so those elements would be retained.
However, at the same time, the Commission proposes using a modified
definition of
[[Page 51822]]
``independent directors'' because of changes in scope of this proposed
rulemaking. Regulation MC resulted from a public roundtable discussion
and meetings held with interested persons, in part, to gain further
insight into the sources of conflicts of interest at security-based
swap clearing agencies.\82\ Regulation MC had proposed a narrower
definition of independent director, which would have excluded directors
who had material relationships with participants and their affiliates
as well,\83\ and the proposal would have covered only one class of
registered clearing agencies: security-based swap clearing agencies.
Pursuant to Section 765, Regulation MC was designed to address
anticipated governance concerns relating to participant activity \84\
that existed in the OTC derivatives market. At the time of the
proposal, the Commission also proposed Rules 17Ad-25 and 17Ad-26 for
registered clearing agencies that took a broad, principles-based
approach to clearing agency governance. Because some registered
clearing agencies that would be subject to this proposal have
participants who are also owners, the Commission's current proposal,
under proposed Rule 17Ad-25(b)(1), creates a carve-out from the
majority independence requirement when a majority of voting interests
are owned by participant-owners, as set forth below.
---------------------------------------------------------------------------
\80\ See, e.g., Bruce Dravis, Director Independence and the
Governance Process (Aug. 14, 2018), https://www.americanbar.org/groups/business_law/publications/blt/2018/08/05_dravis/. In the
United States, independent directors traditionally are not selected
from among management and are not intended to serve as
representatives of management, and therefore they do not carry the
same financial or other relationships that might create a conflict
of interest between the director's interests and the director's
duties to the company.
\81\ See Regulation MC Proposing Release, supra note 1, at
65897.
\82\ See id. at 65885.
\83\ See id. at 65928 (defining independent director as ``(1) A
director who has no material relationship with: (i) The security-
based swap execution facility or national securities exchange or
facility thereof that posts or makes available for trading security-
based swaps, or security-based swap clearing agency, as applicable;
(ii) Any affiliate of the security-based swap execution facility or
national securities exchange or facility thereof that posts or makes
available for trading security-based swaps, or security-based swap
clearing agency, as applicable; (iii) A security-based swap
execution facility participant, a member of a national securities
exchange that posts or makes available for trading security-based
swaps, or a participant in the security-based swap clearing agency,
as applicable; or (iv) Any affiliate of a security-based swap
execution facility participant, a member of a national securities
exchange that posts or makes available for trading security-based
swaps, or a participant in the security-based swap clearing agency,
as applicable.'').
\84\ See id. at 65885 (``These [security-based swap] entities
are not wholly-owned by participants or exchanges and may have
different governance related issues than the securities clearing
agencies currently registered with the Commission.'').
---------------------------------------------------------------------------
The Commission believes that requiring a registered clearing agency
to include independent directors on the board can improve the board's
ability to conduct more effective oversight of management, which is a
critical component of the effectiveness of a registered clearing
agency. Independent directors constitute a set of directors that do not
have potential conflicts of interest resulting from their relationships
with management. This helps the board manage conflicts of interest
among directors because independent directors do not have the existing
relationships or accompanying incentives that might, for example,
discourage or dis-incentivize the board to review management's
decisions in a thorough, transparent, and consistent way. The
appearance of conflicts of interest can reduce confidence among direct
and indirect participants, other stakeholders, and the public in the
functioning of the clearing agency, particularly during periods of
market stress when general confidence in market resilience may be low.
The practice of employing independent directors is common across
the financial industry and across public companies more generally.\85\
Although Commission rules do not currently require the boards of
registered clearing agencies to include independent directors, each of
the registered clearing agencies already require directors with some
independence characteristics (such as ``nonexecutive,'' or ``public''
directors).\86\
---------------------------------------------------------------------------
\85\ See, e.g., Quoc Trung Tran, Independent Directors and
Corporate Investment: Evidence from an Emerging Market, 21 J. Econ.
& Dev. 30 (2019), https://www.emerald.com/insight/content/doi/10.1108/JED-06-2019-0008/full/html (noting that ``independent
directors have become a common approach of corporate governance'' in
recent years). For example, the NYSE listing standards require that
a majority of the board of directors of a listed company be
independent, and they preclude managers or employees of the company
from meeting the independence standard, among other criteria. See,
e.g., Weil, Gotshal & Manges LLP, Requirements for Public Company
Boards (Jan. 3, 2022), https://www.weil.com/-/media/files/pdfs/2022/january/requirements_for_public_company_boards_including_ipo_transition_rules.pdf.
\86\ See DTCC, Board Mission Statement and Charter (Oct. 2021),
at 5, https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/DTCC-BOD-Mission-and-Charter.pdf; ICC, Regulation and
Governance Fact Sheet (Sept. 2021), at 2, https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf; ICEEU, Disclosure
Framework (Jan. 31, 2021), at 20, https://www.theice.com/publicdocs/clear_europe/ICE_Clear_Europe_Disclosure_Framework.pdf; OCC, Board
of Directors Charter and Corporate Governance Principles (Sept. 22,
2021), at 4-5, https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf; LCH SA, Board of
Directors (2022), https://www.lch.com/about-us/structure-and-governance/board-directors-0.
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In that vein, in addition to the above dynamic that exists between
the board and management, registered clearing agencies must also manage
the competing and sometimes divergent interests of owners and
participants, as previously discussed in Part II.A.\87\ The structure
of a registered clearing agency, and the risk management tools that it
employs, affect how the interests of owners, participants, and other
types of stakeholders align. For example, the risk mutualizing and
trade guaranty features provided by covered clearing agencies provide
for the shift of the consequences of one party's actions to another,
binding disparate interests together in certain circumstances, such as
a participant default. These features both affect how different
stakeholders maximize their own self-interest and also distinguish the
governance of a clearing agency from other corporate structures, such
as those of other financial services companies or, more generally,
publicly traded companies, who are unable to legally bind their
customers with financial obligations that are theoretically uncapped.
In particular, the owners of a clearing agency may seek to shift risks
to the participants of the clearing agency to decrease the level of
exposure that the owners face by capitalizing the clearing agency.
Meanwhile, participants in the registered clearing agency may seek to
raise the cost of participation to exclude competitors from the
benefits of the clearing agency's risk mutualizing and mitigating
tools, or they may seek to reduce their exposure to the clearing agency
by not making certain assets available for use by the clearing agency
during loss allocation. As described below, there can be countervailing
benefits to having the interests of a director and the interests of an
owner aligned, so as to increase the likelihood that decisions made
will benefit shareholders. Likewise, there are benefits to having the
interests of a director and the interests of a participant aligned, in
order to increase the likelihood that decisions will take into account
the long-term needs of participants. The requirement in Section 17A for
fair representation recognizes that clearing agencies may serve
competing stakeholders, such as owners and participants, both in the
selection of directors and administration of their affairs.\88\
Directors may carry these perspectives when they serve on the board,
and these perspectives may influence the ultimate decision-making of
the board. For example, one set of
[[Page 51823]]
stakeholders could use the board to shift costs and risk exposure to
others (e.g., owners shifting them to participants), in ways that could
undermine the risk mutualizing and mitigating purpose of the clearing
agency.\89\ The Commission is also mindful that ultimately, owners (as
holders of voting interests) are generally in the position of electing
directors (subject to any restrictions on ownership, classes of shares,
etc.), meaning that any director who has a material relationship with a
participant and who has been nominated as a potential independent
director must nonetheless be voted onto the board of directors by the
owners; so ultimate approval of a director would remain in the hands of
owners, creating an incentive for even a director who is employed by a
participant to take into account the views of owners. Nonetheless, the
criteria for independent directors under the proposed rules would help
ensure that independent directors retain those features that
distinguish their interests from those of other directors because, for
example, an independent director cannot have an employment relationship
with or otherwise receive compensation (other than as a director) from
the registered clearing agency or any affiliate thereof, or the holder
of a controlling voting interest of the registered clearing agency. In
addition, although independent directors may be elected, in part, by
owners, the views of owners would not be the only stakeholders' views
that independent directors would consider.
---------------------------------------------------------------------------
\87\ See, e.g., Securities Industry Study, Report of the
Subcommittee on Commerce and Finance, H.R. Rep. No. 92-1519, at 84
(1972) (``1972 House Report'') (stating generally about SROs such as
clearing agencies, ``[s]elf-regulators may be parochial in
adjustment and accommodating competing aims and policies.
Furthermore, since self-regulatory bodies are composed of disparate
subsidiary groups, the legitimate interests of a particular group
may be overridden, or the tugging and pulling may result in inaction
or impasse'').
\88\ See 15 U.S.C. 78q-1(b)(3)(C).
\89\ See, e.g., PFMI, supra note 4, at 11 (``FMIs and their
participants do not necessarily bear all the risks and costs
associated with their payment, clearing, settlement, and recording
activities. Moreover, the institutional structure of an FMI may not
provide strong incentives or mechanisms for safe and efficient
design and operation, fair and open access, or the protection of
participant and customer assets. In addition, participants may not
consider the full impact of their actions on other participants,
such as the potential costs of delaying payments or settlements.'').
---------------------------------------------------------------------------
Given the above dynamics between owners and participants, the
Commission believes that registered clearing agency processes involving
risk management or director nominations are also implicated in managing
the dynamics between owners and participants. Therefore, the
relationships affecting the independence of a director in the context
of a registered clearing agency also include those between the director
and the registered clearing agency itself or its affiliates.\90\ The
ability of a registered clearing agency to help ensure effective risk
management and loss allocation in the event of a default or non-default
loss is linked to the interests of the owners of the clearing agency,
who may also have financial relationships with the participants (or be
the participants) of such registered clearing agency.\91\ For example,
The Options Clearing Corporation (``OCC'') is owned by certain options
exchanges, whose customers may also be participants of OCC.\92\
Similarly, participants in the registered clearing agencies that are
subsidiaries of The Depository Trust & Clearing Corporation (``DTCC'')
are required to purchase common shares of DTCC as part of periodic
efforts to keep ownership proportionate to such owners' use of clearing
agency services.\93\ Such provisions that require common shares to be
periodically re-allocated to reflect levels of use of the clearing
agency services create financial and other relationships between a
registered clearing agency, its participants, its affiliates, and its
owners. In this sense, registered clearing agencies are not organized
in a way that reflects the corporate ownership of the typical publicly
traded company, where the shareholder base is a dispersed population
that may have coordination problems, and therefore the scope of inquiry
cannot end simply at whether a director is independent from management
alone.\94\ Rather, the owners of a registered clearing agency reflect a
few key groups, who may be owners or participants of the clearing
agency, and board composition will thus necessarily reflect these
different stakeholder groups and their views on risk management.
---------------------------------------------------------------------------
\90\ Affiliate is proposed to mean a person that directly or
indirectly controls, is controlled by, or is under common control
with the registered clearing agency. A director would, of course,
have a relationship with the clearing agency that arises from
service as a director, and the accompanying duties to the company
such as the fiduciary duties of the duty of care or the duty of
loyalty. These relationships and duties, however, do not create a
potential conflict of interest that might impair the independent
judgment of the director.
\91\ In Part III.A.2.f) below, the Commission discusses how
participant-owners may have interests that are well-aligned with the
risk management function of the clearing agency, supporting a lower
threshold of independent directors when a majority of owners are
participant-owners.
\92\ See OCC, Annual Report (2019), https://annualreport.theocc.com/About-OCC.
\93\ See DTCC, NSCC Important Notice No. A8986 (Apr. 5, 2021)
(regarding the period common stock reallocation process), https://www.dtcc.com/-/media/Files/pdf/2021/4/5/A8986.pdf.
\94\ See, e.g., Donald C. Clarke, Three Concepts of the
Independent Director, 32 Del. J. Corp. L. 73 (2007), https://scholarship.law.gwu.edu/cgi/viewcontent.cgi?article=1045&context=faculty_publications.
---------------------------------------------------------------------------
In the context of a registered clearing agency, the Commission
believes that requiring independent directors helps promote the ability
of the board to perform its oversight of management function and to
support a plurality of viewpoints voiced at the board level.
Independent directors would help ensure that, when the interests
between owners and participants diverge, the impact of such divergence
is more manageable because the board would not be composed entirely of
directors who have material relationships either to management (such as
under a situation where managers approve compensation or other payments
from the registered clearing agency to such director), owners, or
participants. Balance between stakeholders with divergent views could
help the board to adequately consider the respective needs of all
stakeholders, and help promote the integrity of the clearing agency's
risk management function. With respect to independent directors serving
on the boards of public companies, some studies have questioned whether
independent directors succeed in improving shareholder value.\95\ For
registered clearing agencies, the Commission is proposing a requirement
for independent directors for reasons unrelated to improving
shareholder value. Rather, registered clearing agencies are subject to
an expansive regulatory framework in which they operate as critical and
often systemically important financial market utilities.\96\ They are
subject to requirements under the Exchange Act to facilitate prompt and
accurate clearance and settlement, promote the public interest,\97\ and
help ensure the fair representation of owners and participants
(regardless of whether these owners and participants are the
controlling owner or the clearing agency's largest participant). As
long as a majority of directors are not solely motivated by the needs
of one category of stakeholders, this structure can help ensure that
the board addresses the full
[[Page 51824]]
set of owners and participants, even smaller participants,\98\ in
fulfilling these statutory objectives. In this way, a requirement for
independent directors is well-suited to help promote more effective
governance of a registered clearing agency and meet the purposes of the
Exchange Act.\99\
---------------------------------------------------------------------------
\95\ See, e.g., id. at 75-77.
\96\ See, e.g., 12 U.S.C. 5461; see also Board of Governors of
the Federal Reserve System, Designated Financial Market Utilities,
https://www.federalreserve.gov/paymentsystems/designated_fmu_about.htm (providing the list of designated financial
market utilities, including five SEC-regulated registered clearing
agencies).
\97\ See 15 U.S.C. 78q-1(b)(3)(C). See also Clarke, supra note
94, at 82-83 (noting that although there are situations where an
independent director may not make an appreciable difference in
outcomes, that provided there is a mechanism for accountability,
``[a] director serving the `public interest' should arguably be
independent of everyone [such that a director is able to] . . .
follow only the dictates of her conscience'').
\98\ See id. at 80 (stating that non-management directors are
viewed as potentially protecting small shareholders from big
shareholders).
\99\ See infra Part IV.C.1 (discussing proposed Rules 17Ad-
25(b), (e), and (f)).
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(c) Definition of ``Material Relationship''
To be an independent director consistent with the proposed rules, a
director must have no material relationships with a registered clearing
agency or its affiliate. As defined in proposed Rule 17Ad-25(a), which
was carried forward from the Commission's previous proposal in
Regulation MC,\100\ a ``material relationship'' means a relationship,
whether compensatory or otherwise, that reasonably could affect the
independent judgment or decision-making of the director. The scope
covers relationships during a lookback period of one year counting back
from making the initial determination in proposed Rule 17Ad-25(b)(2).
The proposed definition is identical to the definition proposed in
Regulation MC, except for the addition of a one-year look back period,
which is intended to address recently terminated business or personal
relationships to prevent evasion of the purposes of this provision, as
discussed further below. The Commission is retaining its prior proposed
definition of material relationship because the definition of material
relationship is not impacted by the type of security cleared (i.e.,
expanding this proposal to cover all registered clearing agencies
rather than security-based swap clearing agencies does not alter the
rationale provided under the Regulation MC). Establishing a materiality
and reasonableness threshold for such relationships provides a
registered clearing agency with discretion to apply this requirement
across a range of fact patterns while ensuring that they ultimately
facilitate the fair representation of owners and participants.
---------------------------------------------------------------------------
\100\ See Regulation MC Proposing Release, supra note 1, at
65897.
---------------------------------------------------------------------------
The proposed rule includes relationships both compensatory and
otherwise to help ensure that the evaluation of a director's
independence is thorough. Such scope of relationships would include not
only pecuniary transactions but other types of quid pro quo
arrangements, biases, or obligations between persons. Under the
Commission's proposed rule, however, such non-compensatory
relationships must reach the level of materiality to affect a
director's status as an independent director. In addition, the proposed
rule would carve out any past relationships that have terminated at
least one year prior because the Commission believes such past
relationships are unlikely to have a material effect on a director's
future decision-making. The proposed definition includes a lookback
period, which is meant to cover recently terminated relationships as a
method to avoid circumvention of the proposed independent director
requirements. As discussed below, the Commission has experience with a
one-year lookback period applied to employment relationships between
auditors and former audit clients, and the Commission believes that the
same objectives underpinning that lookback period would apply
here.\101\
---------------------------------------------------------------------------
\101\ See generally Sarbanes-Oxley Act of 2002, Public Law 107-
204, sec. 206, 116 Stat. 745, 774 (2002) (``SOX'').
---------------------------------------------------------------------------
Finally, the definition would require consideration of material
relationships between a director and any affiliate that directly or
indirectly controls, is controlled by, or is under common control with
the registered clearing agency. The purpose of this provision is to
address potential conflicts of interest that would arise when a
director is serving in a management or director role for an affiliate,
such as a parent company, of the registered clearing agency,\102\ or
when a director has a material level of investment in a registered
clearing agency or its affiliate. The Commission is not including a
bright-line test as to what is a material level of investment because
such an investment could be either material to the director, such as a
financial investment that is a material percentage of an individual's
wealth, or material to the registered clearing agency or its affiliate,
such as a material percentage of ownership of a company. For example,
if a director held ownership in an affiliated company of a registered
clearing agency, this investor relationship should be evaluated for
materiality and whether it could affect the independent judgment or
decision-making of the director, even if such investment did not amount
to such director being a controlling shareholder of such affiliate
(which is specifically prohibited for independent directors under
proposed rule 17Ad-25(f)(4), as discussed further below). If such
relationships were not considered, then a director who serves on the
management of the parent company and therefore indirectly manages the
registered clearing agency itself through the holding structure could
nonetheless be considered independent. The proposed definition would
help mitigate evasion of the spirit of the independent director
requirement through the use of multi-tier holding company structures
that place management responsibility at multiple levels of the
organizational structure. If the functional role of managing a clearing
agency was housed in a parent company, thereby allowing a manager to
claim to be an independent director by virtue of not being an employee
of the registered clearing agency itself but instead of the parent
company, then the Commission's intent in this proposed rule could be
easily circumvented.
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\102\ The potential implications of a director of a registered
clearing agency having a material relationship with an affiliated
company have been discussed in the context of European Union-based
CCPs under the 2012 Regulatory Technical Standards (``RTS''),
adopted by the European Commission as part of the European Market
Infrastructure Regulation (``EMIR''). Chapter III, Article 3 of the
RTS states, ``[a] CCP that is part of a group shall take into
account any implications of the group for its own governance
arrangements including whether it has the necessary level of
independence to meet its regulatory obligations as a distinct legal
person and whether its independence could be compromised by the
group structure or by any board member also being a member of the
board of other entities of the same group. In particular, such a CCP
shall consider specific procedures for preventing and managing
conflicts of interest including with respect to outsourcing
arrangements.'' See Commission Delegated Regulation (EU) No 153/2013
of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the
European Parliament and of the Council with regard to regulatory
technical standards on requirements for central counterparties, 2013
O.J. (L 52), at art. 3(4), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0153&from=EN.
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(d) Process for Assessing Relationships
Proposed Rule 17Ad-25(b)(2) establishes a process by which a
registered clearing agency must identify, evaluate, and document its
determinations regarding director independence. These requirements have
been included in the rule because achieving director independence
necessarily requires an assessment of a director's relationships. The
provisions of Rule 17Ad-25(b)(2) include requirements to establish a
process to identify and evaluate any such relationships and to document
that process to help ensure that a registered clearing agency has
considered a wide range of potential relationships, and applied its
analysis transparently and consistently over time.
The proposed rule also requires a registered clearing agency to
affirmatively determine that no material relationships exist, broadly
considering
[[Page 51825]]
all the relevant facts and circumstances. The Commission believes that
establishing a process helps ensure more effective identification and
evaluation of any material relationships. The Commission also believes
that affirmatively determining that a director is independent helps
promote a thorough review of the director's relationships and helps
promote confidence in the governance arrangements of the clearing
agency because each such director's independence status will have been
evaluated by the registered clearing agency. The Commission has not
specified in the rule the particular sources of information to be
reviewed or the particular approach to inquiring about relationships
because the facts and circumstances of each director or candidate's
relationships are likely to differ. The Commission is not specifying a
checklist of sources to consult and searches to perform, in order to
avoid inadvertently leaving off such checklist a source that cannot be
foreseen.
(e) Excluded Relationships
The process set forth under Rule 17Ad-25(b)(2) would also require
analysis of certain circumstances pursuant to which a director would be
precluded from being an independent director, regardless of any
determinations otherwise made pursuant to Rule 17Ad-25(b)(2). These
scenarios are intended to address cases where, in the Commission's
view, the circumstances clearly prevent a director from exercising
independent judgment or decision-making.
Currently, owners of registered clearing agencies are predominantly
non-natural persons such as participants, exchanges, or a parent
company. The Commission does not expect that a natural person serving
as a director would typically be a controlling shareholder of such
registered clearing agency, although there may be future registered
clearing agencies with this organizational structure. However, due to
the fact that directors are natural persons, but owners of registered
clearing agencies currently tend to be non-natural persons, many of the
circumstances described below seek to address the connection between
the natural person director and the non-natural person owner.
Proposed Rule 17Ad-25(f)(1) limits the ability for a registered
clearing agency to undercut the authority of independent directors,
such as through provisions established by a registered clearing agency
in the bylaws or other organizational documents. For example, if one
director who happened to be associated with management was authorized
to remove independent directors him or herself, rather than through the
normal channels of removing a director via a majority vote of the
shareholders, then any independent directors might be beholden to such
director. Likewise, if some directors--such as those with relationships
to management--could conduct closed meetings that exclude independent
directors to discuss matters before the board, the ability of
independent directors to perform their duties could be undercut. This
provision would not limit the ability of a registered clearing agency
to manage or mitigate conflicts of interests among its directors, such
as by implementing through policies and procedures a requirement that
conflicted directors recuse themselves from a matter pursuant to a
conflicts of interest policy, if such recusal would be necessary for
that director to operate more effectively. Rather, the provision
addresses whether independent directors would be limited, restricted,
or chilled in expressing their views because they were subject to
removal by a management director or denied information relevant to the
decision-making process.
Proposed Rules 17Ad-25(f)(2) through (5) identify circumstances
where a director is precluded from being an independent director
because the director has an employment relationship or has received a
payment from the clearing agency, its affiliates, or its holders of
controlling voting interests, either directly or through indirect
channels. Several of the provisions reference a family member, which
the Commission is proposing to define broadly, to include natural
persons who are related by blood, marriage, or household, including
living antecedents and descendants, as well an non-natural persons
(trusts and other legal entities) that are controlled by such natural
persons. The Commission is intending for the prohibition to be
comprehensive as to the relationship in order to cover potentially
meaningful relationships. Although the list includes non-natural
persons controlled by an extensive list of natural persons, a director
would not necessarily need to compile a list of trusts or companies
controlled by various in-laws and relatives. Instead, if the director
compiled the list of natural persons referenced in the definition, a
registered clearing agency could determine whether those persons (or
legal entities under their control) were doing business with the
registered clearing agency, any of its affiliates, the holder of a
controlling voting interest of the registered clearing agency, the
outside auditor, or an entity where an executive officer of the
registered clearing agency serves on such entity's compensation
committee, in a manner that would exclude a person from being
considered an independent director under proposed Rule 17Ad-25(f), as
described below. A registered clearing agency is likely already
determining who it is conducting business with as part of evaluating
whether to enter into contracts with those companies.
Proposed Rule 17Ad-25(f)(2) precludes a director from being an
independent director when the director is also an employee of the
registered clearing agency or its affiliates, a requirement intended to
reflect the traditional concept of director independence from
management, discussed above. Proposed Rule 17Ad-25(f)(3) and (4)
preclude a director from being an independent director when receiving
certain types of payments, such as in a scenario where the director is
a partner or a controlling shareholder of a consulting firm that
contracts with the registered clearing agency, or where the director's
spouse is a partner or controlling shareholder of a service provider
that is hired by the registered clearing agency. These proposed rules
address circumstances where payments would create a conflict of
interest and undermine the ability of the director to maintain
independent judgment. The proposed rules would carve out certain types
of payments, such as payments from pensions or deferred compensation
for prior services. The Commission believes that such payments are
generally made in response to past, rather than future, activity and
therefore do not have the potential to create conflicts of interest by
affecting future decision-making by the director.
The list of payments for property or services in proposed Rule
17Ad-25(f)(4) scopes in participant clearing fees as well. The
Commission is restricting the ability of a director to be independent
if he or she is a partner or controlling shareholder of a participant
because he or she could directly profit from reducing the size of the
clearing fees even if that impairs the quality of the risk management
of the clearing agency.
Proposed Rule 17Ad-25(f)(5) would preclude independence if a
director, or a family member, is employed the as an executive officer
of another entity where any executive officers of the registered
clearing agency serve on that entity's compensation committee. The
intent of this provision would prevent circular arrangements whereby
compensation
[[Page 51826]]
could be elevated among a chain of interested persons.
Proposed Rule 17Ad-25(f)(6) would preclude a director from being an
independent director when the director is a partner of an outside
auditor or is an employee working on an audit of the registered
clearing agency. As above, these limitations are designed to reduce the
potential for conflicts of interest that would impair an independent
director's independent judgment.
Finally, proposed Rule 17Ad-25(f) would subject paragraphs (f)(2)-
(6) to a one-year lookback period, which is intended to capture
conflicts of interest that may arise from relationships that have
recently terminated (such as departure from a job). As with the
lookback period in the ``material relationship'' definition, the
purpose of this lookback period is the same for all provisions, as well
as in the material relationship definition, which is to cover
relationships that have recently terminated, while not reaching back so
far in time as to impede the registered clearing agency's ability to
select from a large pool of skilled and experienced candidates for
independent director. The Commission believes that a one-year lookback
period is consistent with similar requirements in other statutes and
Commission rules.\103\
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\103\ See SOX, supra note 101.
