Standards for Covered Clearing Agencies

Federal RegisterMar 26, 2014

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-71699; File No. S7-03-14]

RIN 3235-AL48

Standards for Covered Clearing Agencies

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“SEC” or “Commission”) proposes to amend Rule 17Ad-22 and add Rule 17Ab2-2 pursuant to Section 17A of the Securities Exchange Act of 1934 (“Exchange Act”) and the Payment, Clearing, and Settlement Supervision Act of 2010 (“Clearing Supervision Act”), adopted in Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). Among other things, the proposed rules would establish standards for the operation and governance of certain types of registered clearing agencies that meet the definition of a “covered clearing agency.”

DATES:

Submit comments on or before May 27, 2014.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (

http://www.sec.gov/rules/proposed.shtml

); or

• Send an email to

rule-comments@sec.gov

. Please include File Number S7-03-14 on the subject line; or

• Use the Federal eRulemaking Portal (

http://www.regulations.gov

). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments to Kevin M. O'Neill, Deputy Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090. All submissions should refer to File Number S7-03-14.

To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (

http://www.sec.gov/rules/proposed.shtml

Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Katherine Martin, Senior Special Counsel; Stephanie Park, Special Counsel; Mark Saltzburg, Special Counsel; Matthew Lee, Attorney-Adviser; and Abraham Jacob, Attorney-Adviser; Office of Clearance and Settlement, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010, at (202) 551-5710.

SUPPLEMENTARY INFORMATION:

The Commission proposes to amend Rule 17Ad-22 to add new Rule 17Ad-22(e) to establish requirements for risk management, operations, and governance of registered clearing agencies that meet the definition of a “covered clearing agency.” Covered clearing agencies would include registered clearing agencies that (i) have been designated as systemically important by the Financial Stability Oversight Council (“FSOC”) and for which the Commission is the supervisory agency, pursuant to the Clearing Supervision Act (“designated clearing agencies”), (ii) provide central counterparty (“CCP”) services for security-based swaps or are involved in activities the Commission determines to have a more complex risk profile, where in either case the Commodity Futures Trading Commission (“CFTC”) is not the supervisory agency for such clearing agency as defined in Section 803(8) of the Clearing Supervision Act, or (iii) are otherwise determined to be covered clearing agencies by the Commission. The Commission also proposes to add new Rule 17Ad-22(f) to codify the Commission's statutory authority and new Rule 17Ab2-2 to establish procedures for making determinations regarding covered clearing agencies under proposed Rule 17Ad-22(e). The Commission also proposes to amend existing Rule 17Ad-22(d) to limit its application to clearing agencies other than covered clearing agencies and to revise existing Rule 17Ad-22(a) to add 15 new definitions. The Commission has begun, and intends to continue, consultation with the FSOC and the Board of Governors of the Federal Reserve System (“the Board”) and has considered the relevant international standards as required by Section 805(a)(2)(A) of the Clearing Supervision Act.

See

Committee on Payment and Settlement Systems and Technical Committee of the International Organization of Securities Commissions (“CPSS-IOSCO”), Principles for Financial Market Infrastructures (Apr. 16, 2012),

available at http://www.bis.org/publ/cpss101a.pdf

(“PFMI Report”).

Table of Contents

I. Current Regulatory Framework for Clearing Agencies

A. Section 17A of the Exchange Act

B. OTC Swaps Clearing and the Dodd-Frank Act

1. Title VII of the Dodd-Frank Act

2. Title VIII of the Dodd-Frank Act

C. Rule 17Ad-22 Under the Exchange Act

D. Relevant International Standards

II. Discussion of the Proposed Amendments to Rule 17AD-22 and Proposed Rule 17AB2-2

A. Overview

1. Scope of Proposed Rule 17Ad-22(e)

2. Role of Written Policies and Procedures

3. Frequency of Review Required Under Certain Policies and Procedures

4. Anticipated Impact of Proposed Rule 17Ad-22(e)

5. General Request for Comments

B. Proposed Rule 17Ad-22(e)

1. Proposed Rule 17Ad-22(e)(1): Legal Risk

2. Proposed Rule 17Ad-22(e)(2): Governance

3. Proposed Rule 17Ad-22(e)(3): Framework for the Comprehensive Management of Risks

a. Policies and Procedures Requirements, Periodic Review, and Annual Board Approval