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(f) Majority of Independent Directors
In assessing the appropriate quantum of independent directors to be
required under the proposed rule, the Commission has considered the
potential impact of divergent interests between owners and
participants, or the potential in which the interests of owners and
participants might diverge. The Commission believes that requiring a
majority of independent directors is most likely to result in the board
acting from a position where the interests of all the stakeholders of
the clearing agency are considered, rather than the interests of a
particular subset of owners or participants. Having a majority of
independent directors reduces the potential misalignment of interests
among directors and management, and among owners and participants,
helping to ensure that a majority of directors are unattached to these
dynamics. In other words, an unattached or ``disinterested'' majority
helps promote consideration of the risk management purposes of the
clearing agency, and helps decrease the likelihood that other interests
that may arise from a potential conflict of interest are the
determinative factor in board decisions. If a majority of directors are
non-independent directors, then a majority of directors influenced by
potential or perceived conflicts of interest could sway the outcome of
board decisions.
The Commission recognizes, however, that the interests of an owner
and a participant can overlap in some cases, such as when a participant
also owns a portion of its equity. For example, the Exchange Act
provides that the Commission may determine that the representation of
participants is fair if they are afforded a reasonable opportunity to
acquire voting stock of the clearing agency, directly or indirectly, in
reasonable proportion to their use of such clearing agency.\104\ The
opportunity for a participant to become such an owner of a clearing
agency is one method to mitigate the potential for conflicts of
interest among these two groups, by more closely aligning the interests
of a participant with those of a voting interest holder (i.e., owner).
---------------------------------------------------------------------------
\104\ See 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------
In this structure, owners and participants would be one and the
same, and the dynamic where diverging interests between owners and
participants undermine the risk management function of the clearing
agency is less likely because participant-owners would necessarily
internalize and synthesize the divergent interests resulting from
ownership and participation. In other words, participant-owners are
less likely to use their equity share to shift the burdens of risk
management to the participants of the clearing agency because they are
themselves participants. When a majority of voting shares are held by
participant-owners, the Commission believes that the interests of the
board will be more closely aligned with ensuring more effective risk
management. In this circumstance, the Commission believes it is
appropriate to reduce the number of independent directors required
under the rule to promote the selection of directors by participant-
owners because directors voted by a majority of persons intended to
represent the clearing agency's participant-owners would mitigate
against the possibility of a divergence of interests. Accordingly, the
Commission is proposing a lower requirement for independent directors
of at least 34 percent of directors when the registered clearing agency
has a majority of its voting interests directly or indirectly held by
participants; indirectly held by participants refers to participant
ownership of a parent company. For example, if a registered clearing
agency is wholly-owned by a holding company, and the holding company is
majority owned by the participants of the registered clearing agency,
then a 34 percent threshold would apply. Alternatively, if a registered
clearing agency was 51 percent owned by a holding company, and that
holding company was 100 percent owned by the participants of the
registered clearing agency, then that would also amount to a majority
ownerships of participants, which would cause the 34 percent
independent director provision to apply. The Commission proposes to
require 34 percent, or greater than one-third of directors, to
encourage a significant portion of directors to meet the independence
requirement but to provide a comparatively higher level of discretion
to the clearing agency to select non-independent directors. A
requirement for greater than one-third independent directors would
align with the requirement for independence in other jurisdictions for
clearing agencies.\105\ In addition, if 34 percent of directors are
independent directors, and participants and owners of the registered
clearing agency are predominantly the same entity (i.e., participant-
owners), then it remains less likely that any one of the three distinct
groups seeking to influence the registered clearing agency--owners,
management, and participants--will establish an outsized influence over
the remaining non-independent directors.
---------------------------------------------------------------------------
\105\ See EMIR at art. 27(2), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32012R0648&from=EN (stating that ``[a]
CCP shall have a board. At least one third, but no less than two, of
the members of that board shall be independent''); see also id. at
art. 2(28) (defining independent member of the board to mean a
member of the board who has no business, family or other
relationship that raises a conflict of interests regarding the CCP
concerned or its controlling shareholders, its management or its
clearing members, and who has had no such relationship during the
five years preceding his membership of the board).
---------------------------------------------------------------------------
Finally, the proposed rule defines the 34 percent requirement using
the term ``holders of voting interests'' rather than simply ``owners''
so that the lower threshold only applies when participant-owners are
entitled to vote to elect a director, irrespective of whether someone
is otherwise entitled to the financial attributes of such ownership.
The Commission is not using the term owner as the equivalent concept of
holder of a voting interest, because the financial attributes of a
security can be separated from the voting rights of a security. The
Commission is focused on who has the ability to influence who is voted
onto the board--which accompanies voting rights, not financial
attributes--as the relevant factor in deciding whether
[[Page 51827]]
participants can enjoy that benefit of ownership as participant-owners.
(g) Other Committees of the Board Generally
Proposed Rule 17Ad-25(e) would impose the independent director
requirement as applied to the full board of directors under Rule 17Ad-
25(b)(1) to any board committee that has the authority to act on behalf
of the board. For example, if 34 percent of the board must be composed
of independent directors, any committee that is taking action based on
a board delegation also should have at least 34 percent of its members
be independent directors, unless otherwise required to meet a higher
standard under the rules.\106\ The purpose of the proposed rule is to
prevent a registered clearing agency from circumventing the proposed
requirement for independent directors by delegating key decisions of
the board to a committee with fewer independent directors than those
required of the full board under Rule 17Ad-25(b)(1).
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\106\ For example, to help ensure that evaluations of director
nominees made by the nominating committee reflect independent
judgment, proposed Rule 17Ad-25(c)(2) would require that the
nominating committee be composed of a majority of independent
directors in all cases. See infra Part III.B.1 (discussing the
proposed rule).
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3. Request for Comment
The Commission requests comment on all aspects of proposed Rules
17Ad-25(b), (e), and (f). In particular, the Commission requests
comment on the following specific topics:
1. Is requiring that the boards of registered clearing agencies
have a majority of independent directors an effective tool for ensuring
a transparent and objective governance process that balances the
potentially competing or divergent interests of owners and
participants? Has the Commission accurately described the benefits of
independent directors, as defined in this release, to the board of a
registered clearing agency? Why or why not?
2. Are there other ways to define ``independent director'' or
``material relationship'' that would achieve the Commission's goals? If
so, what are they? Should the Commission establish a numerical
threshold, such as $100,000 annually, for compensatory relationships in
order for them to be considered material under this rule? If so, what
should that numerical threshold be? Please be specific. Should the
Commission create a list of the types of relationships that should be
considered either material or that could affect the independent
judgment or decision-making of a director under this rule, and should
that list distinguish between compensatory and non-compensatory
relationships? Why or why not?
3. Should the Commission define the term ``control'' in the
proposed rules? If so, would it be appropriate to adopt a definition
similar to the one in 17 CFR 246.2, which states that control means the
possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of a person, whether through
the ownership of voting securities, by contract, or otherwise?
4. What is the appropriate percentage of independent directors on
the board of a registered clearing agency? Does the requirement for a
majority of directors to be independent directors support the goals
discussed in this proposal? Would another threshold be more effective
at addressing diverging views among owners, participants, and other
relevant stakeholders in the registered clearing agency? For example,
would a requirement that one-third of the directors be independent
(which has been adopted by European jurisdictions) provide the benefits
of independent directors without any of the potential drawbacks? Please
explain.
5. Is the application of director independence requirements
appropriate for all registered clearing agencies, or should there be
distinctions made among registered clearing agencies based on certain
factors, such as organizational structure or products cleared? If so,
what factors are relevant and why? Would these proposed rules apply to
all types of organizational structures in a consistent manner, or would
they impede a registered clearing agency from changing its
organizational structure into a more innovative or efficient structure?
6. Is a one-year lookback period adequate for purposes of the
``material relationship'' definition and proposed Rules 17Ad-25(f)(2)-
(6)? For example, is a one-year time period for the receipt of certain
payments by clearing agencies the appropriate length of time to
determine that a director is precluded from being considered
independent? How will this impact the ability of clearing agencies to
recruit experienced persons to serve as directors? More generally, how
large is the pool of potential directors that could serve as
independent directors, as defined in this release, on the boards of
registered clearing agencies? Are there particular elements of the
independent director definition that limit the pool of potential
independent directors? Should those elements be modified to expand the
pool?
7. Is it appropriate to include affiliates of registered clearing
agencies as relevant to the consideration of material relationships of
independent directors, as well as certain scenarios that preclude
independence?
8. Is the scope of the scenario in proposed Rule 17Ad-25(f)(4)
overly broad or overly narrow in covering all partners, regardless of
relative holdings, and controlling shareholders? Should this provision
cover all shareholders, or non-managing partners, instead? Why or why
not?
9. The Commission is proposing in Rule 17Ad-25(f)(3) to carve out
directors who are serving as directors on other boards from the list of
scenarios that explicitly preclude independence. Is this carve-out
appropriate in order to permit a director of a registered clearing
agency who also serves as a director of another legal entity to qualify
as independent (provided all other requirements are met), or should
there be some restrictions, such as restrictions on serving as a
director of an affiliate, or participant? Why or why not?
10. The Commission requests comment on whether the proposal to
require independent directors raises any potential legal issues for
those directors or clearing agency governance committee members.
Specifically, as a matter of corporate law, would independent directors
or committee members be forced to contend with competing duties or
obligations to the clearing agency such as under laws of another
jurisdiction, including any duties or obligations that would foreclose
participation in the board or the committees? If so, how may the goal
of receiving independent, diverse opinions be achieved?
11. The Commission requests comment on whether the proposed
approach to board composition and board member independence may raise
compliance issues with respect to being registered with the Commission
and the CFTC or a non-U.S. regulatory authority. If so, what steps
should the Commission take to continue to facilitate dually-registered
clearing agencies?
12. The Commission requests comment on whether the requirement to
undergo a broad consideration of facts and circumstances when
determining whether a board member is independent is sufficiently
clear. Is there additional guidance needed on what sources could be
consulted or what types of relationships could be considered?
13. The Commission is applying the lowered threshold applicable to
registered clearing agencies whose voting interests are majority-held
by participants, or whose parent company's
[[Page 51828]]
voting interests are majority-held by the registered clearing agency's
participants. Does this scope strike the right balance between
permitting flexibility in ownership structures versus providing the
lowered threshold of 34 percent independent directors only when
warranted (i.e., when the interests of participants and owners are less
likely to diverge when participant-owners are the holders of voting
interests)? Why or why not?
14. Should the Commission permit directors who have material
relationships with participants (such as being an employee of a
participant), other than those relationships that are explicitly
precluded in Rule 17Ad-25(f), to meet the definition of independent
director, or should these relationships be precluded as well? Should
the Commission be more restrictive, as is proposed in paragraph (f)(2),
with respect to compensation and payments received from the registered
clearing agency or its affiliates, rather than participants? Why or why
not?
15. The Commission is soliciting comment on how to view participant
clearing fees or other payments from participants that generate revenue
for the clearing agency as a potential scenario that precludes director
independence. Is it sufficiently clear in the text of proposed Rule
17Ad-22(f)(4) that revenues from participants are covered under the
scope of this prohibition? Should the Commission treat revenues from
participants differently from other sources of revenues or
expenditures? Should the Commission create a carve out for lower levels
of revenues in order to promote the opportunity for partners or
controlling shareholders of small participants to be able to qualify as
an independent director, such as by creating a minimum threshold of
payments covered by this provision? Why or why not?
16. The Commission is proposing an extensive list of natural
persons who fall within the definition of family member for this
rulemaking, along with legal entities under their control. Has the
Commission chosen an appropriate scope for the definition of family
member, or is the definition unworkable, either because it is
overbroad, or because it misses an important category of persons?
17. Should the Commission define ``family member'' to refer to
``spouse or spousal equivalent''? Why or why not? Is adding ``spousal
equivalent'' unnecessary because such person would be covered as ``any
person (other than a tenant or employee) sharing a household,'' which
is already part of the definition? Please explain.
18. The Commission is not specifying particular roles for several
aspects of this rulemaking, such as who makes the determination that a
director is an independent director. Should the Commission be more
prescriptive and specify whose responsibility it is to make such a
determination? Why or why not?
B. Nominating Committee
1. Proposed Rule 17Ad-25(c)
Proposed Rule 17Ad-25(c)(1) would require each registered clearing
agency to establish a nominating committee and a written evaluation
process whereby such nominating committee shall evaluate individual
nominees to serve as directors. Proposed Rule 17Ad-25(c)(2) would
require that (i) independent directors comprise a majority of the
nominating committee, and (ii) an independent director chair the
nominating committee. Proposed Rule 17Ad-25(c)(3) would require the
nominating committee to specify and document fitness standards approved
by the board. Such fitness standards for serving as a director would
need to be consistent with all the requirements of proposed Rule 17Ad-
25, and also would include that the individual nominee is not subject
to any statutory disqualification as defined under Section 3(a)(39) of
the Exchange Act.\107\ Proposed Rule 17Ad-25(c)(4) would require the
nominating committee to document the outcome of the clearing agency's
written evaluation process in a manner that is consistent with the
nominating committee's written fitness standards required under
proposed Rule 17Ad-25(c)(3). The process would require the nominating
committee to: (i) take into account each nominee's expertise,
availability, and integrity, and demonstrate that the board, taken as a
whole, has a diversity of skills, knowledge, experience, and
perspectives; (ii) demonstrate that the nominating committee has
considered whether a particular nominee would complement the other
board members, such that, if elected, the board of directors, taken as
a whole, would represent the views of the owners and participants,
including a selection of directors that reflects the range of different
business strategies, models, and sizes across participants, as well as
the range of customers and clients the participants serve; (iii)
demonstrate that the nominating committee considered the views of other
stakeholders who may be impacted by the decisions of the registered
clearing agency, including transfer agents, settlement banks, nostro
agents, liquidity providers, technology or other service providers; and
(iv) identify whether each selected nominee would meet the definition
of independent director in proposed Rules 17Ad-25(a) and (f), and
whether each selected nominee has a known material relationship with
the registered clearing agency or any affiliate thereof, an owner, a
participant, or a representative of another type of stakeholder of the
registered clearing agency described in (iii) above.
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\107\ Section 3(a)(39) of the Exchange Act lists the particular
events that would subject a person to ``statutory disqualification''
with respect to membership or participation in, or association with
a member of, a self-regulatory organization, such as a registered
clearing agency. 15 U.S.C. 78q-1(a)(3)(C).
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2. Discussion
In Part III.A.2, the Commission discussed the importance of
requiring independent directors on the board of a registered clearing
agency to help manage the dynamics that exist between owners and
participants. To help ensure that the nomination process for the
selection of independent directors is thoughtful and transparent,
promote the integrity of determinations that a nominee is independent
and is qualified to serve, and also promote more effective governance,
the Commission is proposing to require a nominating committee that is
composed of a majority of independent directors and chaired by an
independent director. The Commission is proposing to require that the
nominating committee be composed of a majority of independent directors
in all cases, even where a clearing agency is majority-owned by
participants, to help ensure that the evaluation of director nominees
by the nominating committee reflects independent judgment.\108\
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\108\ See supra note 106 and accompanying text (explaining that,
despite the composition requirements for certain board committees
under proposed Rule 17Ad-25(e), the lower independence threshold
under proposed Rule 17Ad-25(b)(1) will not apply to the nominating
committee).
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(a) Requirement for Nominating Committee
Many registered clearing agencies already have a designated
nominating committee.\109\ However, these nominating committees may not
serve as the exclusive governing body for evaluating director nominees.
To create a record that would help to ensure the integrity of the
nominating committee's consideration of each potential nominee's
qualifications, including
[[Page 51829]]
whether such nominee would qualify as an independent director under
proposed Rules 17Ad-25(b), (e), and (f), the Commission believes that
requiring the nominating committee to be the exclusive governing body
for evaluating director nominees helps ensure that director selections
are made consistent with the proposed requirements and without
influence from potential conflicts of interest. Some registered
clearing agencies currently allow other governing bodies and/or
constituents of their organizational structure to select certain
directors.\110\ While the proposed rule would not prohibit such
approaches, it would require that any such nominees be submitted first
to the nominating committee for evaluation--before being considered by
the board--pursuant to a written evaluation process established by the
registered clearing agency. This proposed requirement would help ensure
that nominees are evaluated in a manner consistent with the
requirements for independent directors and other qualifications to
serve.
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\109\ See infra Part IV.B.4.a)(2) (discussing the current
baseline for the proposed rule).
\110\ For example, OCC currently allows certain participant
exchanges to select Exchange Director nominees for election to OCC's
board. See OCC, By-Laws (rev. Apr. 11, 2022), at 39, https://www.theocc.com/getmedia/3309eceb-56cf-48fc-b3b3-498669a24572/occ_bylaws.pdf (``An individual may be nominated by, elected by, and
serve as an Exchange Director for more than one Equity Exchange.'');
see also OCC, Board of Directors Charter and Corporate Governance
Principles (rev. Sept. 22, 2021), at 4, 6, https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf (providing that Public Director and
Member Director nominees are selected by OCC's Governance and
Nominating Committee, but Exchange Director nominees are instead
selected by OCC's Equity Exchanges).
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(b) Role of Independent Directors
Not all registered clearing agencies require that the nominating
committee be chaired by an independent director or composed of a
majority of independent directors. As discussed above, however,
independent directors are well-suited to help manage the divergent
interests that exist among management, owners, and participants,\111\
and are also best incentivized to help ensure that nominees do not have
conflicts of interest that would preclude independent decision-making
or otherwise undermine the decisions of the board.\112\ Because a
majority of independent directors can help provide perspectives broader
than owners and participants, constituting the nominating committee
with a majority of independent directors would help promote the fair
representation of owners and participants in the selection of
directors. In addition, independent directors would facilitate a fair
evaluation of a nominee's qualifications, including whether such
individual would meet the Commission's proposed criteria for being an
independent director, as such an evaluation would be conducted by a
body that is free from influence in the performance of its duties and
whose majority would itself satisfy the proposed criteria for being
independent directors. By contrast, when evaluating nominees, directors
serving on the nominating committee who are not independent directors
may be more likely to favor board candidates whose views align with
those persons with whom the director has a material relationship,
reducing the likelihood that the nominating committee will consider a
set of director nominees that represent the different stakeholders in a
clearing agency. Thus, having a nominating committee that is composed
of majority independent directors should help to address and facilitate
both the selection of independent directors, as well as the selection
of a broad range of directors that reflect the different stakeholder
groups in a fair and more representative way.
---------------------------------------------------------------------------
\111\ See supra Part III.A.2 (discussing independent directors
as a governance tool to address such divergent interests).
\112\ See supra Part III.A.2 (discussing independent directors
as a governance tool to address such conflicts).
---------------------------------------------------------------------------
(c) Fitness Standards
Fitness standards for directors help ensure that directors have the
necessary qualifications and experience to contribute more effectively
to board governance, and most clearing agencies already have documented
fitness standards for serving as director. The Commission believes that
codifying this practice by requiring documented fitness standards will
help ensure that directors are subject to consistent standards, fairly
applied over time by the nominating committee and the board. Because
the Commission is proposing rules to require independent directors, the
Commission also believes requiring documented fitness standards will
help ensure that a nominee's qualifications and relationships are
reviewed pursuant to a consistent set of standards before the
nomination is voted on by the board. In addition, the Commission is
establishing that the nominating committee is responsible for
maintaining the fitness standards because the composition of the
nominating committee, in which a majority of directors must be
independent directors, helps ensure that the standards are objective
and evenly applied across nominees and over time because they will be
maintained by a majority of directors from among the objective and
disinterested group of independent directors.
Although many registered clearing agencies already have documented
fitness standards for selecting nominees to serve as directors
generally, not all registered clearing agencies have an existing
requirement to forbid directors who have been subject to a statutory
disqualification. Because such individuals have been found in violation
of applicable laws or suspended from membership or participation in an
SRO, the Commission does not believe such an individual should serve in
the capacity of a director, where functionally the individual would be
in a position to advise and direct the decisions of a registered
clearing agency. The Commission believes that adding such a requirement
helps ensure a nominee's fitness to serve on the board.
(d) Selection Criteria for Directors
Based on its supervisory experience, the Commission believes that
enhancements to clearing agency governance practices would facilitate
the ability of clearing agencies to obtain and address input from a
broader array of market participants, especially on risk management
issues, to improve resilience. Additionally, based on its supervisory
experience, the Commission believes that clearing agencies should
consider the views of relevant stakeholders, such as clearing members
and clients, in their decision-making, as these groups will ultimately
bear the majority of any losses incurred as a result of decisions
affecting the clearing agency's risk profile. Further, based on its
supervisory experience, the Commission believes that smaller
participants and clients of participants should be represented on
clearing agency boards and board committees, including the risk
management committee, such that their views and perspectives are
formally considered in board decisions that may impact them. In the
Commission's view, the diverse perspectives and expertise that smaller
participants and clients of participants can provide will help inform a
clearing agency's operations and thereby improve the resilience of the
registered clearing agency. Therefore, the Commission believes that
board governance of the risk management function of the clearing agency
will be enhanced when it has the benefit of more diverse perspectives
on relevant risk management issues from across the range of
stakeholders--owners, direct participants, and indirect participants--
[[Page 51830]]
in a registered clearing agency. Accordingly, proposed Rules 17Ad-
25(c)(4)(i), (ii), and (iii) would require that clearing agencies take
steps to facilitate diverse perspectives and expertise on the board of
directors, as well as greater involvement by these stakeholders.
In the Commission's view, the proposed rules would complement the
Exchange Act requirements for fair representation of owners and
participants in the clearing agency's selection of directors and the
administration of the clearing agency's affairs.\113\ Proposed Rule
17Ad-25(c)(4)(ii) would help ensure that, when evaluating director
nominees, the nominating committee considers nominees that represent
the views of a broad range of participants with different business
strategies, models, and sizes--such as smaller participants and clients
of participants--for director positions. The Commission believes that
it is useful for the nominating committee to also consider nominees who
are representatives from participants and their clients for director
positions because directors representative of a diverse cross-section
of the clearing agency's participants and clients of participants are
more likely to identify and understand the disparate impacts of
different risks and risk management practices across the full set of
participants and their clients.
---------------------------------------------------------------------------
\113\ See 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------
While proposed Rule 17Ad-25(c)(4)(iii) does not require a
registered clearing agency to include other types of stakeholders in
the selection of directors, the Commission understands that other
stakeholders--including transfer agents, settlement banks, nostro
agents, liquidity providers, technology or other service providers--may
be impacted by board decisions concerning risk management and other
significant operational issues. Therefore, the Commission believes that
board governance may benefit in some instances from considering such
stakeholders' perspectives in the evaluation process for director
nominees. Accordingly, proposed Rule 17Ad-25(c)(4)(iii) would help
ensure that the nominating committee considers the views of other
stakeholders who may be impacted by the decisions of the clearing
agency into the evaluation process for director nominees. In this
regard, the Commission believes that proposed Rule 17Ad-25(c)(4)(iii)
would facilitate a process that considers the wide variety of
perspectives that may have an interest in the risk management purpose
of the clearing agency.
Proposed Rule 17Ad-25(c)(4)(iii) would give the nominating
committee discretion to determine how to consider the views of other
stakeholders, in part based on the markets served by the clearing
agency and the relevant interested stakeholders. In the Commission's
view, relevant stakeholders generally would include persons and
entities 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 more
effectively provide services to investors and market participants, and
other market infrastructures.\114\ The Commission believes that
considering the views of such persons and entities in particular would
support the Exchange Act requirements that clearing agencies be able to
facilitate prompt and accurate clearance and settlement, protect
investors and the public interest, and ensure the safeguarding of
securities and funds in the custody or control of the clearing agency
or for which the clearing agency is responsible.\115\ The Commission
understands that the scope of relevant stakeholders who may be impacted
by the decisions of the registered clearing agency will vary for each
registered clearing agency and could include direct participants,
indirect participants, and other stakeholders described in proposed
Rule 17Ad-25(c)(4)(iii).
---------------------------------------------------------------------------
\114\ See CCA Standards Adopting Release, supra note 13, at
70803 (``Other relevant stakeholders currently include, for example,
transfer agents, liquidity providers, and other linked market
infrastructures, including exchanges, matching service providers,
and payment systems.'').
\115\ See supra Part I and Part II.A; see also 15 U.S.C 78q-
1(b)(3)(A).
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Finally, proposed Rule 17Ad-25(c)(4)(iv) would require the
nominating committee's process to identify whether each selected
nominee would meet the independent director definition in proposed
Rules 17Ad-25(a) and (f), and whether each selected nominee has a known
material relationship with the registered clearing agency or any
affiliate thereof, an owner, a participant, or a representative of
another stakeholder of the registered clearing agency described in
proposed Rule 17Ad-25(c)(4)(iii). Such record would help to ensure and
verify the integrity and consistency of the nominating committee's
process and adherence to the clearing agency's standards for
independent directors, consistent with proposed Rules 17Ad-25(b), (e),
and (f).
3. Request for Comment
The Commission requests comment on all aspects of proposed Rule
17Ad-25(c). In particular, the Commission requests comment on the
following specific topics:
19. Is it appropriate for the Commission to require that the
nominating committee be the exclusive venue for evaluating nominees for
director to the board of directors? What alternative arrangements or
processes might also be appropriate for evaluating director nominees?
Should the rules incorporate such arrangements? Why or why not? Please
explain.
20. Should the Commission be more prescriptive in requiring that
certain types of stakeholders, such as smaller participants and
customers, be afforded a right of participation in the board of a
clearing agency? Why or why not? If so, which types of stakeholders?
Please explain with specific information.
21. Do commenters agree with the Commission's assessment that
requiring a majority of independent directors on the nominating
committee will improve the quality of nominees? Please explain.
22. Do commenters believe that the proposed rule will help ensure
that the nominating committee considers nominees that represent the
views of smaller participants and clients of participants? Please
explain. Should the Commission consider additional specific composition
requirements? Why or why not? If so, what should those requirements be?
23. Has the Commission provided sufficient specificity regarding
the scope and content of the evaluation process for director nominees?
Please identify and explain other types of criteria, if any, that
should be included in the evaluation process for director nominees.
Please identify and explain any proposed criteria that should be
excluded from the evaluation process for director nominees.
C. Risk Management Committee
1. Proposed Rule 17Ad-25(d)
Proposed Rule 17Ad-25(d)(1) would require each registered clearing
agency to establish a risk management committee (or committees) to
assist the board of directors in overseeing the risk management of the
registered clearing agency. Proposed Rule 17Ad-25(d)(1) would also
require each risk management committee to reconstitute its membership
on a regular basis and at all times include representatives from the
owners and participants of the registered clearing agency. Proposed
Rule 17Ad-25(d)(2) would require that a risk management committee, in
the
[[Page 51831]]
performance of its duties, be able to provide a risk-based,
independent, and informed opinion on all matters presented to it for
consideration in a manner that supports the safety and efficiency of
the registered clearing agency.
2. Discussion
(a) Purpose and Experience of the Risk Management Committee
Covered clearing agencies are subject to the requirements of Rule
17Ad-22(e) under the Exchange Act, while all registered clearing
agencies other than covered clearing agencies are subject to the
requirements of Rule 17Ad-22(d) under the Exchange Act.\116\ Currently,
all registered clearing agencies are covered clearing agencies and, as
such, they are required to have risk management committees as a part of
their governance arrangements under Rule 17Ad-22(e)(3)(iv).\117\ While
Rule 17Ad-22(e)(3)(iv) requires covered clearing agencies to have a
risk management committee, no parallel requirement exists for
registered clearing agencies that are subject to Rule 17Ad-22(d). The
Commission recognizes that there may be future registered clearing
agencies that are not covered clearing agencies and, as a result, would
be subject to Rule 17Ad-22(d). The Commission believes that clearing
agencies subject to Rule 17Ad-22(d) will also likely face risk
management issues related to their activities and, therefore, that any
clearing agency subject to Rule 17Ad-22(d) will likely benefit from
having a risk management committee. Accordingly, the Commission is
proposing Rule 17Ad-25(d) so that clearing agencies subject to Rule
17Ad-22(d) will also be required to have risk management committees as
a part of their governance arrangements.\118\ Additionally, because the
general requirement for a risk management committee under Rule 17Ad-
22(e)(3)(iv) does not outline minimum requirements for such committee,
proposed Rule 17Ad-25(d) establishes more defined requirements related
to the purpose and function of risk management committees. The specific
requirements imposed by proposed Rule 17Ad-25(d) will help enhance risk
management governance across all registered clearing agencies.
---------------------------------------------------------------------------
\116\ See supra notes 17-23 and accompanying text (explaining
that there are two categories of clearing agencies: covered clearing
agencies and all registered clearing agencies other than covered
clearing agencies).
\117\ See 17 CFR 240.17Ad-22(e)(3)(iv); see also CCA Standards
Adopting Release, supra note 13, at 70807-09 (discussing that, under
Rule 17Ad-22(e)(3)(iv), a registered clearing agency's risk
management framework must provide risk management personnel with a
direct reporting line to, and oversight by, a risk management
committee of the board of directors).
\118\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)(1), which requires a risk management committee to assist the
board in overseeing the risk management of a registered clearing
agency); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
As discussed above, each registered clearing agency is also a
covered clearing agency and, therefore, has established some form of
risk management committee to consider risk issues generally.\119\
Critical to the effective functioning of a clearing agency is the
board's ability to understand and engage with the risks that a
registered clearing agency faces and the risk management practices it
employs to mitigate those risks. The Commission recognizes that while
the board has ultimate responsibility over risk management matters, it
may assign certain tasks to a board committee to assist the board in
discharging its ultimate responsibility.\120\ Therefore, the Commission
believes that a risk management committee of the board is a more
effective way to help ensure that the board is engaged with and
informed of the ongoing risk management of the clearing agency, and
that a dedicated committee of the board remains focused exclusively on
matters related to risk management. The Commission believes that
requiring registered clearing agencies to establish a risk management
committee of the board would help ensure that the board can more
effectively oversee management's decisions concerning matters that
implicate the clearing agency's risk management, including its
policies, procedures, and tools for mitigating risk.
---------------------------------------------------------------------------
\119\ See infra Part IV.B.4.a)(3).
\120\ See CCP Resilience Guidance, supra note 77, at 5.
---------------------------------------------------------------------------
In addition, for the risk management committee itself to be
effective, it must have a clearly defined purpose and obligations to
the board. Accordingly, proposed Rule 17Ad-25(d)(2) would require that
a risk management committee, in the performance of its duties, be able
to provide a risk-based, independent, and informed opinion on all
matters presented to it for consideration in a manner that supports the
safety and efficiency of the registered clearing agency. The proposed
rule is intended to specify the role of the risk management committee
by stating the committee's purpose--namely, to provide a risk-based,
independent, and informed opinion on all matters presented to it in a
way that supports the safety and efficiency of the registered clearing
agency. The Commission believes the proposed rule helps ensure that the
committee has a clear scope and sufficient direction to more
effectively address risk management related matters, regardless of the
participants, markets, and products that a clearing agency serves.
First, with respect to its purpose, the risk management committee's
opinions must be risk-based, meaning that its opinions are focused on
both the risks that the clearing agency faces and the tools at its
disposal to mitigate and address such risks. To facilitate such an
approach, the proposed rule provides that the risk management committee
must be able to provide an opinion that supports the safety and
efficiency of the clearing agency itself. As a result, the Commission
believes that when the risk management committee makes recommendations
to the board, its opinions should reflect how the decisions support the
safety and efficiency of the clearing agency. In the Commission's view,
the stated objective of supporting the safety and efficiency of the
clearing agency helps ensure that the risk management committee's
recommendations represent the best interests of the clearing agency.
Second, the risk management committee's opinions must be independent.
That is, when making recommendations to the board, the risk management
committee's decisions or opinions must be its own, mindful of the
objective discussed above, and not merely a rubber stamp for the
recommendations presented to the committee by management. The
Commission believes that, by requiring the risk management committee to
provide an independent opinion, irrespective of its composition, the
proposed rule helps ensure that the committee is free from influence in
the performance of its duties.
Finally, the risk management committee's opinions must be informed.
That is, when making recommendations to the board, the risk management
committee's opinions should demonstrate that the committee was able to
engage thoughtfully and knowledgeably with the matters presented to it.
In this regard, for the risk management committee to provide an
informed opinion, its members should have a clear understanding of the
clearing agency's operations and risk management procedures, including
the risks that it faces and its methods of addressing such risks.
Accordingly, the Commission believes that, in complying with this
proposed requirement, the risk management committee generally should
include directors with specific risk management expertise and
[[Page 51832]]
experience related to the risks that the clearing agency faces.\121\
Because the risks a clearing agency faces will vary depending on the
products it clears and the markets it serves, the Commission believes
that a clearing agency should have discretion to determine the
appropriate qualifications and expertise needed for the risk management
committee to provide an informed opinion. The Commission also believes
that, by requiring the risk management committee to provide an informed
opinion, the proposed rule helps ensure that the committee's
recommendations are more reliable and effective. In the Commission's
view, the risk management committee's ability to provide risk-based,
independent, and informed opinions is critical to the proper
functioning and effectiveness of the committee.
---------------------------------------------------------------------------
\121\ The Commission has previously recognized that, because
clearing and settlement is a highly specialized area, specific risk
management expertise and experience are needed to serve on the risk
management committee and make informed decisions. See Regulation MC
Proposing Release, supra note 1, at 65899, 65921 (discussing the
``highly specialized risk management expertise required of directors
serving on [the risk management] committee'').
---------------------------------------------------------------------------
(b) Representation of Owners and Participants
Commission rules do not currently require a registered clearing
agency to include representatives from the clearing agency's owners and
participants on the risk management committee. Based on its supervisory
experience, the Commission believes that clearing agencies will benefit
from the diverse perspectives and expertise that representatives from
owners and participants can provide, which enhances the effectiveness
of their risk management practices. With this in mind, the Commission
is proposing that the risk management committee at all times include
representatives from the owners and participants of the registered
clearing agency.\122\ In the Commission's view, these representatives
would be persons who have a relationship with the clearing agency's
owners and participants, such as employees of the owners and
participants or those who have an ownership interest in the owners and
participants. Based on its supervisory experience, the Commission
believes that representatives from a clearing agency's owners and
participants will likely have an understanding of the clearing agency's
operations and procedures, as well as the complex risk management
issues that the clearing agency's board must consider. In this regard,
requiring the risk management committee to include representatives from
the clearing agency's owners and participants helps ensure that the
risk management committee's recommendations to the board reflect these
stakeholders' unique perspectives and expertise on risk management
issues.
---------------------------------------------------------------------------
\122\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)(1)); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(d)(1) requires that the risk management
committee at all times include multiple representatives from the owners
and participants of the registered clearing agency. By requiring the
risk management committee to include representatives from the clearing
agency's owners and participants, the Commission believes that the
committee will likely include representation from a broad range of
participants with different business strategies, models, and sizes. The
committee generally should include both small and large participants.
The Commission recognizes that, other than requiring that multiple
representatives from the clearing agency's owners and participants
serve on the committee at all times, the proposed rule does not require
that a certain percentage or number of such representatives serve on
the committee. Accordingly, the Commission believes that the proposed
rule provides a registered clearing agency with some discretion to
determine the appropriate composition for the risk management committee
with respect to representation from its owners and participants. By
requiring that the risk management committee include multiple
representatives from the owners and participants of the clearing
agency, the proposed rule helps ensure a minimum standard for the
inclusion of market participants on risk management committees while
providing sufficient flexibility to registered clearing agencies given
the range of different sizes, business models, and governance
structures across clearing agencies.
(c) Requirement To Reconstitute Membership
Many registered clearing agencies have established policies and
procedures for governance arrangements that help promote participation
from a broader array of owners and participants on the risk management
committee through the use of regular reconstitution.\123\ The
Commission believes that codifying this practice will set a minimum
standard for the reconstitution of the risk management committee's
membership. Therefore, the Commission is proposing that the risk
management committee reconstitute its membership on a regular
basis.\124\ Requiring the risk management committee to regularly
reconstitute its membership helps ensure that a broad range of owners
and participants will be able to provide their risk management
expertise and participate in the decision-making of the risk management
committee over time. In the Commission's view, the proposed
reconstitution requirement achieves the above objective of ensuring a
broad range of participation on the risk management committee without
imposing specific obligations related to owners, participants, or
independent directors that may be suitable in some, but not necessarily
all, cases.
---------------------------------------------------------------------------
\123\ See, e.g., ICC, ICE Clear Credit Regulation and Governance
Fact Sheet, at 3 (April 2022), https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf; OCC,
Risk Committee Charter, at 1 (rev. Sept. 22, 2021), https://www.theocc.com/getmedia/e71a4c1d-52dc-4c95-aeb1-98dab9159f41/risk_committee_charter.pdf.
\124\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)(1)); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
Because the risk management committee is broadly responsible for
providing recommendations to the board on all risk management related
matters, it is important that the committee's membership reflects a
wide range of owners and participants with relevant experience and
expertise on a variety of risk management issues. By requiring the risk
management committee to regularly reconstitute its membership, proposed
Rule 17Ad-25(d)(1) helps ensure ongoing diversity of perspectives
across owners and participants and expertise on the risk management
committee. The Commission believes the proposed reconstitution
requirement helps ensure that the risk management committee is well-
positioned to provide more effective recommendations to the board on
all risk management matters. The Commission also believes the proposed
reconstitution requirement helps ensure that the committee is able to
provide fresh perspectives on risk management matters, which, in turn,
helps promote more effective and reliable risk management practices at
a registered clearing agency.
The Commission acknowledges that proposed Rule 17Ad-25(d)(1) only
requires the risk management committee to reconstitute its membership
``on a regular basis.'' In this regard, the proposed rule provides a
registered clearing agency with discretion to
[[Page 51833]]
determine the appropriate timing for reconstitution. For example, the
charter for a registered clearing agency's risk management committee
could establish that the committee will conduct a review of its members
on an annual basis, or other specified length of time, to assess
whether the committee continues to be an accurate reflection of the
clearing agency's owners and participants. The charter could also
establish that members of the committee serve for a specified term, or
that the committee would rotate or replace directors on the committee
at certain intervals absent a specified turnover threshold among
directors. Additionally, registered clearing agencies could stagger
terms in order to have regular turnover of participants and other
members of the risk management committee.
3. Request for Comment
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-25(d). In addition, the Commission requests comments
on the following specific issues:
24. The Commission is not proposing to carve out the risk
management committee from the director independence requirements under
proposed Rule 17Ad-25(e). Should the Commission include such a carve-
out for the risk management committee so that a registered clearing
agency would not be required to include independent directors on the
committee? Why or why not? If not, should there be separate director
independence requirements applicable only to the risk management
committee that reflect the highly specialized risk management expertise
needed to serve on the committee? Why or why not?
25. Is the proposed requirement that the registered clearing
agency's risk management committee be a committee of the board a more
effective way to structure the risk management committee than requiring
that the risk management committee be an external committee, such as a
management committee or an advisory committee? Why or why not? If not,
should the risk management committee be structured to represent more
participants, regardless of whether those participants are represented
on a clearing agency's board? Why or why not?
26. The Commission is not specifying whose responsibility it is to
determine the matters presented to the risk management committee for
consideration. Should the Commission be more prescriptive and specify
whose responsibility it is to make such determinations? If so, should
the Commission require the risk management committee to designate
thresholds or identify the types of risk management related matters
that warrant consideration by the committee? Why or why not? Please
explain.
27. Is the proposed requirement that the risk management committee
include at all times representatives from the registered clearing
agency's owners and participants sufficient to help ensure that the
directors serving on the committee will have the specific risk
management expertise and relevant experience needed to make effective
risk management decisions? Why or why not? In requiring that the risk
management committee include such representatives at all times, should
the Commission require that a specific percentage or number of
representatives from the clearing agency's owners and participants
serve on the risk management committee? Why or why not? If so, what
percentage or number? Please explain with specific information.
28. Should the Commission require the risk management committee to
include at all times a specific percentage or number of representatives
from small participants of the clearing agency in addition to
representatives from the owners and participants more generally, as
proposed? Why or why not? If so, what percentage or number? Please
explain with specific information.
29. The Commission is not specifying whose responsibility it is to
determine the appropriate qualifications and expertise needed for a
director to serve on the risk management committee. Should the
Commission be more prescriptive and specify whose responsibility it is
to make this determination, such as the nominating committee, or should
this determination remain up to the discretion of the registered
clearing agency? Why or why not? Please explain.
30. The Commission requests comment on whether the requirement that
a risk management committee ``reconstitute'' its membership on a
regular basis is sufficiently clear. Is there additional guidance
needed on what ``reconstitute'' means? Is it sufficiently clear that
the term ``reconstitute'' refers to the membership of the risk
management committee and not to the form of the committee? Why or why
not? Should the Commission instead require that the membership be
``rotated''? \125\ Please explain.
---------------------------------------------------------------------------
\125\ The CFTC's proposal would require a risk management
committee to ``rotate'' its membership on a regular basis. See supra
note 52 and accompanying text.
---------------------------------------------------------------------------
31. Has the Commission provided a sufficient explanation for what
constitutes ``on a regular basis'' with respect to how often a risk
management committee is required to reconstitute its membership? Why or
why not? Would a more specific reconstitution requirement be
appropriate? For example, should this requirement specify a frequency
for the risk management committee's reconstitution (e.g., annually)?
Why or why not? If so, please explain what the appropriate frequency
should be.
D. Conflicts of Interest
1. Proposed Rules 17Ad-25(g) and (h)
Proposed Rule 17Ad-25(g) would require each registered clearing
agency to establish, implement, maintain, and enforce written policies
and procedures reasonably designed to identify and document existing or
potential conflicts of interest in the decision-making process of the
clearing agency involving directors or senior managers of the
registered clearing agency; and mitigate or eliminate and document the
mitigation or elimination of such conflicts of interest. Additionally,
proposed Rule 17Ad-25(h) would require registered clearing agencies to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to require a director to document and
inform the registered clearing agency promptly of the existence of any
relationship or interest that reasonably could affect the independent
judgment or decision-making of the director.
2. Discussion
At the time of the 2016 CCA Standards Adopting Release, the
Commission declined to incorporate more prescriptive governance
elements into the rule as urged by commenters, including specific
requirements on conflicts of interest,\126\ based on the premise that
the requirements in Section 17A of the Exchange Act relating to fair
representation and the public interest provided sufficient
[[Page 51834]]
grounds to hold covered clearing agencies accountable to these
concerns.\127\ At the time, the Commission also observed that as a
general matter, the market for clearing agency services demonstrates
evidence of a significant volume of activity being concentrated in a
small number of large financial institutions.\128\ The concentration of
clearing and settlement services within a handful of entities
continues, suggesting that additional interventions may be
appropriate.\129\ The Commission is concerned that this characteristic
could impede the continued development of open, transparent, and
competitive markets and, therefore, believes it is appropriate to
propose requirements on registered clearing agencies on mitigating or
eliminating conflicts of interest so that such conflicts do not
undermine the integrity of decisions made in the governance of the
clearing agency. The proposed rules are intended to address concerns
that the institutions that currently dominate the securities markets
would have conflicts of interest that influence their participation in
the development of centralized trading and clearance and settlement
systems for securities. As they relate to clearing agencies that clear
security-based swaps, the proposed rules would also advance the policy
objectives set forth in Section 765 by establishing new requirements
for policies and procedures that require such clearing agencies to
identify, mitigate or eliminate, and document the identification and
mitigation or elimination of conflicts of interest.
---------------------------------------------------------------------------
\126\ See CCA Standards Adopting Release, supra note 13, at
70804 (stating that ``[o]ne 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. The Commission notes . . . 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'').
\127\ See 15 U.S.C. 78q-1(b)(3)(C).
\128\ See CCA Standards Adopting Release, supra note 13, at
70793 (stating that ``the Commission has considered the level of
concentration in the provision of clearing agency services'' and
acknowledging concerns ``that at present the clearance and
settlement industry, like much of the financial sector, can be
described as highly concentrated, and . . . that it is paramount . .
. [to] promote the proliferation of viable new clearing agencies,
given that existing clearing agencies typically serve as
intermediaries for trillions of dollars in trading volumes'').
\129\ See Staff Report on Clearing Agencies, supra note 27, at
21.
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With the above in mind, requirements on registered clearing
agencies to address conflicts of interest would strengthen the
integrity of a registered clearing agency's governance arrangements,
including those regarding director independence, the fitness standards
applied and nominations made by the nominating committee, and the
independent opinions and recommendations made by the risk management
committee previously discussed. Proposed Rules 17Ad-25(g) and (h) help
promote the integrity of these governance arrangements by helping
ensure that a registered clearing agency is capable of both identifying
potential conflicts when they arise and subjecting conflicts to a
transparent and uniform process of review, mitigation or elimination,
and documentation. Specifically, the proposed rules would help ensure
that potential conflicts of interest are identified and documented,
that policies and procedures for their management have been established
ex ante to help ensure a consistent approach over time, and that cases
are subject to established processes for review and mitigation or
elimination. In some cases, for example, a conflicts of interest policy
may simply require that a director or senior manager recuse herself
from a particular decision to mitigate or eliminate the conflict of
interest. At the same time, the Commission believes that disclosure,
while an effective tool for the clearing agency to identify and
recognize a conflict of interest, is insufficient by itself to reduce
the potential harm a conflict of interest may have on the clearing
agency. Instead, the Commission believes that as the clearing agency is
best positioned to identify and address conflicts of interest that may
arise in its operations and risk management and decision-making, the
clearing agency is best positioned through reasonable policies and
procedures to mitigate--namely, reduce--or eliminate these conflicts of
interest so that such conflicts do not undermine the integrity of
decisions made in the governance of the clearing agency. In addition,
the policies and procedures approach helps ensure the documentation of
conflicts of interest and their mitigation or elimination, helping the
Commission to assess and compare the types of conflicts that arise
across clearing agencies to help promote more effective oversight and
regulation of clearing agencies.
In the absence of policies and procedures to address conflicts of
interest, directors and senior managers of a registered clearing agency
could undermine the purpose of requiring independent directors and
centralizing the nominating process for new directors in a nominating
committee composed of a majority of independent directors. More
broadly, the proposed rules help to ensure that when directors and
senior managers develop relationships that create potential conflicts
of interest, the clearing agency has a process to manage those
relationships to mitigate or eliminate conflicts so that they do not
undermine the integrity of decisions made in the governance of the
clearing agency.
(a) Potential Conflicts
Under proposed Rule 17Ad-25(g), the registered clearing agency must
be able to identify and document both existing and potential conflicts
of interest involving directors or senior managers of the registered
clearing agency. The rule is intended to address the conflicts of
interests of directors and senior managers that could undermine the
decision-making process within a registered clearing agency or
interfere with fair representation and equitable treatment of clearing
members or other market participants by a registered clearing agency.
Being able to identify potential conflicts of interest is critical to
ensuring the effective identification and management of actual
conflicts of interest. In other words, a clearing agency must be able
to spot close cases, where another director, manager, employee, or
observer might perceive a conflict of interest, in order to more
effectively manage actual conflicts and help ensure the integrity of
decisions made in the governance of the clearing agency.
As previously discussed in Part II.A, it is important for the
registered clearing agency to consider the differing incentives and
interests of individual directors, once they are on the board, when
they are governing the registered clearing agency. The board as a whole
is ultimately responsible for overseeing the clearing agency's
compliance with the regulatory obligations under the Dodd-Frank Act and
the Exchange Act, including the open and fair access requirements.\130\
Yet, depending on their affiliation with owners, large participants,
small participants, or indirect participants, individual directors may
be subject to different perspectives and motivations when fulfilling
these duties and roles. Like participants themselves, direct
participant directors may on balance be more likely to favor reducing
or minimizing the risk exposure of the clearing agency, potentially at
the expense of more open access; in contrast, indirect participant
directors may be inclined to favor expanded access to products and
services, which may increase the amount of risk that the clearing
agency must successfully manage.\131\
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\130\ See Regulation MC Proposing Release, supra note 1, at
65888.
\131\ See id.
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The Commission believes that because interests and incentives may
vary among directors and over time for
[[Page 51835]]
a range of reasons, it is not possible to predict how any individual
director will address particular matters. For this reason, the approach
taken in proposed Rule 17Ad-25(g)--as well as proposed Rule 17Ad-
25(h)--is intended to achieve an appropriate balance among these
various considerations by taking a principles-based approach to
addressing conflicts of interest. While the proposed rule provides the
registered clearing agency with a certain level of discretion to
address specific facts and circumstances it faces in light of its
governance structure, the product it clears, and the market it serves,
it is designed to complement other applicable, more prescriptive
requirements in this proposal, which the registered clearing agency may
also separately apply where relevant. Additionally, the proposed rule
is intended to limit the clearing agency's discretion through more
prescriptive procedural requirements the clearing agency must undertake
to establish, implement, maintain, and enforce written policies and
procedures reasonably designed to document the identification,
mitigation or elimination of conflicts of interest under proposed Rule
17Ad-25(g).
(b) Obligation of Directors To Report
Because a registered clearing agency may not have access to
information necessary to identify a potential conflict of interest,
proposed Rule 17Ad-25(h) would also require a registered clearing
agency to have policies and procedures that require a director to
document and inform the registered clearing agency promptly of the
existence of any relationship or interest that reasonably could affect
the independent judgment or decision-making of the director. The
proposed rule takes elements from the ``material relationship''
definition, which was carried forward from the Commission's previous
proposal in Regulation MC,\132\ without incorporating the definition
into the proposed rule itself. Specifically, the Commission is
requiring policies and procedures that focus on any relationship or
interest that reasonably could affect the independent judgment or
decision-making of the director, rather than material relationships or
interests, so that the registered clearing agency--not the party with a
reporting obligation--can determine whether a relationship or interest
is subject to mitigation or elimination under the conflicts of interest
policy. This approach helps ensure that the registered clearing agency
has sufficient information to investigate, identify and address
potential conflicts.
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\132\ See id. at 65896-97.
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(c) Policies and Procedures Approach
Because organizational structures vary across clearing agencies, as
do the products, markets, and market participants served by the
clearing agency, the Commission has taken a policies and procedures
approach in the proposed rule to manage conflicts. This provides
registered clearing agencies with discretion to design policies that
fit their particular structure and circumstances, and help ensure that
policies and procedures remain effective over time as circumstances
change. While the Commission has identified some specific circumstances
in proposed Rules 17Ad-25(f) that preclude a director from being an
independent director because they present a clear conflict of interest,
as a general matter the Commission believes that a clearing agency
should have discretion to assess conflicts and determine how to
mitigate or eliminate them.
3. Request for Comment
The Commission generally requests comments on all aspects of
proposed Rules 17Ad-25(g) and (h). In addition, the Commission requests
comments on the following specific issues:
32. Are proposed Rules 17Ad-25(g) and (h) sufficient to have
registered clearing agencies address conflicts of interest within their
governance arrangements? Why or why not? Please provide specific
examples to illustrate your points, if possible.
33. Do commenters agree with the potential conflict concerns that
the Commission has identified? What effect would the identified
conflicts of interest likely have? Should the Commission focus on any
of these conflicts more than others? Are there other existing conflicts
concerns that commenters believe warrant scrutiny? If so, what are they
and how are they likely to affect registered clearing agencies? Which
conflicts of interest could potentially cause the greatest harm to a
registered clearing agency? Please explain.
34. What potential new conflicts of interest could arise that the
Commission should consider? What other parties may have conflicts of
interest that would affect whether they should control or participate
in the governance of a registered clearing agency? In what
circumstances do these conflicts of interest arise?
35. Are there any additional requirements and/or guidance that the
Commission could provide to help registered clearing agencies evaluate
the relationships of their directors and senior managers to identify
potential sources of conflicts? Please explain with specifics in terms
of processes that would help identify both existing and potential
conflicts of interest involving directors or senior managers of the
registered clearing agency.
36. In requiring registered clearing agencies to establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to require a director to document and inform the
registered clearing agency promptly of the existence of any
relationship or interest that reasonably could affect the independent
judgment or decision-making of the director, does proposed Rule 17Ad-
25(h) provide sufficient requirements to have directors document and
inform the registered clearing agency promptly of potential conflicts
of interest? Why or why not?
37. Is the ``reasonably could affect'' standard proposed in Rule
17Ad-25(h) sufficient? Why or why not?
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\133\ The proposed rule would not apply to utility companies,
such as a power company providing general power services for the
registered clearing agency, although general power services are
necessary to allow a registered clearing agency to function and
operate, as a general matter. The Commission believes that such
services neither support the core clearance and settlement
functionality of the registered clearing agency nor are material to
the clearing agency's business, in that the power company does not
perform the core clearance and settlement functionality or material
clearing agency business functions itself. At the same time, the
registered clearing agency should be aware of how issues relating to
such services may impact its obligations under the Exchange Act.
This is consistent with Commission staff's views. See, e.g.,
Division of Trading and Markets: Responses to Frequently Asked
Questions Concerning Regulation SCI (rev. Aug. 21, 2019), https://www.sec.gov/divisions/marketreg/regulation-sci-faq.shtml (stating
that ``an issue at a power utility may interrupt the electric power
supplied to an SCI entity's SCI systems. Even if the outage at the
power utility's system would not itself be an SCI event, there is a
significant likelihood that an SCI entity would nonetheless
experience an SCI event following such an outage'').
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E. Board Obligation To Oversee Service Providers for Critical Services
1. Proposed Rule 17Ad-25(i)
Proposed Rule 17Ad-25(a) would define the term ``service provider
for critical services'' to mean any person that is contractually
obligated to the registered clearing agency for the purpose of
supporting clearance and settlement functionality or any other purposes
material to the business of the registered clearing agency.\133\
Proposed Rule 17Ad-25(i)(1) would require each registered clearing
agency to establish, implement, maintain, and enforce written policies
and procedures reasonably designed to enable the board to confirm and
document that risks
[[Page 51836]]
related to critical service provider relationships are managed in a
manner consistent with the registered clearing agency's risk management
framework, and to review senior management's monitoring of
relationships with service providers for critical services. Proposed
Rule 17Ad-25(i)(2) would require each registered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to enable the board to approve policies
and procedures that govern the relationship with service providers for
critical services. Proposed Rule 17Ad-25(i)(3) would require each
registered clearing agency to establish, implement, maintain, and
enforce written policies and procedures reasonably designed to enable
the board to review and approve plans for entering into third-party
relationships where the engagement entails being a service provider for
critical services to the registered clearing agency. Proposed Rule
17Ad-25(i)(4) would require each registered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to enable the board to, through regular
reporting to the board by senior management, confirm that senior
management takes appropriate actions to remedy significant
deterioration in performance or address changing risks or material
issues identified through ongoing monitoring.
2. Discussion
Under existing requirements, the Commission requires registered
clearing agencies to manage operational risk, which can include risks
associated with relationships with service providers for critical
services. Rule 17Ad-22(d)(4) under the Exchange Act requires a
registered clearing agency that is not a covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to identify sources of operational risk
and minimize them through the development of appropriate systems,
controls, and procedures; implement systems that are reliable,
resilient and secure, and have adequate, scalable capacity; and have
business continuity plans that allow for timely recovery of operations
and fulfillment of a clearing agency's obligations.\134\ Rule 17Ad-
22(e)(17) under the Exchange Act requires a covered clearing agency to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to manage the covered clearing agency's
operational risks by, among other things, 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.\135\ Additionally, under Regulation SCI, the
Commission requires registered clearing agencies as SCI entities to
conduct risk assessments of SCI systems at least once per year and
report the findings to senior management and the board of
directors.\136\
---------------------------------------------------------------------------
\134\ See 17 CFR 240.17Ad-22(d)(4).
\135\ See 17 CFR 240.17Ad-22(e)(17).
\136\ See 17 CFR 242.1000-1007.
---------------------------------------------------------------------------
Based on its supervisory experience, the Commission has observed
that clearing agencies have used service providers to help ensure the
prompt and accurate clearance and settlement of securities
transactions, and that in some cases, service providers are affiliates
or a parent company within the same holding company structure as the
registered clearing agency itself. Service providers may also be third
party entities, such as technology providers, data providers, or
providers of other services. Because of the range of relationships and
needs of a registered clearing agency, service providers can perform a
wide variety of functions. For example, a clearing agency may contract
with its parent company to staff the registered clearing agency.\137\ A
clearing agency may contract with one or more investment advisers to
help facilitate the closing out of a defaulting participant's
portfolio.\138\ A clearing agency may use one or more data service
providers to help calculate pricing information for securities.\139\ A
clearing agency may also purchase technology services from service
providers that may help to facilitate clearance and settlement in a
number of ways. In each of the cases described above, failure of the
service provider to perform its obligations would pose significant
operational risks and have critical effects on the ability of the
registered clearing agency to perform its risk management function and
facilitate prompt and accurate clearance and settlement. In this
regard, under existing requirements, including Regulation SCI,
outsourcing a clearance and settlement functionality to a service
provider for critical services does not relieve the registered clearing
agency of its statutory and regulatory obligations, which remain with
the registered clearing agency.\140\
---------------------------------------------------------------------------
\137\ See, e.g., DTCC, Businesses and Subsidiaries, https://www.dtcc.com/about/businesses-and-subsidiaries; see also Part IV.B.1
(explaining that DTC, FICC, and NSCC are clearing agency
subsidiaries of DTCC).
\138\ See, e.g., NSCC, Disclosure Framework for Covered Clearing
Agencies and Financial Market Infrastructures (Dec. 2021), at 84,
https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/NSCC_Disclosure_Framework.pdf (``NSCC utilizes the
services of investment advisors and executing brokers to facilitate
such [close-out purchase and sale] transactions [for open Continuous
Net Settlement (CNS) positions] promptly following its determination
to cease to act. NSCC may engage in hedging transactions or
otherwise take action to minimize market disruption as a result of
such purchases and sales.'').
\139\ See, e.g., FICC, Disclosure Framework for Covered Clearing
Agencies and Financial Market Infrastructures (Dec. 2021), at 58,
65, https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/FICC_Disclosure_Framework.pdf (``Collateral securities
are re-priced every night, from pricing sources utilized by FRM's
[Financial Risk Management's] Securities Valuation unit . . . . FICC
utilizes multiple third-party vendors to price its eligible
securities and uses a pricing hierarchy to determine a price for
each security.'').
\140\ See Regulation SCI Adopting Release, supra note 39, at
77276 (expressing that an ``SCI entity should be responsible for
managing its relationship with third parties operating systems on
behalf of the SCI entity through due diligence, contract terms, and
monitoring of third party performance'').
---------------------------------------------------------------------------
As firms explore new technologies that can facilitate prompt and
accurate clearance and settlement in new and innovative ways, clearing
agencies may increasingly determine that service providers will offer
the most effective technology to perform key functions.\141\ Reliance
on service providers will require careful oversight of these
relationships because service provider relationships are a key source
of operational risk to a registered clearing agency, risk which can
result in service outages that, due to the centralizing nature of
registered clearing agencies, could have implications for the national
system for clearance and settlement.
---------------------------------------------------------------------------
\141\ See id. at 72252-53.
---------------------------------------------------------------------------
Ultimately, it is the responsibility of the board to oversee the
relationships that management establishes with service providers to
help ensure that management is performing its function more effectively
and that the clearing agency can facilitate prompt and accurate
clearance and settlement. Accordingly, the Commission believes it is
appropriate to propose certain requirements relating to the board
oversight of service providers for critical services.
(a) Definition of Service Providers for Critical Services
Registered clearing agencies perform some oversight of certain
service provider relationships, pursuant to existing Commission
requirements with respect to these relationships.\142\ Against this
backdrop and as part of the evolution of the registered clearing agency
regulatory framework, the
[[Page 51837]]
Commission proposes a companion governance requirement to these
existing rules that makes explicit the registered clearing agency's
board obligation to oversee the range of its service providers for
critical services. In this regard, proposed Rule 17Ad-25(a) would
define the scope of ``service provider for critical services'' to mean
any person that is contractually obligated to the registered clearing
agency for the purpose of supporting clearance and settlement
functionality or any other purposes material to the business of the
registered clearing agency. Absent regular monitoring and oversight,
these relationships could endanger the operational resilience of a
registered clearing agency and call into question the registered
clearing agency's ability to meet its obligations under the Exchange
Act.
---------------------------------------------------------------------------
\142\ See 17 CFR 240.17Ad-22(d)(4) and (e)(17); 17 CFR 242.1000-
1007.
---------------------------------------------------------------------------
(b) Obligations of the Board
In addition, proposed Rule 17Ad-25(i) would explicitly obligate the
registered clearing agency to have policies and procedures that require
its board to oversee a registered clearing agency's relationships with
service providers for critical services. Proposed Rule 17Ad-25(i)
includes a policies and procedures approach because, the Commission
believes that, given the range of potential service provider
relationships, the risks that they pose, and the different ways in
which they might interact with different types of products, markets,
and market participants, a registered clearing agency will need to
exercise its discretion and judgment in managing these risks and
reviewing steps taken by management.
Accordingly, under paragraphs (1) and (2), the board would be
charged with reviewing senior management's monitoring of each
relationship with a service provider for critical services, confirming
and documenting that the risks related to such relationships have been
considered and addressed consistent with the clearing agency's risk
management framework, and, more generally, approving policies and
procedures that govern such relationships. One method of confirming and
documenting the risks posed by a service provider for critical services
to the registered clearing agency would be for the board to complete a
self-assessment based on the format and substance of Annex F in the
PFMI \143\ that highlights oversight expectations applicable to
critical service providers. Annex F, in its form as of the date of this
publication, provides a comprehensive basis for the board of a
registered clearing agency to use to assess a service provider's risk
identification and management, information security management,
reliability and resilience, technology planning, and the strength of
communications with users. Completing such a self-assessment is not
mandatory but may be helpful for the registered clearing agency to
demonstrate compliance with this element of proposed Rule 17Ad-
25(i)(1).
---------------------------------------------------------------------------
\143\ See PFMI, supra note 4, at 170-71.
---------------------------------------------------------------------------
Paragraph (1) would also require review of senior management's
oversight of a service provider relationship. The Commission believes
that the board should be aware of the risks flowing into the registered
clearing agency, including through its relationships with service
providers for critical services, and maintain awareness of those risks
over time by monitoring management's oversight of the relationship. In
its traditional function as a check on management, the board can help
ensure that, for example, management assesses and addresses performance
issues by the provider under any agreement with the provider and helps
to ensure that product or other deliverables are provided timely and
consistent with the terms of the agreement.
Under paragraph (3), the board should review and approve plans for
entering into third-party relationships where the engagement entails
being a service provider for critical services to the registered
clearing agency. The Commission believes the board's participation in
this regard is required as part of sound risk management when the
clearing agency enters into contractual relationships with third
parties. Board involvement would help ensure that the terms of
performance for the service provider are sufficient to support the
needs of the registered clearing agency and any increased level of risk
to the registered clearing agency is evaluated, assessed, and accounted
for. If renewal of third-party contracts or performance issues are
called into question, the Commission believes that the Board should
generally review such matters as part of its oversight responsibilities
in existing governance arrangements and requirements.\144\
---------------------------------------------------------------------------
\144\ See generally 17 CFR 240.17Ad-22(d)(8), (e)(2). Existing
Rules 17Ad-22(d)(8) and (e)(2) impose obligations on a governance
arrangements of the clearing agency to promote the effectiveness of
the clearing agency's risk management procedures. Proposed Rule
17Ad-25(i)(3) would impose obligations on the Board when initiating
a third-party relationship.
---------------------------------------------------------------------------
Finally, under paragraph (4), the board would have responsibility
for overseeing the extent to which senior management remedies
performance issues under a service provider contract. A key source of
risk in any service provider relationship to a registered clearing
agency is the operational risks that may arise if a service provider is
not performing pursuant to the agreed terms of the contractual
relationship. Without the board's effective ongoing monitoring of such
risks and oversight of management's remedial actions to control such
risks, the registered clearing agency may be faced with increasing
levels of risk that undermine sound risk management and operational
resilience. Accordingly, the Commission believes that policies and
procedures should specifically provide for regular reporting to the
board by senior management to ascertain whether senior management is
taking appropriate remedial actions to mitigate or eliminate the risks
of a critical service provider's significant performance deterioration
or other material changes in the relationship that would result in an
unacceptable increase in risk to the registered clearing agency if not
remedied in a timely manner.
3. Request for Comment
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-25(i). In addition, the Commission requests comments
on the following specific issues:
38. Is the definition of ``service provider for critical services''
sufficiently clear and properly scoped? Why or why not? Please explain
and include alternative definitions, if possible.
39. In requiring registered clearing agencies to establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to enable the board to oversee relationships with
service providers of critical services, should the Commission provide
specific guidance regarding the means and measures by which the board
performs such oversight responsibilities? Why or why not?
40. In requiring registered clearing agencies to establish,
implement, maintain, and enforce written policies and procedures
reasonably designed to confirm and document that risks related to
relationships with service providers for critical services are managed
in a manner consistent with its risk management framework, should the
Commission require--rather than provide as guidance, as currently
formulated--that the board confirm and document the risks through a
self-assessment as discussed above? Why or why not?
[[Page 51838]]
F. Obligation to Formally Consider Stakeholder Viewpoints
1. Proposed Rule 17Ad-25(j)
Proposed Rule 17Ad-25(j) would require each registered clearing
agency to establish, implement, maintain, and enforce written policies
and procedures reasonably designed to solicit, consider, and document
its consideration of the views of participants and other relevant
stakeholders of the registered clearing agency regarding material
developments in its governance and operations on a recurring basis.
2. Discussion
Currently, all registered clearing agencies are covered clearing
agencies and, as such, they are subject to requirements for their
governance arrangements to include policies and procedures that support
the public interest and the objectives of owners and participants, as
well as that consider the interests of participants' customers,
securities issuers and holders, and other relevant stakeholders.\145\
However, no parallel requirement exists for registered clearing
agencies that are subject to Rule 17Ad-22(d). Based on its supervisory
experience, the Commission believes that enhancing clearing agency
governance practices will facilitate the ability of clearing agencies
subject to Rule 17Ad-22(d) to obtain and consider the views of a
diverse cross-section of their participants and stakeholders, who will
likely bear any of the losses incurred as a result of the clearing
agency's decisions with respect to its governance and operations.
Accordingly, the proposed rule would supplement existing Commission
requirements by also requiring that a registered clearing agency have
policies and procedures to solicit, consider, and document its
consideration of the views of participants and other relevant
stakeholders regarding material developments in the clearing agency's
governance and operations. The Commission believes that other relevant
stakeholders generally would include investors, customers of
participants, as well as securities issuers.
---------------------------------------------------------------------------
\145\ See 17 CFR 240.17Ad-22(e)(2)(iii) and (vi).
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The Commission understands that many registered clearing agencies
already have established committees, working groups, and other fora of
varying size, scope, and formality to share and solicit information
with participants, the customers of their participants, and other
stakeholders regarding changes to risk management and other services
offered by the clearing agency. These groups and fora are useful tools
for information sharing and gathering, and help promote an open
dialogue between the clearing agency, its participants, and other
relevant stakeholders. Accordingly, the Commission is proposing Rule
17Ad-25(j) to help promote the formalization of these processes and
structures to help ensure their ongoing use, both for the existing set
of registered clearing agencies and for potential future registrants.
The Commission believes that the proposed rule would help ensure that
these types of groups have a clear purpose and scope by requiring that
registered clearing agencies solicit views from relevant stakeholders
in addition to their participants and document their consideration of
views expressed, and that the views solicited concern topics related to
material developments in a clearing agency's governance and operations.
Soliciting and considering viewpoints from participants and other
relevant stakeholders helps ensure that the board of a registered
clearing agency is informed of the full range of views across its
participants and stakeholders while making decisions related to
material developments in the clearing agency's governance and
operations.
In addition, the Commission believes that requiring registered
clearing agencies to document their consideration of such viewpoints
would help ensure that a record exists of the viewpoints provided by
participants and other relevant stakeholders regarding material
developments in a clearing agency's governance and operations, ensuring
that the clearing agency indicated that it had received such viewpoints
and evaluated their merits. Such a requirement also helps promote
confidence in the use of such fora and other structures because records
will help demonstrate the ways in which registered clearing agencies
consider and engage with stakeholder viewpoints. Building a record of
such engagements also would help the Commission itself evaluate the
ways in which clearing agencies consider stakeholder viewpoints and
balance potentially competing viewpoints, facilitating the Commission's
monitoring and oversight of registered clearing agencies and their
impact on the U.S. securities market.
3. Request for Comment
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-25 (j). In addition, the Commission requests
comments on the following specific issues:
41. The Commission understands that some registered clearing
agencies have established multiple groups or fora to target specific
topics or types of participants when sharing and soliciting
information. What should a registered clearing agency consider when
determining to establish one versus multiple fora for soliciting
viewpoints? Why? How should it select the types of stakeholders or
market participants from whom it solicits information? Are there
particular topics for which a group or fora should be required under
the rule? Are there any merits in limiting the number of different
groups or fora to avoid overly fragmenting the discussion of topics and
solicitation of viewpoints? Please explain with specific examples, if
possible.
42. Should the rule include specific requirements applicable to
committees, working groups, or other fora when established by a
clearing agency? Please explain.
43. The proposed rule would require that a registered clearing
agency solicit viewpoints regarding material developments in its
governance and operations. Does limiting the topics for soliciting
viewpoints to ``material'' aspects of a clearing agency's governance
and operations provide for the appropriate scope of topics for which a
clearing agency should solicit viewpoints? Why or why not? Should the
rule limit the topics for soliciting viewpoints only to risk
management? Why or why not? Conversely, should the set of topics be
expanded to include topics such as participation requirements, products
cleared, fees, new technologies, services, or other topics relevant to
participants and other stakeholders? Please explain with specific
examples, if possible.
44. The proposed rule would require that the registered clearing
agency solicit viewpoints on a recurring basis. How frequently should a
registered clearing agency solicit viewpoints? Should the requirement
apply on an annual basis, a quarterly basis, or some other frequency?
How should a clearing agency balance the frequency of its outreach
against the obligation to document its consideration of viewpoints
received?
45. Does the proposed rule interact with the board's fiduciary duty
to the clearing agency? If so, how? Please explain with specific
information.
G. Considerations Related to Implementation and Compliance
The Commission believes it is important to establish governance
requirements for registered clearing agencies given the potentially
[[Page 51839]]
significant risks posed by their size, systemic importance, and/or the
risks inherent in the products they clear, and therefore believes that
implementation of any of the requirements in proposed Rule 17Ad-25, if
adopted, should be prompt. However, the Commission also recognizes that
additional time may be warranted to address any new requirements, if
adopted, by both clearing agencies currently registered with the
Commission and those entities that intend to register as clearing
agencies with the Commission while the rules are being finalized.
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 clearing agencies, including an applicant for
registration as a clearing agency whose application is pending upon the
compliance date. 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).\146\ Following registration, any registered clearing agency
would need to address compliance with any of the requirements in
proposed Rule 17Ad-25, if adopted.
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\146\ See 15 U.S.C. 78q-1(b)(3).
---------------------------------------------------------------------------
The Commission is also mindful of the time and costs that may be
incurred by registered clearing agencies to implement aspects of
proposed Rule 17Ad-25, if adopted, namely the independence requirements
for the board and board committees. Implementation of these proposed
requirements could require changes to policies and procedures currently
utilized to comply with the Commission's clearing agency rules. These
burdens could be exacerbated if affected clearing agencies must begin
complying with any proposed Rule 17Ad-25, if adopted, in their existing
policies and procedures at or near the same time that they are making
changes to their board and board committee composition by undertaking
the steps to identify and select candidates to accommodate these
proposed requirements. The Commission believes that implementation of
the proposed rules, if adopted, can and should be done in a manner that
carries out the fundamental policy goals of the rules while minimizing
burdens and disruptions as much as practicable, including minimizing
the prospect of current directors having to resign before their terms
expire. The Commission believes that this should be done pursuant to a
phased-in compliance schedule whereby the proposed rules, if adopted,
would have a compliance date that is 180 days from publication of the
final rules in the Federal Register for all the provisions other than
proposed Rule 17Ad-25(b)(1), (c)(2), and (e), and 24 months from
publication of the final rules in the Federal Register for the
independence requirement for the board and board committees under
proposed Rule 17Ad-25(b)(1), (c)(2), and (e).
1. Request for Comment
46. Are the 180-day and 24-month compliance periods appropriate?
Why or why not? Please be specific.
47. Does the phased-in compliance date envisioned by the Commission
adequately address the time and resources needed for clearing agencies
to comply with proposed Rule 17Ad-25 if adopted? Please explain. Should
specific requirements be phased in over time, such as to allow current
directors to serve their complete term rather than needing to resign
early in order to adjust the number of independent directors on a
board? If so, what is the appropriate number of days that would allow
current directors to serve their complete terms?
H. General Request for Comment
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-25.
IV. Economic Analysis
A. Introduction
The Commission is sensitive to the economic consequences and
effects of the proposed rules, including their benefits and costs.\147\
The Commission acknowledges that, since many of these proposals could
require a 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.
Further, as stated 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 of
transactions in securities.\148\
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\147\ 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. See 15 U.S.C.
78c(f). In addition, Section 23(a)(2) of the Exchange Act 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. See 15 U.S.C. 78w(a)(2).
\148\ See 15 U.S.C. 78q-1(a)(2)(A).
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This section addresses the likely economic effects of the proposed
rules, including their anticipated and estimated benefits and costs and
their likely effects on efficiency, competition, and capital formation.
Many of the benefits and costs are difficult to quantify. For example,
the issue of misaligned incentives is a core economic matter that is
persistent across many different types of economic interactions among
clearing agency stakeholders. Incentives affect the economic outcome of
a transaction but there is little data about how decision-making
processes directly affect monetary gains and losses. In addition,
quantification of these incentive effects is particularly challenging
due to the number of assumptions that would be needed to forecast how
clearing agencies would respond to the proposed rules, and how those
responses would, in turn, affect the broader market for cleared
securities products. While the Commission has attempted to quantify
economic effects where possible, much of the discussion of economic
effects is qualitative in nature. The Commission also discusses the
potential economic effects of certain alternatives to the approaches
recommended in this proposal.
[[Page 51840]]
B. Economic Baseline
To consider the effect of the proposed rules, the Commission first
explains the current state of affairs in the market (the economic
baseline). All the potential benefits and costs from adopting the
proposed rules are changes relative to the economic baseline. The
economic baseline in this proposal considers (1) the current market for
registered clearing agency activities, including the number of
registered clearing agencies, the distribution of participants across
these clearing agencies, and the volume of transactions these clearing
agencies process, (2) the current regulatory framework for registered
clearing agencies, and (3) the current practices of registered clearing
agencies that relate to the proposed rules.
1. Description of Market
Of the nine registered clearing agencies, there are currently seven
operating businesses.\149\ Six provide CCP services and one provides
CSD services.\150\ NSCC, FICC, and DTC are all registered clearing
agencies that are DTCC subsidiaries. Together they offer clearance and
settlement services for equities, corporate and municipal bonds,
government and mortgage-backed securities, derivatives, money market
instruments, syndicated loans, mutual funds, and alternative investment
products in the United States. ICC and ICEEU are both registered
clearing agencies for credit default swaps (``CDS''), and are both
subsidiaries of Intercontinental Exchange, Inc. (``ICE''). LCH SA, a
France-based subsidiary of LCH Group Holdings Ltd, is a registered
clearing agency that also offers clearing for CDS. The seventh
registered clearing agency, OCC, offers clearing services for exchange-
traded U.S. equity options.
---------------------------------------------------------------------------
\149\ There are two registered but inactive clearing agencies:
BSECC and SCCP. Neither has provided clearing services in well over
a decade. See Exchange Act Release No. 63629 (Jan. 3, 2011) (BSECC
``returned all clearing funds to its members by September 30, 2010,
and [] no longer maintains clearing members or has any other
clearing operations as of that date. [] BSECC [] maintain[s] its
registration as a clearing agency with the Commission for possible
active operations in the future.''); Exchange Act Release No. 63268
(Nov. 8, 2010) (``SCCP ``returned all clearing fund deposits by
September 30, 2009; [and] as of that date SCCP no longer maintains
clearing members or has any other clearing operations. [] SCCP []
maintain[s] its registration as a clearing agency for possible
active operations in the future.''). Because they do not provide
clearing services, BSECC and SCCP are not included in the economic
baseline or the consideration of benefits and costs. They are
included in the PRA for purposes of the PRA estimate, see infra at
Section V.
\150\ See supra note 17 (summarizing typical CCP services) and
note 18 (summarizing typical CSD services).
---------------------------------------------------------------------------
Registered clearing agencies broadly operate under one of two
models. Specifically, the clearing agency may be organized so that the
participants are owners of the clearing agency,\151\ or so that
participants are not owners of the clearing agency.\152\
---------------------------------------------------------------------------
\151\ See supra note 32 (explaining the ownership structure of
DTCC and its subsidiary clearing agencies).
\152\ OCC is owned by certain options exchanges. ICC and ICEEU
are both subsidiaries of ICE, which is listed on the New York Stock
Exchange. LCH SA is a subsidiary of LCH Group Holdings, Ltd., which
is majority-owned by London Stock Exchange Group plc (a publicly
traded company).
---------------------------------------------------------------------------
Registered clearing agencies currently feature specialization and
limited competition. For example, there is only one registered clearing
agency serving as a central counterparty for each of the following
asset classes: Exchange-traded equity options (OCC), government
securities (FICC), mortgage-backed securities (FICC), and equity
securities (NSCC). There is also only one registered clearing agency
providing central securities depository services (DTC). Registered
clearing agency activities exhibit high barriers to entry and economies
of scale. These features of the existing market, and the resulting
concentration of clearing and settlement services within a handful of
entities, informs the Commission's examination of the effects of the
proposed rules on competition, efficiency, and capital formation, as
discussed below. Table 1 summarizes the most recent data on the number
of participants at each registered clearing agency.\153\
---------------------------------------------------------------------------
\153\ Participant statistics are taken from the websites of each
of the listed clearing agencies as of August 2021, September 2021,
or October 2021. See DTCC, NSCC Member Directories, http://www.dtcc.com/client-center/nscc-directories; DTCC, DTC Member
Directories, http://www.dtcc.com/client-center/dtc-directories;
DTCC, FICC-GOV Member Directories, http://www.dtcc.com/client-center/ficc-gov-directories; DTCC, FICC-MBS Member Directories,
http://www.dtcc.com/client-center/ficc-mbs-directories; ICE, ICE
Clear Credit Participants, https://www.theice.com/clear-credit/participants; ICE, ICE Clear Europe Membership, https://www.theice.com/clear-europe/membership; LCH, LCH SA Membership,
https://www.lch.com/membership/member-search; OCC, Member Directory,
http://www.theocc.com/Company-Information/Member-Directory.
Table 1--Number of Participants at Registered Clearing Agencies
------------------------------------------------------------------------
Number of
Registered clearing agency participants
------------------------------------------------------------------------
Subsidiaries of The Depository Trust & Clearing
Corporation
National Securities Clearing Corporation.............. 3,532
The Depository Trust Company.......................... 841
Fixed Income Clearing Corporation (Government 204
Securities Division).................................
Fixed Income Clearing Corporation (Mortgage Backed 140
Securities Division).................................
Subsidiaries of Intercontinental Exchange
ICE Clear Credit...................................... 29
ICE Clear Europe (CDS Participants Only).............. 30
Subsidiaries of LCH
LCH SA (CDSClear Participants Only)................... 25
The Options Clearing Corporation........................ 184
------------------------------------------------------------------------
[[Page 51841]]
Registered clearing agencies have become an essential part of the
infrastructure of the U.S. securities markets due to their role as
intermediaries.\154\ Many securities transactions are centrally cleared
by clearing agencies. For example, in 2021 approximately $1.1 trillion
(65%) of the notional amount of all single-name CDS transactions in the
United States were centrally cleared.\155\ In addition, in 2021 DTCC
processed $2.4 quadrillion in securities transactions, and OCC cleared
9.9 billion individual options contracts.\156\
---------------------------------------------------------------------------
\154\ See supra Part I.
\155\ Data from DTCC's Trade Information Warehouse, compiled by
Commission staff.
\156\ See OCC, Annual Report (2021), https://annualreport.theocc.com; DTCC, Annual Report (2021), https://
www.dtcc.com/~/media/files/downloads/about/annual-reports/DTCC-2021-
Annual-Report. Within DTCC, NSCC cleared $2.0 trillion of equity
trades every day on average, FICC cleared a total of $1.4
quadrillion of government securities transactions and $69 trillion
of agency mortgage-backed securities transactions, and DTC settled a
total of $152 trillion of securities.
---------------------------------------------------------------------------
Central clearing generally benefits the markets in which it is
available through significantly reducing participants' counterparty
risk and through more efficient netting of margin. Consequently,
central clearing also benefits the financial system as a whole by
increasing financial resilience and the ability to monitor and manage
risk.\157\ Notwithstanding the benefits, central clearing concentrates
risk in the clearing agency.\158\ Disruption to a clearing agency's
operations, or failure on the part of a clearing agency to meet its
obligations, could serve as a source of contagion, resulting in
significant costs not only to the clearing agency itself or its
participants but also to other market participants and the broader U.S.
financial system.\159\ As a result, proper management of the risks
associated with central clearing helps ensure the stability of the U.S.
securities markets and the broader U.S. financial system.\160\
---------------------------------------------------------------------------
\157\ See Darrell Duffie, Still the World's Safe Haven?
Redesigning the U.S. Treasury Market After the COVID-19 Crisis,
Hutchins Center Working Paper No. 62 (June 2020), at 15, https://www.brookings.edu/wp-content/uploads/2020/05/wp62_duffie_v2.pdf
(``Central clearing increases the transparency of settlement risk to
regulators and market participants, and in particular allows the CCP
to identify concentrated positions and crowded trades, adjusting
margin requirements accordingly. Central clearing also improves
market safety by lowering exposure to settlement failures. . . . As
depicted, settlement failures rose less in March [2020] for [U.S.
Treasury] trades that were centrally cleared by FICC than for all
trades involving primary dealers. A possible explanation is that
central clearing reduces `daisy-chain' failures, which occur when
firm A fails to deliver a security to firm B, causing firm B to fail
to firm C, and so on.'').
\158\ See generally Albert J. Menkveld & Guillaume Vuillemey,
The Economics of Central Clearing, 13 Ann. Rev. Fin. Econ. 153
(2021).
\159\ See generally Dietrich Domanski, Leonardo Gambacorta &
Cristina Picillo, Central Clearing: Trends and Current Issues, BIS
Q. Rev. (Dec. 2015), 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, Fed. Res. Bank N.Y. Staff
Rep. No. 424, at 9 (Mar. 2010), 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 agency participants, and
therefore to occur during a period of extreme market fragility.'');
Craig Pirrong, The Inefficiency of Clearing Mandates, Policy
Analysis No. 655, at 11-14, 16-17, 24-26 (July 2010), http://www.cato.org/pubs/pas/PA665.pdf (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
under stress in the past, including in connection with the 1987
market break); Hubbard supra note 57, at 96 (``In short, the
systemic consequences from a failure of a major CCP, or worse,
multiple CCPs, would be severe. Pervasive reforms of derivatives
markets following 2008 are, in effect, unfinished business; the
systemic risk of CCPs has been exacerbated and left unaddressed.'');
Froukelien Wendt, Central Counterparties: Addressing their Too
Important to Fail Nature, IMF Working Paper No. 15/21 (Jan. 2015),
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, IMF Working Paper No. 11/66 (Mar. 2011), at 5-11, 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).
\160\ See Paolo Saguato, Financial Regulation, Corporate
Governance, and the Hidden Costs of Clearinghouses, 82 Ohio St. L.J.
1071, 1074-75 (2022), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3269060 (``[T]he decision to centralize risk
in clearinghouses made them critical for the stability of the
financial system, to the point that they are considered not only
too-big-to-fail, but also too-important-to-fail institutions.'').
---------------------------------------------------------------------------
2. Overview of the Existing Regulatory Framework
The existing regulatory framework for clearing agencies registered
with the Commission includes Section 17A of the Exchange Act and the
Dodd-Frank Act, and the related rules adopted by the Commission. The
current regulatory system is discussed in Parts I, II and III of this
proposal.
The Commission is aware that clearing agencies registered in the
U.S. may also be subject to other domestic or foreign regulators.
Specifically, clearing agencies operating in the U.S. may also be
subject to regulation by the CFTC (as clearing agencies for futures or
swaps) and the Board of Governors of the Federal Reserve System (as
systemically important financial market utilities or state member
banks).\161\ In addition, clearing agencies operating in the U.S. may
be subject to foreign clearing agency regulators. For example, LCH SA
is regulated by l'Autorit[eacute] des march[eacute]s financiers,
l'Autorit[eacute] de Contr[ocirc]le Prudentiel et de R[eacute]solution,
and the Banque de France, and is subject to EMIR.\162\ ICEEU is
regulated by the Bank of England and is subject to EMIR.\163\
---------------------------------------------------------------------------
\161\ Currently, ICC, ICEEU, LCH SA, and OCC are regulated by
the CFTC. DTC, FICC, NSCC, ICC, and OCC have been designated
systemically important financial market utilities. DTC is also a
state member bank of the Federal Reserve System.
\162\ See LCH, Company Structure, https://www.lch.com/about-us/structure-and-governance/company-structure.
\163\ See ICE, ICEEU Regulation, https://www.theice.com/clear-europe/regulation.
---------------------------------------------------------------------------
The Commission also considers relevant international standards when
engaged in rulemaking for clearing agencies. For example, in 2012, the
Committee on Payments and Market Infrastructure (CPMI) and the
International Organization of Securities Commissions (IOSCO) issued the
PFMI, a set of international standards for financial market
infrastructures.\164\ In connection with rulemaking required by Section
805(a)(2)(A) of the Clearing Supervision Act, 12 U.S.C. 5464(a)(2)(A),
the Commission considered the principles and responsibilities in the
PFMI when adopting Rule 17Ad-22(e).\165\
---------------------------------------------------------------------------
\164\ See PFMI, supra note 4.
\165\ CCA Standards Adopting Release, supra note 13, at 70789,
70796-97. A CPMI-IOSCO assessment report also has assessed that the
Commission's rules are consistent with the PFMI principles. See
CPMI-IOSCO, Implementation monitoring of PFMI: Assessment report for
the United States--Payment systems, central securities depositories
and securities settlement systems (May 31, 2019), at 2, https://www.bis.org/cpmi/publ/d184.pdf (presenting the conclusions drawn by
the CPMI and IOSCO from a Level 2 assessment).
---------------------------------------------------------------------------
Table 2 summarizes the board composition and independent director
requirements of the CFTC, the Board of Governors of the Federal Reserve
System, and EMIR, as well as the related principle in the PFMI.
[[Page 51842]]
Table 2--Board Composition and Independent Director Requirements of
CFTC, Board of Governors, EMIR, and CPMI-IOSCO (PFMI)
------------------------------------------------------------------------
Board composition and independence
Organization requirements
------------------------------------------------------------------------
CFTC......................... ``A derivatives clearing organization
shall ensure that the composition of the
governing board or board-level committee
of the derivatives clearing organization
includes market participants and
individuals who are not executives,
officers, or employees of the
derivatives clearing organization or an
affiliate thereof.'' (17 CFR 39.26).
Board of Governors of the `` . . . the designated financial market
Federal Reserve System. utility has governance arrangements that
are designed to ensure . . . [t]he board
of directors includes a majority of
individuals who are not executives,
officers, or employees of the designated
financial market utility or an affiliate
of the designated financial market
utility'' (12 CFR 234.3(a)(2)(iv)(D)).
European Market ``A CCP shall have a board. At least one
Infrastructure Regulation third, but no less than two, of the
(EMIR). members of that board shall be
independent. Representatives of the
clients of clearing members shall be
invited to board meetings for matters
relevant to Articles 38 and 39. The
compensation of the independent and
other non-executive members of the board
shall not be linked to the business
performance of the CCP'' (Regulation
(EU) No 648/2012 of the European
Parliament and of the Council of 4 July
2012, Title IV, Article 27).
`` `independent member' of the board
means a member of the board who has no
business, family or other relationship
that raises a conflict of interests
regarding the CCP concerned or its
controlling shareholders, its management
or its clearing members, and who has had
no such relationship during the five
years preceding his membership of the
board'' (Regulation (EU) No 648/2012 of
the European Parliament and of the
Council of 4 July 2012, Title I, Article
2(28)).
CPMI-IOSCO................... ``[Board] members should be able to
exercise objective and independent
judgment. Independence from the views of
management typically requires the
inclusion of non-executive board
members, including independent board
members, as appropriate. Definitions of
an independent board member vary and
often are determined by local laws and
regulations, but the key characteristic
of independence is the ability to
exercise objective, independent judgment
after fair consideration of all relevant
information and views and without undue
influence from executives or from
inappropriate external parties or
interests. The precise definition of
independence used by an F[inancial]
M[arket] I[nfrastructure (FMI)] should
be specified and publicly disclosed, and
should exclude parties with significant
business relationships with the FMI,
cross-directorships, or controlling
shareholdings, as well as employees of
the organization'' (PFMI, Sec. 3.2.10,
footnotes omitted).
------------------------------------------------------------------------
In addition to Federal regulation, as noted earlier, clearing
agencies must also follow state laws applicable to their choice of
organization, such as limited liability companies, corporations, or
trusts.\166\
---------------------------------------------------------------------------
\166\ For example, ``The New York State Department of Financial
Services supervises DTC as a New York State-chartered trust
company.'' See Board of Governors of the Federal Reserve System,
Designated Financial Market Utilities. https://www.federalreserve.gov/paymentsystems/designated_fmu_about.htm. The
OCC is a Delaware corporation. See OCC, Certificate of
Incorporation, https://www.theocc.com/Company-Information/Documents-and-Archives/OCC-Certificate-of-Incorporation.
---------------------------------------------------------------------------
3. Divergent Incentives of Clearing Agency Stakeholders
Several researchers have commented that the misalignment of
interests between clearing agency stakeholders (owners and non-owner
participants, for example) weakens the effectiveness of clearing
agencies' risk management under the existing regulatory framework.\167\
Less effective risk management, in turn, impedes the resilience of
individual clearing agencies, the clearing services market, and the
broader financial markets, as well as competition among participants.
However, academic literature has not coalesced around a standard model
describing clearing agency governance, leaving some uncertainty about
the theoretically best way to mitigate divergent incentives.\168\
---------------------------------------------------------------------------
\167\ See Saguato, supra note 160, at 5, 13 (stating that
``effective risk management in financial institutions can be
achieved only if the final risk bearers have a voice in the
governance of the firm'' and that ``the existing regulatory
framework underestimates and does not address the misaligned
incentives that spill from the agency costs of the separation of
risk and control and from the member-shareholder divide . . .'');
Hester Peirce, Derivatives Clearinghouses: Clearing the Way to
Failure, 64 Clev. St. L. Rev. 589 (2016), https://engagedscholarship.csuohio.edu/cgi/viewcontent.cgi?article=3915&context=clevstlrev (arguing that
clearing members must play a central role in risk management); Craig
Pirrong, The Economics of Central Clearing: Theory and Practice,
ISDA Discussion Papers Series No. 1 (May 2011), at 3, https://www.isda.org/a/yiEDE/isdadiscussion-ccp-pirrong.pdf (``CCPs should
be organized so as to align the control of risks with those who bear
the consequences of risk management decisions.'').
\168\ See Menkveld & Vuillemey, supra note 158, at 21 (``While
the literature on central clearing has made significant progress
over the past ten years, a number of important questions remain
open. On the theoretical front, there is still no standard model of
. . . [CCP] governance.'').
---------------------------------------------------------------------------
As discussed more fully below, the Commission is aware of divergent
incentives at some clearing agencies between clearing agency owners and
non-owner participants, and the importance of actively addressing these
divergent incentives through proactive measures to achieve sound
governance and resilience. In the 2020 Staff Report on the Regulation
of Clearing Agencies, Commission staff emphasized that ``robust written
rules, policies, and procedures are important to clearing agency
functioning, but represent only the first step in achieving resilience
and compliance. To achieve real-life outcomes that help promote
resilience and compliance, rules, policies, and procedures must be . .
. subject to sound governance that ensures they will be executed
promptly and effectively.'' \169\
---------------------------------------------------------------------------
\169\ Staff Report on Clearing Agencies, supra note 27, at 25.
---------------------------------------------------------------------------
(a) Divergent Incentives of Owners vs. Non-Owner Participants
Because clearing agencies mutualize risk among participants but not
all participants necessarily hold an equity interest in the clearing
agencies,\170\ the incentives of clearing agency owners can differ from
the incentives of clearing agency participants.\171\ For example,
owners have an incentive to transfer as much risk of loss as possible
to non-owner participants or to lower risk management standards.\172\
In such
[[Page 51843]]
cases, the owners benefit by receiving higher profits or tying up less
capital in their investment while participants are left with greater
potential losses in the event of a counterparty default or non-default
loss and potentially higher margin and default fund requirements.
---------------------------------------------------------------------------
\170\ For example, OCC, ICC, ICEEU, and LCH SA are not owned by
participants.
\171\ See Saguato, supra note 160, at 1099 (``This new agency
conflict that stems from the separation of risk and control and from
the `member-shareholder divide' misaligns the incentives of the
clearinghouse from those of its members . . .''). This specific
agency conflict is less of a concern in cases where clearing agency
participants own shares of the clearing agency, because there is
less separation of risk and control. For example, DTC, NSCC, and
FICC operate under a utility model, where the participants own
shares of the parent company, DTCC.
\172\ See Menkveld & Vuillemey, supra note 158, at 20 (noting
that because participants are a ``captive clientele,'' clearing
agencies could be incentivized to relax risk management standards);
Saguato, supra note 160, at 1099, 1102. However, it is possible that
a captive clientele could also incentivize a clearing agency to
increase its risk management standards if there is participant
representation in the governance structure.
---------------------------------------------------------------------------
(b) Divergent Incentives Among Participants
In addition, different types of participants (direct vs indirect
participants or large vs small participants, for example) have
divergent incentives. For example, large direct participants have
incentives to influence the clearing agency to adopt policies that
would exclude smaller dealers from participating directly in the
clearing agency.\173\ Because there is only one registered clearing
agency serving as a central counterparty for some asset classes, such
policies could negatively affect competition among clearing agency
participants. The diverging incentives of large direct participants
compared to smaller indirect participants are mitigated by Rule 17Ad-
22, which in part generally requires a clearing agency to admit
participants who meet minimum standards.\174\
---------------------------------------------------------------------------
\173\ See Kristin N. Johnson, Commentary on the Abraham L.
Pomerantz Lecture: Clearinghouse Governance: Moving Beyond Cosmetic
Reform, 77 Brook. L. Rev. 2, 698 (2012), https://brooklynworks.brooklaw.edu/blr/vol77/iss2/5 (``Large dealers have
incentives to limit smaller dealers' access to clearinghouse
membership. When large dealers act as brokers for the smaller
nonmember dealers, the larger dealers earn revenues for executing
transactions for dealers who are nonmembers and ineligible for
membership. If eligibility standards preclude smaller dealers from
gaining the full benefits of membership, then small dealers who
desire to execute transactions must seek the assistance of the
larger dealers who are members. Thus, large dealers have commercial
incentives to ensure that smaller dealers remain ineligible for
membership.''); Sean Griffith, Governing Systemic Risk: Towards a
Governance Structure for Derivatives Clearinghouses, 61 Emory L. J.
1153, 1197 (2012), https://scholarlycommons.law.emory.edu/elj/vol61/iss5/3 (``The major dealers may also use their influence over
clearinghouses to protect [their] trading profits, using the
clearinghouse as a means of increasing their market share and
excluding competitors.'').
\174\ See 17 CFR 240.17Ad-22(b)(5)-(b)(7) and (e)(18).
---------------------------------------------------------------------------
Large participants also have incentives to influence the clearing
agency to adopt policies that could allocate a disproportionately large
risk of loss to smaller participants by allowing the large participant
to contribute lower quality collateral to satisfy margin or default
fund requirements or by promoting margin requirements that are not
commensurate with the risks and particular attributes of each
participant's specific products, portfolio, and market. The diverging
incentives of large participants compared to smaller direct
participants are also mitigated by Rule 17Ad-22, which in part
generally requires a clearing agency to establish minimum margin and
liquidity requirements.\175\ By establishing minimum margin and
liquidity requirements, Rule 17Ad-22 reduces a large participant's
ability to obtain or maintain a competitive advantage through
activities such as providing lower quality collateral or promoting
margin requirements that are not commensurate with the risks and
particular attributes of each participant's specific products,
portfolio, and market.
---------------------------------------------------------------------------
\175\ See 17 CFR 240.17Ad-22(e)(5)-(e)(6).
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(c) Incentives of Clearing Agency Stakeholders Could Diverge From the
Interest of the Broader Financial Markets
Clearing agency stakeholders, such as owners and direct and
indirect participants, also have incentives that may not be in
alignment with the interests of the broader financial markets.\176\ Any
such misalignment, if left unmitigated, could limit the benefits of
central clearing and hinder the resilience of other financial market
intermediaries and the broader financial market.\177\ For example, in
securities markets where all or part of a transaction may not be
subject to a central clearing requirement, a single participant or a
small group of participants may have a profit incentive to select bi-
lateral clearing over central clearing \178\ or seek to influence a
clearing agency to not clear a security that would profit the
participants more if the security were cleared bi-laterally. Not only
could such incentives limit the benefits of central clearing, but they
could also impede resilience in the broader financial market by
increasing systemic risk.\179\ In addition, indirect participants that
are not permitted to directly access clearing services have incentives
to ``avoid clearing and seek higher-margin trading activity through
faux customization.'' \180\ This, too, could hinder resilience in the
broader financial market by increasing systemic risk. Lastly, as
pointed out in a BIS and IOSCO report, ``. . . an FMI and its
participants may generate significant negative externalities for the
entire financial system and real economy if they do not adequately
manage their risks.'' \181\ To the extent these negative externalities
are not adequately internalized by the clearing agency or otherwise
mitigated, they could present systemic risks to the broader financial
markets.\182\
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\176\ Cf. Bank of England, The Bank of England's supervision of
financial market infrastructures--Annual Report (Mar. 2015), at
Chapter 2.1.4 (``Strong user and independent representation in [UK
CCPs] governance structures should help ensure that UK CCPs focus
not only on the management of microprudential risks to themselves
but also on systemic risks.'').
\177\ See Griffith, supra note 173, at 1210 (``[T]he containment
of systemic risk [is] a public good. . . . Because no private party
can enjoy the full benefit of eliminating systemic risk, no private
party has an incentive to fully internalize the cost of doing so. As
a result, no private party can simply be entrusted with the means of
doing so because it is more likely to use those means to some other
ends. . . . In other words, none of the commercial parties has the
right incentives.'').
\178\ Cf. Treasury Market Practices Group (TMPG), Best Practice
Guidance on Clearing and Settlement, at 3 (July 2019), https://www.newyorkfed.org/medialibrary/Microsites/tmpg/files/CS_BestPractices_071119.pdf (in commenting on the ``potential role
for expanded central clearing'' in the secondary U.S. Treasuries
market, the TMPG noted that ``changes to market structure that have
occurred have also resulted in a substantial increase, in both
absolute and percentage terms, in the number of trades that clear
bilaterally rather than through a central counterparty. This
principally stems from the increased prevalence of P[rincipal]
T[rading] F[irm] activity on I[nter]D[ealer ]B[roker] platforms.'').
\179\ See Griffith, supra note 173, at 1197 (``[D]ealers have a
clear incentive to protect the profits they receive from the
bilateral market . . . by keeping trades off of clearinghouses.
Keeping trades off of clearinghouses has obvious systemic risk
implications: a clearinghouse cannot contain the risk of trades that
it does not clear.''). Though bi-lateral clearing serves a well-
defined function in eliminating basis risk and allowing for more
precise hedging, its benefits in terms of systemic risk mitigation
are more limited relative to centralized clearing.
\180\ See Griffith, supra note 173, at 1200.
\181\ See PFMI, supra note 4, at 11.
\182\ Cf. id. at 128 (Noting that regulators have a role in
addressing negative externalities. ``[R]egulation, supervision, and
oversight of an FMI are needed to . . . address negative
externalities that can be associated with the FMI, and to foster
financial stability generally.''); Menkveld & Vuillemey, supra note
158, at 22 (``Network externalities create a role for regulators to
coordinate investors on a socially desirable equilibrium.'').
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4. Current Governance Practices
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.
An overview of current practices at the seven operating clearing
agencies is set forth below and includes discussion of clearing agency
boards' policies and procedures related to the composition of the board
and board committees,
[[Page 51844]]
conflicts of interests involving directors and senior managers, the
obligations of the board regarding overseeing relationships with
service providers for critical services, and consideration of
stakeholders' views. This discussion is based on the Commission's
general understanding of current practices as of the date of this
proposal and reflects the Commission's experience supervising
registered clearing agencies.
(a) Current Practices Regarding Board Composition
Each registered clearing agency has a board that governs its
operations and supervises senior management. Section 17A(b)(3)(C) of
the Exchange Act prohibits a clearing agency from registering unless
the Commission finds that ``the rules of the clearing agency assure a
fair representation of its shareholders (or members) and participants
in the selection of its directors and administration of its affairs.
(The Commission may determine that the representation of participants
is fair if they are afforded a reasonable opportunity to acquire voting
stock of the clearing agency, directly or indirectly, in reasonable
proportion to their use of such clearing agency.).'' \183\ In addition,
Rule 17Ad-22(e)(2) requires governance arrangements that support the
objectives of owners and participants and consider the interests of
other relevant stakeholders.
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\183\ 15 U.S.C. 78q-1(b)(3)(C).
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(1) Independent Directors
Clearing agencies currently use various definitions of independence
and independent director. In addition, current practices vary widely
regarding the board and board committee requirements for independent
directors (as the term is currently used by clearing agencies). For
example, clearing agencies' existing requirements for the minimum
percentage of independent directors on the board ranges from 0% to 55%.
Table 3 summarizes the general board composition and independent
director requirements of each operating clearing agency.
Table 3--Board Composition and Independent Director Requirements of Operating Clearing Agencies
----------------------------------------------------------------------------------------------------------------
Clearing agency Board composition requirements Definition of independent director
----------------------------------------------------------------------------------------------------------------
DTC, FICC, and NSCC (all use the 22 directors: 1 non-executive Chair, Independent director is not defined.
same board as DTCC). 1 DTCC executive (DTCC's Pres. & Independence is listed as one of a
CEO), 14 participant-owner number of ``characteristics
directors, 4 non-participant essential for effectiveness as a
directors, 1 director designated by Board member.'' (See DTCC Board
DTCC preferred stock shareholder Election Procedures.\a\)
ICE, 1 director designated by DTCC
preferred stock shareholder FINRA.
(See https://www.dtcc.com/about/leadership leadership.).
OCC................................ 20 directors: 1 management director A public director ``lacks material
(Chair), 5 public directors, 9 relationships to OCC, OCC's senior
participant directors, 5 exchange management, and other directors''
directors. (See https:// and is ``not affiliated with any
www.theocc.com/Company-Information/ national securities exchange or
Board-of-Directors; OCC Board national securities association or
Charter.\b\). with any broker or dealer in
securities.'' (OCC Board Charter at
4, 6).
..................................... ``A substantial portion of directors
shall be `independent' of OCC and
OCC's management as defined by
applicable regulatory requirements
and the judgment of the Board.''
(OCC Board Charter at 4-5).
ICE Clear Credit................... 9 directors (a/k/a Board of An independent director must satisfy
Managers): at least 5 independent the independence requirements in
directors and 2 management directors. the NYSE Listed Company Manual.\d\
An independent director also may
not (among other things):
5 directors elected by ICE US Holding ``have any material
Company L.P. (3 of 5 are independent relationships with the Company and
and the remaining 2 are from ICE its subsidiaries.''
management). The Risk Committee
designates four nominees (two must
be independent and two may be non-
independent). (See ICC Regulation
and Governance Fact Sheet \c\ at 2.).
..................................... be affiliated with a Member
Organization or, within the last
year, (a) be employed by a Member
Organization, (b) have an immediate
family member who was an executive
officer of a Member Organization,
or (c) have received from any
Member Organization more than
$100,000 per year in direct
compensation. (See ICC Independence
Policy.\e\)
ICE Clear Europe................... 6 to 12 directors (currently 10): at Independent director ``means a
least \1/3\ independent directors person who meets the independence
(excluding the Chair), 1 director criteria for a director, as defined
approved by the Bank of England, and under relevant applicable
the president of ICEEU. (See ICEEU legislation and who is appointed as
Organizational Structure Disclosure a non-executive director'' (ICEEU
\f\ at 1; ICEEU Articles of Articles of Association at
Association \g\ at paragraph 26.). paragraph 3).
LCH SA............................. 3 to 18 directors (currently 11 with Independent director ``means an
5 independent): ``the board shall be independent director, who satisfies
composed of the following categories applicable Regulatory Requirements
of Directors:'' an independent regarding independent directors and
Chair, independent directors, who is appointed in accordance with
executive directors, a director the Nomination Committee terms of
proposed by Euronext, user reference'' (LCH SA Terms of
directors, and a director Reference of the Board at 2).
representing London Stock Exchange
Group plc. (See https://www.lch.com/about-us/structure-and-governance/board-directors-0; LCH SA Terms of
Reference of the Board \h\ at 4-5.).
----------------------------------------------------------------------------------------------------------------
a. DTCC, Procedure for the Annual Nomination and Election of the Board of Directors (Feb. 11, 2021), (``DTCC
Nomination and Election Procedure''), https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/DTCC-BOD-Election-Procedure.pdf.
[[Page 51845]]
b. OCC, Board of Directors Charter and Corporate Governance Principles (Sept. 22, 2021), https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf.
c. ICE, ICC Regulation and Governance Fact Sheet, https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf.
d. See Section 303.A.02 of the NYSE Listed Company Manual, https://nyseguide.srorules.com/listed-company-manual
(``No director qualifies as `independent' unless the board of directors affirmatively determines that the
director has no material relationship with the listed company (either directly or as a partner, shareholder or
officer of an organization that has a relationship with the company).'' The independence requirements also
list five situations that would preclude a director from being considered independent).
e. ICE, Independence Policy of the Board of Directors of Intercontinental Exchange, Inc., https://s2.q4cdn.com/154085107/files/doc_downloads/governance_docs/ICE-Independence-Policy.pdf.
f. ICE, ICEEU Organizational Structure, Objectives and Strategy, https://www.theice.com/publicdocs/clear_europe/Organisational_Structure_Objectives_Strategy.pdf.
g. ICE, Articles of Association of ICEEU (Jan. 29, 2021), https://www.theice.com/publicdocs/regulatory_filings/ICEEU-2021-013.pdf.
h. LCH SA, Terms of Reference of the Board (Aug. 18, 2020), https://www.lch.com/system/files/media_root/LCHSA_Governance%20Arrangements_CFTC%20Self-Certif_18%20Aug%202020.pdf.
(2) Nominating Committee
Six of the seven operating clearing agency boards have a nominating
committee or a committee that serves a similar function. Current
practices regarding the minimum level of independent directors on the
nominating committee vary widely. For example, DTC, NSCC, and FICC
require that the nominating committee be composed entirely of ``non-
management'' directors; ICEEU requires that a majority of the
nominating committee be independent directors (as defined by ICEEU);
LCH SA requires that its nomination committee include an independent
chair, at least two independent directors (as defined by LCH SA), and
one user director; and OCC requires only that the chairman of the
nominating committee be a ``public director.'' \184\ As stated
previously, the definition of independent director varies across
clearing agencies.\185\
---------------------------------------------------------------------------
\184\ See DTCC Governance Committee Charter 1 (Feb. 2020),
https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/DTCC-BOD-Governance-Committee-Charter.pdf (``All members
of the Committee shall be members of the Board who are not employed
by DTCC (`non-management' directors).''); ICEEU Compliance with PFMI
17 (Jan. 31, 2021), https://www.theice.com/publicdocs/clear_europe/ICE_Clear_Europe_Disclosure_Framework.pdf (``[T]he Nominations and
Compensation Committee may consist of up to five Committee Members
the majority of which must be [Independent Non-Executive
Directors].''); LCH SA Terms of Reference of the Nomination
Committee of the Board of Directors (Sept. 9, 2020), https://www.lch.com/system/files/media_root/LCH%20SA%20-%20NomCom%20ToRs.pdf
(``[The] membership shall comprise the Chairman, at least two
Independent Directors, one User Director and the LSEG Director. The
size of the Committee . . . for the current time, will comprise four
to six directors.''); OCC Governance and Nominating Committee
Charter 1 (Sept. 22, 2021), https://www.theocc.com/getmedia/483ac739-0d43-46d2-a1ca-7ed38094975c/governance_nominating_charter.pdf (``The Committee will be composed
of at least one Public Director, one Exchange Director, and one
Member Director. No Management Director will be a member of the
Committee . . . . The Committee Chair will be designated by the
Board from among the Public Director Committee members.'').
\185\ See supra Table 3 and accompanying text.
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All seven boards have fitness standards for directors and processes
for identifying and selecting directors. The fitness standards and
processes for identifying and selecting directors vary across clearing
agencies. For example, OCC's nominating committee is required to
``identify, screen and review individuals qualified to be elected or
appointed [to the Board] after consultation with the Chairman,'' \186\
whereas DTCC's governance committee, which serves as the nominating
committee for DTC, NSCC, and FICC, is not required to consult with the
chairman. Instead, DTCC's governance committee ``considers possible
nominations on its own initiative and invites suggestions from all
participants of each of DTCC's clearing and depository subsidiaries . .
. . The Governance Committee may also use a professional director
search consultant to assist in identifying candidates for the non-
participant Board positions.'' \187\
---------------------------------------------------------------------------
\186\ OCC Governance and Nominating Committee Charter, supra
note 184, at 3.
\187\ DTCC, Procedure for the Annual Nomination and Election of
the Board of Directors (Feb. 11, 2021), at 2, https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/DTCC-BOD-Election-Procedure.pdf.
---------------------------------------------------------------------------
(3) Risk Management Committee
The Commission already requires that all seven operating clearing
agencies have risk management committees, because they are covered
clearing agencies.\188\ All seven clearing agencies include
representatives from participants on the risk management committee,
though only four clearing agencies require it.\189\ Six of the seven
operating clearing agencies identify the risk management committee as a
board committee.\190\ Three of the seven operating clearing agencies
require the risk management committee to be reconstituted on a regular
basis.\191\
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\188\ Covered clearing agencies are required to have risk
management committees to comply with 17 CFR 240.17Ad-22(e)(3)(iv).
\189\ OCC, ICC, ICEEU, and LCH SA each require that the risk
committee include representatives from participants. Article 28 of
EMIR requires that a clearing agency have a risk committee that
includes representatives of its clearing members. See EMIR, supra
note 105, at art. 28(1).
\190\ DTC, NSC, FICC, OCC, ICEEU, and LCH SA.
\191\ OCC, ICC, and LCH SA require that the committee be
reconstituted annually.
---------------------------------------------------------------------------
(b) Current Practices Regarding Conflicts of Interest Involving
Directors or Senior Managers
The boards of all seven operating clearing agencies have policies
and procedures in place to identify and mitigate conflicts of interests
involving directors or senior managers. All seven boards also require
directors to notify the clearing agency if a conflict of interest
arises.
(c) Current Practices Regarding Board Oversight of Relationships With
Service Providers for Critical Services
The Commission already requires registered clearing agencies to
manage risks from operations,\192\ which can include risks associated
with relationships with service providers.\193\ The Commission is aware
that at least some clearing agencies periodically inform their boards
regarding risk management associated with service providers for
critical services.
---------------------------------------------------------------------------
\192\ See 17 CFR 240.17Ad-22(d)(4), (e)(17).
\193\ In addition, DTC, as a state member bank of the Federal
Reserve System, has received guidance from the Board of Governors of
the Federal Reserve System regarding managing service provider
risks. See SR Letter 13-19/CA Letter 13-21, Guidance on Managing
Outsourcing Risk (Dec. 5, 2013, rev. Feb. 26, 2021). The Board of
Governors of the Federal Reserve System, jointly with the Federal
Deposit Insurance Corporation and the Office of the Comptroller of
the Currency, proposed updated guidance for banking organizations in
2021 regarding the management of risks arising from third-party
relationships. See Board of Governors of the Federal Reserve System,
Federal Deposit Insurance Corporation, Office of the Comptroller of
the Currency, Proposed Interagency Guidance on Third-Party
Relationships: Risk Management, 86 FR 38182, 38193 (July 19, 2021).
The proposed guidance is not yet final.
---------------------------------------------------------------------------
The Commission also requires that SCI entities--including
registered clearing agencies--conduct risk assessments of ``SCI
systems'' at least once per year in accordance with Regulation SCI and
report the findings to senior management and the board of
[[Page 51846]]
directors.\194\ Insofar as service providers for critical services are
the providers of SCI systems, each registered clearing agency board
likely already has written policies and procedures reasonably designed
to enable the board of directors to oversee service providers for
critical services, including confirming that the risks related to
service provider relationships are managed in a manner consistent with
its risk management framework, reviewing senior management's monitoring
of relationships with service providers for critical services, and
confirming that senior management takes appropriate actions to remedy
significant deterioration in performance or address changing risks or
material issues identified through ongoing monitoring of service
providers for critical services.\195\
---------------------------------------------------------------------------
\194\ See 17 CFR 242.1000-1007.
\195\ See Regulation SCI Adopting Release, supra note 39, at
77276 (noting that ``The Commission agrees with the comment that an
SCI entity should be responsible for managing its relationship with
third parties operating systems on behalf of the SCI entity through
due diligence, contract terms, and monitoring of third party
performance. [. . .] The Commission believes that it would be
appropriate for an SCI entity to evaluate the challenges associated
with oversight of third-party vendors that provide or support its
applicable systems subject to Regulation SCI. If an SCI entity is
uncertain of its ability to manage a third-party relationship
(whether through due diligence, contract terms, monitoring, or other
methods) to satisfy the requirements of Regulation SCI, then it
would need to reassess its decision to outsource the applicable
system to such third party.'').
---------------------------------------------------------------------------
(d) Current Practices Regarding Board Consideration of Stakeholder
Viewpoints
Currently, each covered clearing agency is required to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide governance arrangements that consider
the interests of participants' customers, securities issuers and
holders, and other relevant stakeholders of the covered clearing
agency.\196\ The Commission understands that clearing agency boards
currently use both formal and informal channels to solicit, receive,
and consider the viewpoints of participants and other relevant
stakeholders.\197\ Clearing agency participants acknowledge that their
ability to offer viewpoints has yielded positive but mixed
results.\198\
---------------------------------------------------------------------------
\196\ See 17 CFR 240.17Ad-22(e)(2)(vi).
\197\ See, e.g., OCC, Order Approving Proposed Rule Change,
Exchange Act Release No. 88029 (Jan. 24, 2020), 85 FR 5500, 5508
(Jan. 30, 2020) (``OCC also describes the formal and informal
mechanisms that OCC employs to solicit feedback from Clearing
Members and other interested stakeholders, including its Financial
Risk Advisory Committee, Operations Roundtable, multiple letters and
open calls with Clearing Members and other interested stakeholders,
and routine in-person meetings with trade groups and individual
firms.''); Cf. J.P. Morgan et al., A Path Forward for CCP
Resilience, Recovery and Resolution (Mar. 10, 2020), https://www.jpmorgan.com/content/dam/jpm/cib/complex/content/news/a-path-forward-for-ccp-resilience-recovery-and-resolution/pdf-0.pdf
(``[C]learing participants have provided diverse perspectives and
detailed feedback to CCPs and regulators through individual firm and
industry association position papers, targeted comment letters, and
participation in regulatory and industry-sponsored forums on a
global scale.'').
\198\ See, e.g., J.P. Morgan et al., supra note 197, at 1
(explaining that ``[w]hile CCPs and the regulatory community have
taken significant steps to address the feedback received, there
remain outstanding issues that require additional attention'' and
recommending ``[e]nhancing governance practices to obtain and
address input from a broader array of market participants on
relevant risk issues'' to enhance CCP resilience).
---------------------------------------------------------------------------
C. Consideration of Benefits and Costs
The discussion below sets forth the potential economic effects
stemming from adopting the proposed rules, including the effects on
efficiency, competition, and capital formation.
The benefits and costs discussed in this section are relative to
the economic baseline discussed earlier, which includes clearing
agencies' current practices. In some instances, the proposed rules
reflect what we believe to be current practices at many registered
clearing agencies. To the extent that a clearing agency's current
practices could reasonably be considered to be in compliance with a
proposed rule, the clearing agency and broader market would have
already absorbed the benefits of the proposed rule and so might not
experience any direct benefits if the Commission adopts the rule.\199\
In these cases, the Commission believes that imposing these
requirements on all registered clearing agencies would have the effect
of imposing consistent governance standards across all registered
clearing agencies.
---------------------------------------------------------------------------
\199\ However, a clearing agency whose current practices could
reasonably be considered to be in compliance with the proposed rules
might still be required to expend resources if the Commission
adopted the rule, because the clearing agency would likely need to
review its policies and procedures in response to the adoption.
---------------------------------------------------------------------------
If adopted, many of the proposed rules could result in a clearing
agency needing to amend its bylaws, rulebook, or other governance
documents. Because clearing agencies are SROs, any such amendments that
constitute rule changes would be subject to Commission review pursuant
to Rule 19b-4. Adopting the proposed rules could also cause a clearing
agency to make different business decisions, such as capital
expenditure decisions, which would not be subject to the same
Commission review process.
It is uncertain to what extent the costs discussed in this section
would be borne by clearing agencies, as opposed to participants. For
clearing agencies owned by participants, all of the costs will
ultimately be passed on to participants because they are residual
beneficiaries of the clearing agency. For clearing agencies not owned
by participants, the level of pass through would depend upon a number
of factors, including the lack of competition among clearing agencies.
1. Economic Considerations for Rule Proposals Regarding Board
Composition
As discussed in more detail above, proposed Rules 17Ad-25(b), (e),
and (f) would (1) require that a majority of the board (or 34 percent,
if a majority of the voting rights are directly or indirectly held by
participants) be independent directors (as determined by the clearing
agency and precluding certain circumstances that impact independence),
(2) establish minimum independent director requirements for the
composition of certain board committees, and (3) identify circumstances
that would exclude a director from being an independent director.\200\
---------------------------------------------------------------------------
\200\ See supra Part III.A.1 (discussing proposed Rules 17Ad-
25(b), (e), and (f)).
---------------------------------------------------------------------------
To the extent an operating clearing agency could determine that its
current board meets the proposed minimum requirements for independent
directors on the board and board committees, adopting the proposed rule
will not directly affect the effectiveness of the clearing agency's
governance or directly affect the management of divergent interests
between owners and participants, among various types of participants,
and between clearing agency stakeholders and the broader financial
markets.
To the extent operating clearing agencies would need to change the
composition of their boards or board committees to meet the proposed
minimum requirements, the proposed rule could help promote more
effective governance by providing impartial perspectives and helping
mitigate the impact of the divergent interests between owners and
participants, among various types of participants, and between clearing
agency stakeholders and the broader financial markets. The Commission
believes that more effective governance will improve the effectiveness
of a clearing agency's risk management practices, which will promote
resilience at individual clearing agencies and in the broader
[[Page 51847]]
financial markets.\201\ For example, more effectively managing
divergent interests could help the clearing agency better internalize
the costs of participant defaults and non-default losses, which could
mitigate a clearing agency's incentive to underinvest in risk
management services such as liquidity arrangements and risk modelling.
The proposed rules could also help clearing agencies ensure that an
appropriate risk-based margin system is in place.
---------------------------------------------------------------------------
\201\ See Paolo Saguato, The Unfinished Business of Regulating
Clearinghouses, 2020 Colum. Bus. L. Rev. 449, 488 (2020), https://journals.library.columbia.edu/index.php/CBLR/article/view/7219/3838
(``The agency costs between clearinghouses' shareholders and members
(the former participating in the profits of the business, and the
latter bearing its final costs) increase the moral hazard of these
institutions and threaten clearinghouses' systemic resilience.'');
Saguato, supra note 160.
---------------------------------------------------------------------------
The Commission also believes that better managing the divergent
interests could improve the ability of indirect participants to compete
with direct participants of the clearing agency. Given that the cleared
derivatives market is an imperfect substitute for uncleared
derivatives, some commentators argue that large dealers may have an
incentive to protect economic rents and therefore may urge boards to
adopt policies that restrict the classes or volume of transactions that
may use clearinghouse platforms.\202\
---------------------------------------------------------------------------
\202\ See Johnson, supra note 173, at 698-700.
---------------------------------------------------------------------------
Some academic literature on corporate governance could be
interpreted to suggest that, under the proposed definition of
independent director and the proposed minimum requirements for
independent directors on the board and board committees, divergent
interests between owners and participants, among various types of
participants, and between clearing agency stakeholders and the broader
financial markets may continue to adversely impact governance because
independent directors in closely held companies will cede to the
interests of controlling shareholders unless they are affirmatively
incentivized to protect the interests of one or more stakeholder
groups.\203\ One author suggests that independent directors will be
more effective if (1) their explicit purpose is to ``prevent minority
expropriation at the hands of the block-holders,'' (2) there is a
strong regulation and enforcement regime, and (3) the nomination
procedure and the design of incentives guarantee the independent
director is accountable to a specific constituency other than
controlling shareholders.\204\ Another author argues that including
independent directors in the governance process provides a roadmap, but
does not guarantee results in terms of favoritism and objectivity.\205\
While studies on the benefits of independent directors offer mixed
results and while independence alone is unlikely to be sufficient to
motivate a director to act in the public interest,\206\ director
independence, particularly when complemented with other governance
requirements, may help mitigate divergent incentives.
---------------------------------------------------------------------------
\203\ See, e.g., Clarke, supra note 94, at 85 (``The dominant
view has been that directors who are responsible to many
constituencies are in effect responsible to none . . . ''); Lucian
A. Bebchuk & Assaf Hamdani, Independent Directors and Controlling
Shareholders, 165 Univ. Pa. L. Rev. 1271, 1274 (2017), https://scholarship.law.upenn.edu/penn_law_review/vol165/iss6/1/ (taking the
position that the best way to help ensure an independent director
does not capitulate to controlling shareholders' or management's
interests is to help ensure the independent director is accountable
to (i.e., nominated by) another group of stakeholders).
\204\ See Maria Gutierrez & Maribel Saez, Deconstructing
Independent Directors, 13 J. Corp. L. Stud. 63, 90 (2013).
\205\ See Dravis, supra note 80.
\206\ See Clarke, supra note 94, at 82-83 (``If one is to rely
on NMDs [Non-Management Director's] to exercise their voting power
in favor of compliance with external standards, then there needs to
be some reason for believing that NMDs will be more likely to do so
than non-NMDs. Both kinds of directors can be subject to sanctions
for voting to violate clear legal obligations. If the purpose is to
encourage corporations to act in accordance with principles that do
not constitute legal obligations (for example, ``maximize local
employment''), then it is unlikely that NMDs elected by, and
accountable to, profit-maximizing shareholders will produce this
result. A director serving the ``public interest'' should arguably
be independent of everyone--dominant shareholders, management, and
indeed all those who have an interest in the company--and follow
only the dictates of her conscience. Assuming accountability to be a
good thing, however, it is hard to see how such a director could
properly be made accountable. In the real world, of course, any
director without security of tenure will, in the absence of
counterincentives and assuming that the position is desirable, tend
to be accountable to whoever was responsible for appointing her.'').
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The Commission believes that the proposed independence rules will
work in conjunction with (1) existing governance rules that emphasize
the clearing agency's responsibility to owners, participants and other
stakeholders,\207\ (2) Commission enforcement of securities
regulations, and (3) the adoption of other rules in this proposal (such
as the proposed nominating committee requirements) to help independent
directors mitigate the effects of divergent interests between owners
and participants, among various types of participants, and between
clearing agency stakeholders and the broader financial markets.
---------------------------------------------------------------------------
\207\ See, e.g., Rule 17Ad-22(e)(2).
---------------------------------------------------------------------------
In addition, the Commission believes that standardizing the
definition of independent director could improve efficiency by reducing
economic frictions and search costs related to monitoring by
stakeholders.
The Commission is aware of three primary costs associated with
adopting the proposed rules regarding the composition of the board.
First, adopting the proposed rules would cause clearing agency boards
to immediately expend resources memorializing information that has been
gathered for consideration in determining each director's independence,
and then preserving the records of the determination. The Commission
estimates that each registered, operating clearing agency would incur a
one-time burden of approximately $20,353 \208\ to comply with proposed
Rules 17Ad-25(b), (e), and (f) if the rules were adopted. Clearing
agencies would also expend future resources to repeat the above process
of memorializing information and documenting a determination, likely
twice a year. The Commission estimates that each registered, operating
clearing agency would incur an annual, recurring burden of
approximately $40,706 \209\ to comply with proposed Rules 17Ad-25(b),
(e), and (f) if the rules were adopted.
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\208\ This figure is calculated as follows: Chief Compliance
Officer for 5 hours at $577 per hour + Compliance Attorney for 44
hours at $397 per hour = $2,885 + $17,468 = $20,353. No hours are
allocated to proposed Rules 17Ad-25(e) or (f). See infra notes 236
and 237. The per-hour costs ($577 for a Chief Compliance Officer and
$397 for a Compliance Attorney) are from SIFMA's Management and
Professional Earnings in the Securities Industry--2013, modified by
Commission staff to account for an 1800-hour work-year and
inflation, and multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead. See SIFMA, Management and
Professional Earnings in the Securities Industry--2013 (Oct. 7,
2013), https://www.sifma.org/resources/research/management-and-professional-earnings-in-the-securities-industry-2013/.
\209\ This figure is calculated as follows: Chief Compliance
Officer for 10 hours at $577 per hour + Compliance Attorney for 88
hours at $397 per hour = $5,770 + $34,936 = $40,706. No hours are
allocated to proposed Rules 17Ad-25(e) or (f). See infra note 239.
The per-hour costs ($577 for a Chief Compliance Officer and $397 for
a Compliance Attorney) are from SIFMA's Management and Professional
Earnings in the Securities Industry--2013, supra note 208.
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Second, clearing agencies may need to add independent directors to
the board, either by replacing directors or increasing the board
size.\210\ As mentioned earlier, approaches to defining independence
for directors vary across clearing agencies. Thus, if proposed Rules
17Ad-25(b), (e), and (f) were adopted, to the extent that a clearing
agency's definition of an
[[Page 51848]]
``independent director'' conflicts with the proposed rules, including
the prohibitions in proposed Rule 17Ad-25(f), a clearing agency
currently reporting a majority of its directors as independent (or 34
percent, if a majority of the voting rights are directly or indirectly
held by participants) on its board may need to replace directors to
comply with the rule requirements.\211\
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\210\ Alternatively, clearing agencies might achieve compliance
by reducing the board size and eliminating a sufficient number of
non-independent directors.
\211\ On the other hand, a clearing agency that does not require
a minimum percentage of independent directors could determine that
its current slate of directors already satisfies the independence
requirements in the proposed rules.
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Adding independent directors would require a clearing agency to
expend resources conducting a search for new directors. The costs
incurred by the clearing agency may vary based on whether it conducts
its own search or retains an outside consultant. The Commission
estimates that retaining a recruitment specialist to secure an
independent director could cost approximately $90,000 per
director.\212\
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\212\ The Commission is basing this estimate on a report by The
Good Search noting that the retainer fee for outside directors is on
average $90,000. See The Good Search, Retained Search Fees, https://tgsus.com/executive-search-blog/retained-search-fees/. The
Commission believes that this amount could serve as a proxy for the
amount of any fee to be charged by a recruitment firm that would
conduct a national search for an independent director.
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Third, to the extent that non-independent directors tend to have
more relevant knowledge and experience than independent directors do,
requiring that a majority of directors (or 34 percent, if a majority of
the voting rights are directly or indirectly held by participants) be
independent could reduce the depth or breadth of relevant expertise
that can be brought to clearing agency boards. A reduced level of
combined experience on a clearing agency board might impair clearing
agency efficiency in the near term. However, the Commission believes
that any such effect would be short-lived, as new independent directors
gain more experience and prospective director nominees to the board
that may not meet existing experience criteria would qualify under the
proposed new independence requirements and fitness standards.
The Commission believes that the expected costs to implement
proposed Rules 17Ad-25(b), (e), and (f) are sufficiently small that
they would not have a material effect on (1) competition among the
existing clearing agencies or on a new entrant's ability to enter the
market; (2) capital formation, including clearing agencies' ability to
raise capital; and (3) the efficiency of clearing agencies or their
participants. For example, the Commission estimates that a clearing
agency would spend approximately $20,353 plus whatever director search
costs were necessary in the first year if the rules were adopted (which
the Commission estimates to be up to $90,000 per director), and $40,706
in each year thereafter.
2. Economic Considerations for Rule Proposals Regarding the Nominating
Committee
As discussed in more detail above, proposed Rule 17Ad-25(c) would
establish minimum requirements for nominating committees, including a
minimum composition requirement, fitness standards for serving on the
board, and a documented process for evaluating board nominees,
including those who would meet the Commission's proposed independence
criteria.\213\
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\213\ See supra Part III.B (discussing proposed Rule 17Ad-
25(c)); infra Part VIII (providing the proposed rule text).
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Given that six of the seven operating clearing agencies already
have nominating committees (or a committee that serves a similar
function), the primary benefit of adopting proposed Rule 17Ad-25(c)
would be to increase the number of independent directors on existing
nominating committees. Insofar as a lack of independent directors on a
clearing agency's nominating committee has prevented the clearing
agency from having a fairer representation of their shareholders and
participants in the selection of their directors and the administration
of their affairs, proposed Rule 17Ad-25(c) would help the clearing
agency better meet Section 17A's fair representation requirements.
Adopting proposed Rule 17Ad-25(c) would cause clearing agency
boards to immediately expend resources reviewing, revising, and
possibly creating governance documents and related policies and
procedures. The Commission estimates that each registered, operating
clearing agency would incur a one-time burden of approximately $35,060
\214\ to comply with proposed Rule 17Ad-25(c) if the rule was adopted.
Clearing agencies would also need to expend future resources for
monitoring, compliance, and documentation activities related to the new
or revised policies and procedures. The Commission estimates that each
registered, operating clearing agency would incur an annual, recurring
burden of approximately $11,910 \215\ to comply with proposed Rule
17Ad-25(c) if the rule were adopted.
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\214\ This figure is calculated as follows: Assistant General
Counsel for 30 hours at $507 per hour + Compliance Attorney for 50
hours at $397 per hour = $15,210 + $19,850 = $35,060. See infra note
242. The per-hour costs ($507 for an Assistant General Counsel, and
$397 for a Compliance Attorney) are from SIFMA's Management and
Professional Earnings in the Securities Industry--2013, supra note
208.
\215\ This figure is calculated as follows: Compliance Attorney
for 30 hours at $397 per hour = $11,910. See infra note 244. The
$577 per hour cost for a Chief Compliance Officer is from SIFMA's
Management and Professional Earnings in the Securities Industry--
2013, supra note 208.
---------------------------------------------------------------------------
The Commission believes that the expected costs to implement
proposed Rule 17Ad-25(c) are sufficiently small that they would not
have a material effect on (1) competition among the existing clearing
agencies or on a new entrant's ability to enter the market; (2) capital
formation, including clearing agencies' ability to raise capital; and
(3) the efficiency of clearing agencies or their participants.
3. Economic Considerations for Rule Proposals Regarding the Risk
Management Committee
As discussed in more detail above, proposed Rule 17Ad-25(d) would
require each registered clearing agency to establish a risk management
committee (or committees) and establish minimum requirements for the
composition, reconstitution, and function of such risk management
committees. Based on the Commission staff's review of relevant
governance documents, the Commission understands that many registered
clearing agencies currently have written governance arrangements that
largely conform to the requirements for risk management committees in
proposed Rule 17Ad-25(d). The Commission believes that each clearing
agency's governance documents and related policies and procedures would
need minimal modifications if proposed Rule 17Ad-25(d) were adopted. To
the extent that a clearing agency's existing governance documents and
related policies and procedures could reasonably be considered to be in
compliance with the proposed rules, the benefits of the proposed rule
would already be incorporated by market participants.
Adopting proposed Rule 17Ad-25(d) would cause clearing agency
boards to immediately expend resources reviewing, revising, and
possibly creating governance documents and related policies and
procedures. The Commission estimates that each registered, operating
clearing agency would incur a one-time burden of approximately $3,506
\216\ to comply
[[Page 51849]]
with proposed Rule 17Ad-25(d) if the rule was adopted. Clearing
agencies would also need to expend future resources for monitoring,
compliance, and documentation activities related to the new or revised
governance documents and related policies and procedures. The
Commission estimates that each registered, operating clearing agency
would incur an annual, recurring burden of approximately $1,191 \217\
to comply with proposed Rule 17Ad-25(d) if the rule was adopted.
---------------------------------------------------------------------------
\216\ This figure is calculated as follows: Assistant General
Counsel for 3 hours at $507 per hour + Compliance Attorney for 5
hours at $397 per hour = $1,521 + $1,985 = $3,506. See infra note
248. The per-hour costs ($507 for an Assistant General Counsel, and
$397 for a Compliance Attorney) are from SIFMA's Management and
Professional Earnings in the Securities Industry--2013, supra note
208.
\217\ This figure is calculated as follows: Compliance Attorney
for 3 hours at $397 per hour = $1,191. See infra note 250. The per-
hour cost is from SIFMA's Management and Professional Earnings in
the Securities Industry--2013, supra note 208.
---------------------------------------------------------------------------
The Commission believes that the expected costs to implement
proposed Rule 17Ad-25(d) are sufficiently small that they would not
have a material effect on (1) competition among the existing clearing
agencies or on a new entrant's ability to enter the market; (2) capital
formation, including clearing agencies' ability to raise capital; and
(3) the efficiency of clearing agencies or their participants.
4. Economic Considerations for Rule Proposals Regarding Conflicts of
Interest Involving Directors or Senior Managers
As discussed in more detail above, proposed Rules 17Ad-25(g) and
(h) would (1) require policies and procedures that identify and
document existing or potential conflicts of interest, mitigate or
eliminate the conflicts of interest and document the actions
taken,\218\ and (2) require policies and procedures that obligate
directors to report potential conflicts.\219\
---------------------------------------------------------------------------
\218\ See supra Part III.D.1 (discussing proposed Rule 17Ad-
25(g)).
\219\ See supra Part III.D.1 (discussing proposed Rule 17Ad-
25(h)).
---------------------------------------------------------------------------
The Commission believes that each clearing agency's existing
policies and procedures for identifying, reporting, and mitigating
conflicts of interest by directors or senior managers would need
minimal modifications if the proposed rules were adopted. To the extent
a clearing agency's existing policies and procedures could reasonably
be considered to be in compliance with the proposed rules, the benefits
discussed below would already be incorporated by market participants.
The Commission believes that adopting the proposed rules regarding
conflicts of interest would help clearing agencies continue to identify
and mitigate conflicts of interest by directors and senior managers as
circumstances change. For example, by codifying current best practices,
the proposed rules would reduce the future ability of clearing agencies
to change a clearing agency's conflict of interest disclosure
requirements to the detriment of participants and the economic
efficiency of the clearing market.
In addition, to the extent that adopting the proposed rule would
require clearing agencies to strengthen policies and procedures that
deal with identifying, reporting, mitigating or eliminating, and
documenting conflicts of interest, strengthening those policies and
procedures could reduce the monitoring costs borne by clearing agency
stakeholders.
Finally, to the extent a previously undisclosed conflict of
interest resulted in less favorable outcomes for the clearing agency--
such as higher expenses with service providers or the loss of business
from smaller participants--adopting the proposed rule would improve the
clearing agency's profitability (operating efficiency) and the economic
efficiency of the clearing market.
Adopting the proposed rules regarding conflicts of interest would
cause clearing agency boards to immediately expend resources reviewing,
revising, and possibly creating governance documents and related
policies and procedures. The Commission estimates that each registered,
operating clearing agency would incur a one-time burden of
approximately $6,945 \220\ to comply with proposed Rules 17Ad-25(g) and
(h) if the rules were adopted. Clearing agencies would also need to
expend future resources for monitoring, compliance, and documentation
activities related to the new or revised policies and procedures. The
Commission estimates that each registered, operating clearing agency
would incur an annual, recurring burden of approximately $2,382 \221\
to comply with proposed Rules 17Ad-25(g) and (h) if the rules were
adopted.
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\220\ This figure is calculated as follows: Assistant General
Counsel for 9 hours at $507 per hour + Compliance Attorney for 6
hours at $397 per hour = $4,563 + $2,382 = $6,945. The Assistant
General Counsel's 9 hours are allocated among the proposed rules: 8
hours for proposed Rule 17Ad-25(g) and 1 hour for proposed Rule
17Ad-25(h). The Compliance Attorney's 6 hours are allocated among
the proposed rules: 5 hours for proposed Rule 17Ad-25(g) and 1 hour
for proposed Rule 17Ad-25(h). See infra notes 251, 253, and 255. The
per-hour costs ($507 for an Assistant General Counsel and $397 for a
Compliance Attorney) are from SIFMA's Management and Professional
Earnings in the Securities Industry--2013, supra note 208.
\221\ This figure is calculated as follows: Compliance Attorney
for 6 hours at $397 per hour = $2,382. The Compliance Attorney's 6
hours are allocated among the proposed rules: 5 hours for proposed
Rule 17Ad-25(g) and 1 hour for proposed Rule 17Ad-25(h). See infra
notes 252, 254, and 256. The per-hour cost is from SIFMA's
Management and Professional Earnings in the Securities Industry--
2013, supra note 208.
---------------------------------------------------------------------------
The Commission believes that the expected costs to implement
proposed Rules 17Ad-25(g) and (h) are sufficiently small that they
would not have a material effect on (1) competition among the existing
clearing agencies or on a new entrant's ability to enter the market;
(2) capital formation, including clearing agencies' ability to raise
capital; and (3) the efficiency of clearing agencies or their
participants.
5. Economic Considerations for Rule Proposals Regarding Oversight of
Service Providers for Critical Services
As discussed in more detail above, proposed Rule 17Ad-25(i) would
require policies and procedures enabling the board to oversee
relationships with service providers for critical services.
The Commission believes that, to the extent a clearing agency's
risk management framework does not already consider how reliance on an
affiliated or third-party service provider might affect clearing
agency's risks, adopting the proposed rule would enhance the
effectiveness of a clearing agency's risk management framework. A more
effective risk management framework would reduce the probability of
clearing agency failure or financial distress. The reduced probability
of these outcomes directly and positively affects the stability of the
broader financial system.
Adopting the proposed rules regarding the board's ultimate
responsibility for the oversight of relationships with service
providers for critical services would cause clearing agency boards to
immediately expend resources reviewing, revising, and possibly creating
governance documents and related policies and procedures. For example,
boards might need to create or revise policies for overseeing
relationships with service providers for critical services. The
Commission estimates that each registered, operating clearing agency
would incur a one-time burden of approximately $35,060 \222\ to
[[Page 51850]]
comply with proposed Rule 17Ad-25(i) if the rule was adopted. Clearing
agency boards would also need to expend future resources for
monitoring, compliance, and documentation activities related to the new
or revised policies and procedures. The Commission estimates that each
registered, operating clearing agency would incur an annual, recurring
burden of approximately $11,910 \223\ to comply with proposed Rule
17Ad-25(i) if the rule was adopted.
---------------------------------------------------------------------------
\222\ This figure is calculated as follows: Assistant General
Counsel for 30 hours at $507 per hour + Compliance Attorney for 50
hours at $397 per hour = $15,210 + $19,850 = $35,060. See infra note
261. The per-hour costs ($507 for an Assistant General Counsel and
$397 for a Compliance Attorney) are from SIFMA's Management and
Professional Earnings in the Securities Industry--2013, supra note
208.
\223\ This figure is calculated as follows: Compliance Attorney
for 30 hour at $397 per hour = $11,910. See infra note 263. The per-
hour cost is from SIFMA's Management and Professional Earnings in
the Securities Industry--2013, supra note 208.
---------------------------------------------------------------------------
The Commission believes that the expected costs to implement
proposed Rule 17Ad-25(i) are sufficiently small that they would not
have a material effect on (1) competition among the existing clearing
agencies or on a new entrant's ability to enter the market; (2) capital
formation, including clearing agencies' ability to raise capital; and
(3) the efficiency of clearing agencies or their participants.
6. Economic Considerations for Rule Proposals Regarding Formalized
Solicitation, Consideration, and Documentation of Stakeholders'
Viewpoints
As discussed in more detail above, proposed Rule 17Ad-25(j) would
require policies and procedures to solicit, consider, and document the
registered clearing agency's consideration of the views of its
participants and other relevant stakeholders regarding material
developments in its governance and operations.
The Commission believes that, to the extent clearing agency boards'
inadequate solicitation of stakeholder viewpoints has caused some
stakeholder views not to be considered, adopting the proposed rules
regarding the solicitation, consideration, and documentation of
stakeholders' views would improve boards' consideration of different
stakeholder views. The Commission believes the improved consideration
of different views would help persuade stakeholders with divergent
interests to assert their needs more vigorously, which would encourage
debate amongst actors with different goals. More informed debates
would, in turn, help to foster consensus agreements with mandates and
other decisions that are supported by a broader spectrum of
stakeholders. Consequently, clearing agencies would identify and
develop rule proposals that (to the extent the Commission considers
them) would be more likely to meet the public interest requirements
under Section 17A of the Exchange Act.\224\
---------------------------------------------------------------------------
\224\ See 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------
Adopting the proposed rules regarding obligations of the board
would cause clearing agency boards to immediately expend resources
reviewing, revising, and possibly creating governance documents and
related policies and procedures. For example, boards might need to
create policies for soliciting, considering, and documenting the
consideration of stakeholders' views. The Commission estimates that
each registered, operating clearing agency would incur a one-time
burden of approximately $6,438 \225\ to comply with proposed Rule 17Ad-
25(j) if the rule was adopted. Clearing agency boards would also need
to expend future resources for monitoring, compliance, and
documentation activities related to the new or revised policies and
procedures. The Commission estimates that each registered, operating
clearing agency would incur an annual, recurring burden of
approximately $1,588 \226\ to comply with proposed Rule 17Ad-25(j) if
the rule was adopted.
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\225\ This figure is calculated as follows: Assistant General
Counsel for 8 hours at $507 per hour + Compliance Attorney for 6
hours at $397 per hour = $4,056 + $2,382 = $6,438. See infra note
267. The per-hour costs ($507 for an Assistant General Counsel and
$397 for a Compliance Attorney) are from SIFMA's Management and
Professional Earnings in the Securities Industry--2013, supra note
208.
\226\ This figure is calculated as follows: Compliance Attorney
for 4 hours at $397 per hour = $1,588. See infra note 269. The per-
hour cost is from SIFMA's Management and Professional Earnings in
the Securities Industry--2013, supra note 208.
---------------------------------------------------------------------------
The Commission believes that the expected costs to implement
proposed Rule 17Ad-25(j) are sufficiently small that they would not
have a material effect on (1) competition among the existing clearing
agencies or on a new entrant's ability to enter the market; (2) capital
formation, including clearing agencies' ability to raise capital; and
(3) the efficiency of clearing agencies or their participants.
D. Reasonable Alternatives to the Proposed Rule
1. More Flexibility in Governance, Operations, and Risk Management
The Commission believes that when determining the content of its
policies and procedures, each clearing agency must have the ability to
consider the effects of its unique characteristics and circumstances,
including ownership and governance structures, on direct and indirect
participants, markets served, and the risks inherent in products
cleared.\227\
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\227\ See CCA Standards Adopting Release, supra note 13, at
70806 (``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.'').
---------------------------------------------------------------------------
It has been the Commission's experience that particular securities
markets (e.g., equities, fixed income, and options) have unique
conventions, characteristics, and structures 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.\228\
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\228\ See CCA Standards Adopting Release, supra note 13, at
70801; see also Randall S. Kroszner, Central Counterparty Clearing:
History, Innovation, and Regulation, 30 Econ. Persp. 37, 39 (2006)
(``[37, 39 (2006) (``[M]ore intense government regulation of CCPs
may prove counterproductive if it creates moral hazard or impedes
the ability of CCPs to develop new approaches to risk
management.'').
---------------------------------------------------------------------------
Even where current practices at clearing agencies do not
significantly differ from the proposed rules, clearing agencies could
still potentially face costs associated with the limitations on
discretion that would 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 clearing
agencies having boards with a majority of independent directors value
the ability to sometimes have less than a majority of independent
directors on the board of directors, they may incur additional costs
because, if proposed rules were adopted, they would lose the option to
do so.
Although there may be costs to limiting the degree of discretion
clearing agencies have over governance, operations, and risk
management, the Commission believes there are also potential benefits.
For example, clearing agencies may not fully internalize the social
costs of differing incentives between owners and participants, among
various types of participants, and between clearing agency stakeholders
and the broader financial markets and thus, without more granular
regulations,
[[Page 51851]]
may not appropriately address the needs and incentives of the direct or
indirect participants or the broader financial market.
2. Ownership Limits
In 2010, the Commission proposed Regulation MC, which was
``designed to mitigate potential conflicts of interest . . . through
conditions and structures related to ownership, voting, and
governance.'' \229\ Regulation MC proposed mitigating divergent
incentives, especially between larger and smaller owners, by imposing
maximum ownership limits. Specifically, Regulation MC proposed that
security-based swap clearing agencies be required to choose one of two
governance alternatives. The Voting Interest Alternative in part
prevented any single participant from having more than 20 percent
ownership or voting interest in a clearing agency, and limited total
participant ownership or voting rights to no more than 40 percent. The
Voting Interest Alternative also required that at least 35 percent of
the board be independent directors.
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\229\ See Regulation MC Proposing Release, supra note 1, at
65882.
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The Governance Interest Alternative in part limited any participant
to no more than 5 percent ownership or voting rights in the clearing
agency, and required that at least 51 percent of the board be
independent directors.
The Commission has not proposed ownership limits in the current
proposal because (1) rules during the intervening time have
significantly altered how clearing agencies must treat smaller
participants \230\ and (2) bright-line ownership limits are easy to
manipulate, for example by obfuscating beneficial ownership or by
getting extremely close to the limit.
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\230\ See supra Part II.B. (discussing, in part, how the
Commission has adopted rules to promote access to registered
clearing agencies, including access for smaller participants).
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3. Increase Shareholders' At-Risk Capital (``Skin in the Game'')
The proposed rules are intended, in part, to better manage
divergent incentives of clearing agency owners and non-owner
participants. One suggested cause of the incentive misalignment is
owners' lack of at-risk capital (``skin in the game'').\231\ Under the
existing regulatory structure, for-profit clearing agencies can
bifurcate risk from reward, sending the reward (e.g., profits) to
owners and requiring participants to hold disproportionate risks (e.g.,
responsibility for non-default losses or participants' defaulted
positions). Thus, it is reasonable to consider using skin in the game
to correct the incentive alignment.\232\
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\231\ See, e.g., Saguato, supra note 201, at 488 (``[There is]
significant imbalance of the economic exposure of clearing members
vis-[agrave]-vis clearinghouses and their holding groups. This
imbalance . . . results in the misaligned incentives of members and
share-holders, which creates agency costs between the firms' primary
stakeholders that threaten clearinghouses' systemic resilience.'').
\232\ See OCC, Order Approving Proposed Rule Change to Establish
OCC's Persistent Minimum Skin-In-The-Game, Exchange Act Release No.
92038 (May 27, 2021), 86 FR 29861, 29863 (June 3, 2021) (``The
Commission continues to regard skin-in-the-game as a potential tool
to align the various incentives of a covered clearing agency's
stakeholders, including management and clearing members.'').
---------------------------------------------------------------------------
The Commission is not currently proposing skin-in-the-game
requirements. Instead, the Commission is proposing using governance
requirements to help manage the divergent incentives of clearing agency
shareholders and participants. The Commission believes that the
improved management of misaligned incentives will help facilitate
clearing agencies' ability to adopt policies, such as skin-in-the-game
requirements, that can further ameliorate the divergent incentives of
shareholders and participants.
4. Increase Public Disclosure
One of the purposes of the proposed rules is to increase
transparency into board governance. Increased transparency could also
be achieved by requiring clearing agencies to enhance their governance
disclosures. For example, the Commission could require clearing
agencies to publicly disclose, for each director, the existence of any
relationship or interest that reasonably could affect the independent
judgment or decision-making of the director. This requirement could
include each director's affiliation with clearing agency participants.
The Commission could require these disclosures to be submitted in a
structured (i.e., machine-readable) data language, which could augment
any transparency benefits resulting from the disclosures by increasing
the efficiency with which they are processed.
E. Request for Comment
The Commission requests comment on all aspects of this initial
economic analysis, including the potential benefits and costs, all
effects on efficiency, competition (including any effects on barriers
to entry), and capital formation, and reasonable alternatives to the
proposed rules. We request and encourage any interested person to
submit comments regarding the proposed rules, our analysis of the
potential effects of the proposed rules, and other matters that may
have an effect on the proposed rules. We request that commenters
identify sources of data and information as well as provide data and
information to assist us in analyzing the economic consequences of the
proposed rules and each reasonable alternative. We also are interested
in comments on the qualitative benefits and costs we have identified
and any benefits and costs we may have overlooked, including those
associated with each reasonable alternative. In addition, we are
interested in comments on any other reasonable alternative, including
any alternative that would distinguish registered clearing agencies
based on certain factors, such as organizational structure or products
cleared.
V. Paperwork Reduction Act
Certain provisions of the proposed rules contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\233\ We are submitting the proposed
collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with the PRA.\234\ The title for the
collection of information is: ``Clearing Agency Standards for Operation
and Governance'' (OMB Control No. 3235-0695).\235\ 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 OMB
control number.
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\233\ 44 U.S.C. 3502.
\234\ 44 U.S.C. 3507.
\235\ Id.
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As discussed further below, proposed Rules 17Ad-25(b) through (d)
and ((g) through (j) each contain collections of information. The
collections in proposed Rules 17Ad-25(b) through (d) and (g) through
(j) are mandatory. Respondents under these rules are registered
clearing agencies, of which there are currently nine. The Commission
estimates for purposes of the PRA that one additional entity may seek
to register as a clearing agency in the next three years, and so for
purposes of this proposal the Commission has assumed ten respondents.
A. Rule 17Ad-25(b)
The elements of proposed Rule 17Ad-25(b) are discussed in Part
III.A.1. The purpose of the rule is to require either a majority or 34
percent of independent directors, depending on the circumstances set
forth in the rule. Proposed Rule 17Ad-25(b)(2) would
[[Page 51852]]
impose a collection of information requirement.
The Commission estimates that proposed Rule 17Ad-25(b)(2) would
require respondent clearing agencies to incur a one-time burden of 44
hours \236\ to memorialize information that has been gathered for the
person(s) making the determination to consider prior to making it, as
well as 5 hours \237\ to document and preserve the records of the
determination. The Commission estimates that the initial activities
required by Rule 17Ad-25(b)(2) would impose an aggregate initial burden
on respondent clearing agencies of 490 hours.\238\ Due to the fact that
board composition changes on occasion after elections or due to
unexpected events such as restructuring, resignations, or deaths, the
Commission estimates that respondent clearing agencies would incur an
ongoing annual burden of 98 hours to repeat the above process of
memorializing information and documenting a determination twice a
year.\239\ The Commission estimates that the ongoing activities
required by Rule 17Ad-25(b)(2) would impose an aggregate ongoing burden
on respondent clearing agencies of 980 hours.\240\
---------------------------------------------------------------------------
\236\ This figure is calculated as follows: ((Chief Compliance
Officer for 4 hours) + (Compliance Attorney for 40 hours)) = 44
hours.
\237\ This figure is calculated as follows: ((Chief Compliance
Officer for 1 hours) + (Compliance Attorney for 4 hours)) = 5 hours.
\238\ This figure is calculated as follows: 49 hours x 10
respondent clearing agencies = 490 hours.
\239\ This figure is calculated as follows: ((Chief Compliance
Officer for 10 hours) + (Compliance Attorney for 88 hours)) = 98
hours.
\240\ This figure is calculated as follows: 98 hours x 10
respondent clearing agencies = 980 hours.
---------------------------------------------------------------------------
B. Rule 17Ad-25(c)
As discussed in Part III.B above, the Commission is proposing
certain composition and process requirements for nominating committees
of registered clearing agencies. As proposed, Rule 17Ad-25(c)(1)
through (4) would add governance requirements regarding the nominating
committee of the Board that do not appear in the existing requirements
for governance arrangements in Rules 17Ad-22(d)(8) and 17Ad-
22(e)(2).\241\ Based on the Commission staff's review of relevant
governance documents, the Commission understands that many registered
clearing agencies currently have written governance arrangements
broadly similar to the requirements for nominating committees in
proposed Rule 17Ad-25(c)(1) through (4). Therefore, the Commission
would expect that the PRA burden for a respondent clearing agency
includes the incremental burdens of reviewing and revising existing
governance documents and related policies and procedures, and creating
new governance documents and related policies and procedures, as
necessary, pursuant to the proposed rule. Accordingly, the Commission
estimates that respondent clearing agencies would incur an aggregate
one-time burden of approximately 800 hours to review and revise
existing governance documents and related policies and procedures and
to create new governance documents and related policies and procedures,
as necessary.\242\
---------------------------------------------------------------------------
\241\ 17 CFR 240.17Ad-22(d)(8), (e)(2).
\242\ This figure is calculated as follows: ((Assistant General
Counsel for 30 hours) + (Compliance Attorney for 50 hours)) = 80
hours x 10 respondent clearing agencies = 800 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(c)(1) through (4) would also impose ongoing
burdens on a respondent clearing agency. The proposed rule would
require ongoing monitoring and compliance activities with respect to
governance documents and related policies and procedures created in
response to the proposed rule. The proposed rule would also require
ongoing documentation activities with respect to the implementation of
a written process for a nominating committee to evaluate board
nominees, including those who would meet the definition of an
independent director, pursuant to the proposed rule. Based on the
Commission's previous estimates for ongoing monitoring and compliance
burdens with respect to Rule 17Ad-22,\243\ the Commission estimates
that the ongoing activities required by proposed Rule 17Ad-25(c)(1)
through (4) would impose an aggregate annual burden on respondent
clearing agencies of 300 hours.\244\
---------------------------------------------------------------------------
\243\ See Clearing Agency Standards Adopting Release, supra note
8, at 66260-63; CCA Standards Adopting Release, supra note 13, at
70891-99.
\244\ This figure is calculated as follows: (Compliance Attorney
for 30 hours) x 10 respondent clearing agencies = 300 hours.
---------------------------------------------------------------------------
C. Rule 17Ad-25(d)
Proposed Rule 17Ad-25(d)(1) would require a registered clearing
agency to establish a risk management committee (or committees) to
assist the board of directors in overseeing the risk management of the
registered clearing agency. Under proposed Rule 17Ad-25(d)(1), each
risk management committee would be required to reconstitute its
membership on a regular basis and at all times include representatives
from shareholders (or members) and participants of the registered
clearing agency. Proposed Rule 17Ad-25(d)(2) would require each risk
management committee, in the performance of its duties, to be able to
provide a risk-based, independent, and informed opinion on all matters
presented to it for consideration in a manner that supports the safety
and efficiency of the registered clearing agency.\245\
---------------------------------------------------------------------------
\245\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
The purpose of this collection of information is to promote sound
risk management and governance arrangements at registered clearing
agencies, to help ensure diversity of perspective across shareholders
(or members) and participants in the oversight of registered clearing
agencies' risk management practices, and to mitigate potential or
existing conflicts of interest that could undermine the recommendations
of risk management committees.
Proposed Rule 17Ad-25(d)(1) through (2) would add governance
requirements regarding the risk management committee (or committees) of
a registered clearing agency's board of directors that do not appear in
the existing requirements for governance arrangements in Rules 17Ad-
22(d)(8) and 17Ad-22(e)(2).\246\ Based on the Commission staff's review
of relevant governance documents, the Commission understands that many
registered clearing agencies currently have written governance
arrangements that largely conform to the requirements for risk
management committees in proposed Rule 17Ad-25(d)(1) through (2).
Therefore, the Commission would expect that the PRA burden for a
respondent clearing agency includes the incremental burdens of
reviewing and revising its existing governance documents and related
policies and procedures and creating new governance documents and
related policies and procedures, as necessary, pursuant to the proposed
rule.\247\ Accordingly, the Commission estimates that respondent
clearing agencies would incur an aggregate one-time burden of
approximately 80 hours to review and revise existing governance
documents and related policies and procedures and to create new
governance documents
[[Page 51853]]
and related policies and procedures, as necessary.\248\
---------------------------------------------------------------------------
\246\ See 17 CFR 240.17Ad-22(d)(8), (e)(2).
\247\ Because the written governance arrangements at many
registered clearing agencies already largely conform to the proposed
requirements for risk management committees, the Commission believes
that registered clearing agencies may need to make only limited
changes to update their governing documents and related policies and
procedures to help ensure compliance with proposed Rule 17Ad-
25(d)(1) through (2).
\248\ This figure is calculated as follows: ((Assistant General
Counsel for 3 hours) + (Compliance Attorney for 5 hours)) = 8 hours
x 10 respondent clearing agencies = 80 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(d)(1) through (2) would also impose ongoing
burdens on a respondent clearing agency. The proposed rule would
require ongoing monitoring and compliance activities with respect to
the governance documents and related policies and procedures created in
response to the proposed rule. The proposed rule would also require
ongoing documentation activities with respect to the establishment of a
risk management committee (or committees) pursuant to the proposed
rule. Based on the Commission's previous estimates for ongoing
monitoring and compliance burdens with respect to Rule 17Ad-22,\249\
the Commission estimates that the ongoing activities required by
proposed Rule 17Ad-25(d)(1) through (2) would impose an aggregate
annual burden on respondent clearing agencies of 30 hours.\250\
---------------------------------------------------------------------------
\249\ See Clearing Agency Standards Adopting Release, supra note
8, at 66260-63; CCA Standards Adopting Release, supra note 13, at
70891-99.
\250\ This figure is calculated as follows: (Compliance Attorney
for 3 hours) x 10 respondent clearing agencies = 30 hours.
---------------------------------------------------------------------------
D. Rule 17Ad-25(g)
Proposed Rule 17Ad-25(g)(1) would contain similar provisions to
Rules 17Ad-22(d)(8) and 17Ad-22(e)(2) in that they reference clear and
transparent governance arrangements, but also adds additional
requirements that do not appear in those rules. The Commission
therefore would expect that a respondent clearing agency may have
written rules, policies, and procedures similar to the requirements in
the rule, and 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 Rules 17Ad-
22(d)(8) and 17Ad-22(e)(2), the Commission estimates that respondent
clearing agencies would incur an aggregate one-time burden of
approximately 80 hours to review and revise existing policies and
procedures and to create new policies and procedures as necessary to
help ensure compliance with proposed Rule 17Ad-25(g)(1).\251\
---------------------------------------------------------------------------
\251\ This figure is calculated as follows: ((Assistant General
Counsel for 5 hours) + (Compliance Attorney for 3 hours)) = 8 hours
x 10 respondent clearing agencies = 80 hours.
---------------------------------------------------------------------------
Rule 17Ad-25(g)(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 Rules 17Ad-22(d)(8) and 17Ad-
22(e)(2) and because the modifications to Rule 17Ad-25(g)(1) will
require updating current policies and procedures or establishing new
policies and procedures to help ensure compliance, the Commission
estimates that the ongoing activities required by Rule 17Ad-25(g)(1)
would impose an aggregate annual burden on respondent clearing agencies
of 30 hours.\252\
---------------------------------------------------------------------------
\252\ This figure is calculated as follows: (Compliance Attorney
for 3 hours) x 10 respondent clearing agencies = 30 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(g)(2) would contain similar provisions to
Rules 17Ad-22(d)(8) and 17Ad-22(e)(2) in that they reference clear and
transparent governance arrangements, but also adds additional
requirements that do not appear in those rules. The Commission
therefore would expect 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. The
Commission recognizes that while registered clearing agencies may have
existing policies and procedures to comply with proposed Rule 17Ad-
25(g)(1), they may not have current policies and procedures designed
specifically to mitigate and document the how the conflict of interest
was mitigated, as required by Rule 17Ad-25(g)(2). Accordingly, based on
the similar provisions and the corresponding burden estimates
previously made by the Commission for Rules 17Ad-22(d)(8) and 17Ad-
22(e)(2), the Commission estimates that respondent clearing agencies
would incur an aggregate one-time burden of approximately 50 hours to
review and revise existing policies and procedures and to create new
policies and procedures as necessary to help ensure compliance with
proposed Rule 17Ad-25(g)(2).\253\
---------------------------------------------------------------------------
\253\ This figure is calculated as follows: ((Assistant General
Counsel for 3 hours) + (Compliance Attorney for 2 hours)) = 5 hours
x 10 respondent clearing agencies = 50 hours.
---------------------------------------------------------------------------
Rule 17Ad-25(g)(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 Rules 17Ad-22(d)(8) and 17Ad-
22(e)(2) and because the modifications to Rule 17Ad-25(g)(2) will
require updating current policies and procedures or establishing new
policies and procedures to help ensure compliance, the Commission
estimates that the ongoing activities required by Rule 17Ad-25(g)(2)
would impose an aggregate annual burden on respondent clearing agencies
of 20 hours.\254\
---------------------------------------------------------------------------
\254\ This figure is calculated as follows: (Compliance Attorney
for 2 hours) x 10 respondent clearing agencies = 20 hours.
---------------------------------------------------------------------------
E. Rule 17Ad-25(h)
Proposed Rule 17Ad-25(h) would contain similar provisions to Rules
17Ad-22(d)(8) and 17Ad-22(e)(2) in that they reference clear and
transparent governance arrangements, but also adds additional
requirements that do not appear in those rules. The Commission
therefore would expect 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 Rules 17Ad-
22(d)(8) and 17Ad-22(e)(2), the Commission estimates that respondent
clearing agencies would incur an aggregate one-time burden of
approximately 20 hours to review and revise existing policies and
procedures and to create new policies and procedures as necessary to
help ensure compliance with proposed Rule 17Ad-25(h).\255\
---------------------------------------------------------------------------
\255\ This figure is calculated as follows: ((Assistant General
Counsel for 1 hours) + (Compliance Attorney for 1 hours)) = 2 hours
x 10 respondent clearing agencies = 20 hours.
---------------------------------------------------------------------------
Rule 17Ad-25(h) 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 Rules 17Ad-22(d)(8) and 17Ad-
22(e)(2) and because the modifications to Rule 17Ad-25(h) will require
updating current policies and procedures or establishing new
[[Page 51854]]
policies and procedures to help ensure compliance, the Commission
estimates that the ongoing activities required by Rule 17Ad-25(h) would
impose an aggregate annual burden on respondent clearing agencies of 10
hours.\256\
---------------------------------------------------------------------------
\256\ This figure is calculated as follows: (Compliance Attorney
for 1 hours) x 10 respondent clearing agencies = 10 hours.
---------------------------------------------------------------------------
F. Rule 17Ad-25(i)
As discussed in Section III.F above, the Commission is proposing
certain obligations of the board to oversee service providers for
critical services to a registered clearing agency under proposed Rule
17Ad-25(i). Such obligation does not appear in the existing
requirements for governance arrangements in Rules 17Ad-22(d)(8) and
17Ad-22(e)(2),\257\ but certain aspects of the proposed rule may be
addressed in existing requirements. For example, proposed rule 17Ad-
25(i)(1) references the existence of a risk management framework but
does not itself require the creation of such framework. Instead,
maintenance of a risk management framework is already required for all
currently registered clearing agencies under Rule 17Ad-
22(e)(3)(i).\258\ Additionally, as discussed above, there are existing
requirements for managing operational risk under Rule 17Ad-22(d)(4)
\259\ and Rule 17Ad-22(e)(17).\260\ Therefore, the Commission would
expect that the PRA burden for a respondent clearing agency includes
the incremental burdens of reviewing and revising its existing
governance documents and related policies and procedures and creating
new governance documents and related policies and procedures, as
necessary, pursuant to the proposed rule. Accordingly, the Commission
estimates that respondent clearing agencies would incur an aggregate
one-time burden of approximately 800 hours to review and revise
existing governance documents and related policies and procedures and
to create new governance documents and related policies and procedures,
as necessary.\261\
---------------------------------------------------------------------------
\257\ 17 CFR 240.17Ad-22(d)(8), (e)(2).
\258\ 17 CFR 240.17Ad-22(e)(3)(i).
\259\ 17 CFR 240.17Ad-22(d)(4).
\260\ 17 CFR 240.17Ad-22(e)(17).
\261\ This figure is calculated as follows: ((Assistant General
Counsel for 30 hours) + (Compliance Attorney for 50 hours)) = 80
hours x 10 respondent clearing agencies = 800 hours.
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(i) would also impose ongoing burdens on a
respondent clearing agency. The proposed rule would require ongoing
documentation, monitoring, and compliance activities with respect to
the governance documents and related policies and procedures created in
response to the proposed rule. Based on the Commission's previous
estimates for ongoing monitoring and compliance burdens with respect to
Rule 17Ad-22,\262\ the Commission estimates that the ongoing activities
required by Rule 17Ad-25(i) would impose an aggregate annual burden on
respondent clearing agencies of 300 hours.\263\
---------------------------------------------------------------------------
\262\ See Clearing Agency Standards Adopting Release, supra note
38, at 66260-63; CCA Standards Adopting Release, supra note 38, at
70891-99.
\263\ This figure is calculated as follows: (Compliance Attorney
for 30 hours) x 10 respondent clearing agencies = 300 hours.
---------------------------------------------------------------------------
G. Rule 17Ad-25(j)
Proposed Rule 17Ad-25(j) would require a registered clearing agency
to establish, implement, maintain, and enforce written policies and
procedures reasonably designed to solicit, consider, and document its
consideration of the views of participants and other relevant
stakeholders of the registered clearing agency regarding material
developments in the clearing agency's governance and operations on a
recurring basis.\264\
---------------------------------------------------------------------------
\264\ See supra Part III.F.2 (discussing proposed Rule 17Ad-
25(j)); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(j) contains similar provisions to Rules 17Ad-
22(d)(8) and 17Ad-22(e)(2) but would also impose additional governance
obligations that do not appear in the existing requirements for
governance arrangements in Rule 17Ad-22.\265\ Therefore, the Commission
would expect that a respondent clearing agency may have written rules,
policies, and procedures similar to some of the requirements in the
proposed rule and that the PRA burden includes the incremental burdens
of reviewing and revising existing policies and procedures and creating
new policies and procedures, as necessary, pursuant to the proposed
rule. Accordingly, based on the similar policies and procedures
requirements and the corresponding burden estimates previously made by
the Commission for Rules 17Ad-22(d)(8) and 17Ad-22(e)(2),\266\ the
Commission estimates that respondent clearing agencies would incur an
aggregate one-time burden of approximately 140 hours to review and
revise existing policies and procedures and to create new policies and
procedures, as necessary.\267\
---------------------------------------------------------------------------
\265\ See 17 CFR 240.17Ad-22(d)(8), (e)(2).
\266\ See Clearing Agency Standards Adopting Release, supra note
8, at 66260; CCA Standards Adopting Release, supra note 13, at
70891-92.
\267\ This figure was calculated as follows: ((Assistant General
Counsel for 8 hours) + (Compliance Attorney for 6 hours)) = 14 hours
x 10 respondent clearing agencies = 140 hours.
---------------------------------------------------------------------------
Rule 17Ad-25(j) also imposes ongoing burdens on a respondent
clearing agency. The proposed rule would require ongoing monitoring and
compliance activities with respect to the written policies and
procedures created in response to the proposed rule. The proposed rule
would also require ongoing documentation activities with respect to the
board's consideration of participants' and relevant stakeholders' views
pursuant to the proposed rule. Based on the Commission's previous
estimates for ongoing monitoring and compliance burdens with respect to
Rule 17Ad-22,\268\ the Commission estimates that the ongoing activities
required by proposed Rule 17Ad-25(j) would impose an aggregate annual
burden on respondent clearing agencies of 40 hours.\269\
---------------------------------------------------------------------------
\268\ See Clearing Agency Standards Adopting Release, supra note
8, at 66260-63; CCA Standards Adopting Release, supra note 13, at
70891-99.
\269\ This figure was calculated as follows: (Compliance
Attorney for 4 hours) x 10 respondent clearing agencies = 40 hours.
---------------------------------------------------------------------------
H. Chart of Total PRA Burdens
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial burden Ongoing burden Total annual
Name of information collection Type of burden Number of per entity per entity burden per Total industry
respondents (hours) (hours) entity (hours) burden (hours)
--------------------------------------------------------------------------------------------------------------------------------------------------------
17Ad-25(b)................................ Recordkeeping............... 10 49 98 147 1,470
17Ad-25(c)................................ Recordkeeping............... 10 80 30 110 1,100
17Ad-25(d)................................ Recordkeeping............... 10 8 3 11 110
17Ad-25(g)................................ Recordkeeping............... 10 13 5 18 180
17Ad-25(h)................................ Recordkeeping............... 10 2 1 3 30
17Ad-25(i)................................ Recordkeeping............... 10 80 30 110 1,100
17Ad-25(j)................................ Recordkeeping............... 10 14 4 18 180
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 51855]]
I. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
1. Evaluate whether the proposed collection of information is
necessary for the proper performance of the Commission's functions,
including whether the information shall have practical utility;
2. Evaluate the accuracy of the Commission's estimates of the
burden of the proposed collection of information;
3. Determine whether there are ways to enhance the quality,
utility, and clarity of the information to be collected;
4. Evaluate whether there are ways to minimize the burden of
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology; and
5. Evaluate whether the proposed rules would have any effects on
any other collection of information not previously identified in this
section.
Persons wishing to submit comments on the collection of information
requirements should direct them to the OMB Desk Officer for the
Securities and Exchange Commission,
[email protected], and should also send a copy
of their comments to Secretary, Securities and Exchange Commission, 100
F Street NE, Washington, DC 20549-1090, with reference to File Number
S7-21-22. Requests for materials submitted to OMB by the Commission
with regard to this collection of information should be in writing,
with reference to File Number S7-21-22 and be submitted to the
Securities and Exchange Commission, Office of FOIA/PA Services, 100 F
Street NE, Washington, DC 20549-2736. As OMB is required to make a
decision concerning the collection of information between 30 and 60
days after publication, a comment to OMB is best assured of having its
full effect if OMB receives it within 30 days of publication.
VI. Small Business Regulatory Enforcement Fairness Act
Under the Small Business Regulatory Enforcement Fairness Act of
1996, a rule is considered ``major'' where, if adopted, it results or
is likely to result in (i) an annual effect on the economy of $100
million or more (either in the form of an increase or a decrease); (ii)
a major increase in costs or prices for consumers or individual
industries; or (iii) significant adverse effect on competition,
investment, or innovation.\270\ The Commission requests comment on the
potential impact of proposed Rule 17Ad-25 on the economy on an annual
basis, any potential increase in costs or prices for consumers or
individual industries, and any potential effect on competition,
investment, or innovation. Commenters are requested to provide
empirical data and other factual support for their views to the extent
possible.
---------------------------------------------------------------------------
\270\ Public Law 104-121, 110 Stat. 857 (1996) (codified in
various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
---------------------------------------------------------------------------
VII. Regulatory Flexibility Act Certification
The Regulatory Flexibility Act (``RFA'') requires the Commission,
in promulgating rules, to consider the impact of those rules on small
entities.\271\ Section 603(a) of the Administrative Procedure Act,\272\
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.'' \273\ Section 605(b)
of the RFA states that this requirement shall not apply to any proposed
rule which, if adopted, would not have a significant impact on a
substantial number of small entities.\274\
---------------------------------------------------------------------------
\271\ See 5 U.S.C. 601 et seq.
\272\ 5 U.S.C. 603(a).
\273\ Section 601(b) of the RFA permits agencies to formulate
their own definitions of ``small entities.'' See 5 U.S.C. 601(b).
The Commission has adopted definitions for the term ``small entity''
for the purposes of rulemaking in accordance with the RFA. These
definitions, as relevant to this proposed rulemaking, are set forth
in Rule 0-10, 17 CFR 240.0-10.
\274\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------
A. Registered Clearing Agencies
Proposed Rule 17Ad-25 would apply to all registered clearing
agencies. For the purposes of Commission rulemaking and as applicable
to proposed Rule 17Ad-25, 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.\275\
---------------------------------------------------------------------------
\275\ See 17 CFR 240.0-10(d).
---------------------------------------------------------------------------
Based on the Commission's existing information about the clearing
agencies currently registered with the Commission,\276\ the Commission
believes that all such registered clearing agencies exceed the
thresholds defining ``small entities'' set out above. While other
clearing agencies may emerge and seek to register as clearing agencies
with the Commission, the Commission believes that no such entities
would be ``small entities'' as defined in Exchange Act Rule 0-10.\277\
---------------------------------------------------------------------------
\276\ In 2021, DTCC processed $2.37 quadrillion in financial
transactions. Within DTCC, DTC settled $152 trillion of securities
and held securities valued at $87.1 trillion, NSCC processed an
average daily value of $2.029 trillion in equity securities, and
FICC cleared $1.4 quadrillion of transactions in government
securities and $69 trillion of transactions in agency mortgage-
backed securities. See DTCC, 2021 Annual Report, https://www.dtcc.com/annuals/2021/. ICE averaged daily trade volume of 5.97
million contracts and total revenues of $7.1 billion in 2021. See
ICE, 2021 Annual Report, https://s2.q4cdn.com/154085107/files/doc_financials/2021/ar/250217_009_Web_BMK-(1).pdf. In addition, OCC
cleared more than 7.5 billion contracts and held margin of $180
billion at the end of 2020. See OCC, 2020 Annual Report, https://annualreport.theocc.com/. These trade volumes exceed the $500
million threshold for small entities.
\277\ 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
proposed Rule 17Ad-25 would not have a significant economic impact on a
substantial number of small entities for purposes of the RFA. The
Commission requests comment regarding this certification. The
Commission requests that commenters describe the nature of any impact
on small entities and provide empirical data to support the extent of
the impact. Persons wishing to submit written comments should refer to
the instructions for submitting comments in the front of this release.
VIII. Statutory Authority and Text of Proposed Rule
The Commission is proposing Rule 17Ad-25 under the Commission's
rulemaking authority in the Exchange Act, particularly Section 17(a),
15 U.S.C. 78q(a), Section 17A, 15 U.S.C. 78q-1, Section 23(a), 15
U.S.C. 78w(a), Section 765 of the Dodd-Frank Act, and 805 of the
Clearing Supervision Act, 15 U.S.C. 8343 and 15 U.S.C. 5464
respectively.
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Text of Amendment
In accordance with the foregoing, title 17, chapter II of the Code
of Federal Regulations is proposed to be amended as follows:
[[Page 51856]]
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
1. The authority citation for part 240 continues to read in part 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, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 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.
* * * * *
0
2. Section 240.17Ad-25 is added to read as follows:
Sec. 240.17Ad-25 Clearing agency boards of directors and conflicts of
interest.
(a) Definitions. All terms used in this section have the same
meaning as in the Securities Exchange Act of 1934, and unless the
context otherwise requires, the following definitions apply for
purposes of this section:
Affiliate means a person that directly or indirectly controls, is
controlled by, or is under common control with the registered clearing
agency.
Board of directors means the board of directors or equivalent
governing body of the registered clearing agency.
Director means a member of the board of directors or equivalent
governing body of the registered clearing agency.
Family member means any child, stepchild, grandchild, parent,
stepparent, grandparent, spouse, sibling, niece, nephew, mother-in-law,
father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-
in-law, including adoptive relationships, any person (other than a
tenant or employee) sharing a household with the director or a nominee
for director, a trust in which these persons (or the director or a
nominee for director) have more than fifty percent of the beneficial
interest, a foundation in which these persons (or the director or a
nominee for director) control the management of assets, and any other
entity in which these persons (or the director or a nominee for
director) own more than fifty percent of the voting interests.
Independent director means a director of the registered clearing
agency who has no material relationship with the registered clearing
agency or any affiliate thereof.
Material relationship means a relationship, whether compensatory or
otherwise, that reasonably could affect the independent judgment or
decision-making of the director. A material relationship also includes
a relationship that existed during a lookback period of one year
counting back from making the initial determination in paragraph (b)(2)
of this section.
Service provider for critical services means any person that is
contractually obligated to the registered clearing agency for the
purpose of supporting clearance and settlement functionality or any
other purposes material to the business of the registered clearing
agency.
(b) Composition of the board of directors. (1) A majority of the
members of the board of directors of a registered clearing agency must
be independent directors, unless a majority of the voting rights issued
as of the immediately prior record date are directly or indirectly held
by participants, in which case at least 34 percent of the members of
the board of directors must be independent directors.
(2) Each registered clearing agency shall broadly consider all the
relevant facts and circumstances, including under paragraph (g) of this
section, on an ongoing basis, to affirmatively determine that a
director does not have a material relationship with the registered
clearing agency or an affiliate of the registered clearing agency, and
is not precluded from being an independent director under paragraph (f)
of this section, in order to qualify as an independent director. In
making such determination, a registered clearing agency must:
(i) Identify the relationships between a director, the registered
clearing agency, and any affiliate thereof and any circumstances under
paragraph (f) of this section;
(ii) Evaluate whether any relationship is likely to impair the
independence of the director in performing the duties of director; and
(iii) Document this determination in writing.
(c) Nominating committee. (1) Each registered clearing agency must
establish a nominating committee and a written evaluation process
whereby such nominating committee shall evaluate nominees for serving
as directors.
(2) A majority of the directors serving on the nominating committee
must be independent directors, and the chair of the nominating
committee must be an independent director.
(3) The fitness standards for serving as a director shall be
specified by the nominating committee, documented in writing, and
approved by the board of directors. Such fitness standards must be
consistent with the requirements of this section and include that the
individual is not subject to any statutory disqualification as defined
under Section 3(a)(39) of the Act.
(4) The nominating committee must document the outcome of the
written evaluation process consistent with the fitness standards
required under paragraph (c)(3) of this section. Such process shall:
(i) Take into account each nominee's expertise, availability, and
integrity, and demonstrate that the board of directors, taken as a
whole, has a diversity of skills, knowledge, experience, and
perspectives;
(ii) Demonstrate that the nominating committee has considered
whether a particular nominee would complement the other board members,
such that, if elected, the board of directors, taken as a whole, would
represent the views of the owners and participants, including a
selection of directors that reflects the range of different business
strategies, models, and sizes across participants, as well as the range
of customers and clients the participants serve;
(iii) Demonstrate that the nominating committee considered the
views of other stakeholders who may be impacted by the decisions of the
registered clearing agency, including transfer agents, settlement
banks, nostro agents, liquidity providers, technology or other service
providers; and
(iv) Identify whether each selected nominee would meet the
definition of independent director in paragraphs (a) and (f) of this
section, and whether each selected nominee has a known material
relationship with the registered clearing agency or any affiliate
thereof, an owner, a participant, or a representative of another
stakeholder of the registered clearing agency described in paragraph
(c)(4)(iii) of this section.
(d) Risk management committee. (1) Each registered clearing agency
must establish a risk management committee (or committees) to assist
the board of directors in overseeing the risk management of the
registered clearing agency. The membership of each risk management
committee must be reconstituted on a regular basis and at all times
include representatives from the owners and participants of the
registered clearing agency.
(2) In the performance of its duties, the risk management committee
must be able to provide a risk-based, independent, and informed opinion
on all matters presented to the committee for consideration in a manner
that supports the safety and efficiency of the registered clearing
agency.
(e) Committees generally. If any committee has the authority to act
on
[[Page 51857]]
behalf of the board of directors, the composition of that committee
must have at least the same percentage of independent directors as is
required for the board of directors, as set forth in paragraph (b)(1)
of this section.
(f) Circumstances that preclude directors from being independent
directors. In addition to how the definition of independent director
set forth in this section is applied by a registered clearing agency,
the following circumstances preclude a director from being an
independent director, subject to a lookback period of one year
(counting back from making the initial determination in paragraph
(b)(2) of this section) applying to paragraphs (f)(2) through (6) of
this section:
(1) The director is subject to rules, policies, or procedures by
the registered clearing agency that may undermine the director's
ability to operate unimpeded, such as removal by less than a majority
vote of shares that are entitled to vote in such director's election;
(2) The director, or a family member, has an employment
relationship with or otherwise receives compensation other than as a
director from the registered clearing agency or any affiliate thereof,
or the holder of a controlling voting interest of the registered
clearing agency;
(3) The director, or a family member, is receiving payments from
the registered clearing agency, or any affiliate thereof, or the holder
of a controlling voting interest of the registered clearing agency,
that reasonably could affect the independent judgment or decision-
making of the director, other than the following:
(i) Compensation for services as a director on the board of
directors or a committee thereof; or
(ii) Pension and other forms of deferred compensation for prior
services not contingent on continued service;
(4) The director, or a family member, is a partner in, or
controlling shareholder of, any organization to or from which the
registered clearing agency, or any affiliate thereof, or the holder of
a controlling voting interest of the registered clearing agency, is
making or receiving payments for property or services, other than the
following:
(i) Payments arising solely from investments in the securities of
the registered clearing agency, or affiliate thereof; or
(ii) Payments under non-discretionary charitable contribution
matching programs;
(5) The director, or a family member, is employed as an executive
officer of another entity where any executive officers of the
registered clearing agency serve on that entity's compensation
committee; or
(6) The director, or a family member, is a partner of the outside
auditor of the registered clearing agency, or any affiliate thereof, or
an employee of the outside auditor who is working on the audit of the
registered clearing agency, or any affiliate thereof.
(g) Conflicts of interest. Each registered clearing agency must
establish, implement, maintain and enforce written policies and
procedures reasonably designed to:
(1) Identify and document existing or potential conflicts of
interest in the decision-making process of the clearing agency
involving directors or senior managers of the registered clearing
agency; and
(2) Mitigate or eliminate and document the mitigation or
elimination of such conflicts of interest.
(h) Obligation of directors to report conflicts. Each registered
clearing agency must establish, implement, maintain, and enforce
written policies and procedures reasonably designed to require a
director to document and inform the registered clearing agency promptly
of the existence of any relationship or interest that reasonably could
affect the independent judgment or decision-making of the director.
(i) Obligation of board of directors to oversee relationships with
service providers for critical services. Each registered clearing
agency must establish, implement, maintain, and enforce written
policies and procedures reasonably designed to enable the board of
directors to:
(1) Confirm and document that risks related to relationships with
service providers for critical services are managed in a manner
consistent with its risk management framework, and review senior
management's monitoring of relationships with service providers for
critical services;
(2) Approve policies and procedures that govern the relationship
with service providers for critical services;
(3) Review and approve plans for entering into third-party
relationships where the engagement entails being a service provider for
critical services to the registered clearing agency; and
(4) Through regular reporting to the board of directors by senior
management, confirm that senior management takes appropriate actions to
remedy significant deterioration in performance or address changing
risks or material issues identified through ongoing monitoring.
(j) Obligation of board of directors to solicit and consider
viewpoints of participants and other relevant stakeholders. Each
registered clearing agency must establish, implement, maintain, and
enforce written policies and procedures reasonably designed to solicit,
consider, and document its consideration of the views of participants
and other relevant stakeholders of the registered clearing agency
regarding material developments in its governance and operations on a
recurring basis.
By the Commission.
Dated: August 8, 2022.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2022-17316 Filed 8-22-22; 8:45 am]
BILLING CODE 8011-01-P