b. Recovery and Orderly Wind-Down Plans

c. Risk Management and Internal Audit

d. Request for Comments

4. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management

a. Overview of Financial Risks Faced by Clearing Agencies

b. Current Financial Risk Management Requirements for CCPs

c. Proposed Rule 17Ad-22(e)(4): Credit Risk

i. Prefunded Financial Resources

ii. Combined or Separately Maintained Clearing or Guaranty Funds

iii. Testing the Sufficiency of Financial Resources

iv. Annual Conforming Model Validation

d. Proposed Rule 17Ad-22(e)(5): Collateral

e. Proposed Rule 17Ad-22(e)(6): Margin

i. Active Management of Model Risk

ii. Collection of Margin

iii. Ninety-Nine Percent Confidence Level

iv. Price Data Source

v. Method for Measuring Credit Exposure

vi. Backtesting and Sensitivity Analysis

vii. Annual Conforming Model Validation

f. Proposed Rule 17Ad-22(e)(7): Liquidity Risk

i. Sufficient Liquid Resources

ii. Qualifying Liquid Resources

iii. Access to Account Services at a Federal Reserve Bank or Other Relevant Central Bank

iv. Liquidity Providers

v. Maintenance and Annual Testing of Liquidity Provider Procedures and Operational Capacity

vi. Testing the Sufficiency of Liquid Resources

vii. Annual Conforming Model Validation

viii. Address Liquidity Shortfalls and Seek To Avoid Unwinding Settlement

ix. Replenishment of Liquid Resources

x. Feasibility Analysis for “Cover Two”

g. Request for Comments

5. Proposed Rule 17Ad-22(e)(8): Settlement Finality

6. Proposed Rule 17Ad-22(e)(9): Money Settlements

7. Proposed Rule 17Ad-22(e)(10): Physical Delivery Risks

8. Proposed Rule 17Ad-22(e)(11): Central Securities Depositories

a. Controls To Safeguard the Rights of Securities Issuers and Holders and Prevent the Unauthorized Creation or Deletion of Securities

b. Periodic and at Least Daily Reconciliation of Securities Maintained

c. Protect Assets Against Custody Risk

d. Request for Comments

9. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems

10. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures

a. Address Allocation of Credit Losses

b. Describe Replenishment of Financial Resources

c. Test Default Procedures Annually and Following Material Changes

d. Request for Comments

11. Proposed Rule 17Ad-22(e)(14): Segregation and Portability

12. Proposed Rule 17Ad-22(e)(15): General Business Risk

a. Determining Liquid Net Assets for Recovery and an Orderly Wind-Down

b. Requirements for Liquid Net Assets

c. Plan for Raising Additional Equity

d. Request for Comments

13. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks

14. Proposed Rule 17Ad-22(e)(17): Operational Risk Management

15. Proposed Rule 17Ad-22(e)(18): Access and Participation Requirements

16. Proposed Rule 17Ad-22(e)(19): Tiered Participation Agreements

17. Proposed Rule 17Ad-22(e)(20): Links

18. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness

19. Proposed Rule 17Ad-22(e)(22): Communication Procedures and Standards

20. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures, and Market Data

a. Comprehensive Public Disclosure

b. Updates to the Comprehensive Public Disclosure

c. Request for Comments

C. Proposed Rule 17Ab2-2

1. Determination That a Registered Clearing Agency is a Covered Clearing Agency

2. Determination That a Covered Clearing Agency is Systemically Important in Multiple Jurisdictions

3. Determination That a Clearing Agency Has a More Complex Risk Profile

4. Request for Comments

D. Proposed Rule 17Ad-22(f)

E. Proposed Amendment to Rule 17Ad-22(d)

III. Paperwork Reduction Act

A. Overview and Organization

B. Summary of Collection of Information and Proposed Use of Information for Proposed Rule 17Ad-22(e) and Proposed Rule 17Ab2-2

1. Proposed Rules 17Ad-22(e)(1) Through (3): General Organization

a. Proposed Rule 17Ad-22(e)(1)

b. Proposed Rule 17Ad-22(e)(2)

c. Proposed Rule 17Ad-22(e)(3)

2. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management

a. Proposed Rule 17Ad-22(e)(4)

b. Proposed Rule 17Ad-22(e)(5)

c. Proposed Rule 17Ad-22(e)(6)

d. Proposed Rule 17Ad-22(e)(7)

3. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement

a. Proposed Rule 17Ad-22(e)(8)

b. Proposed Rule 17Ad-22(e)(9)

c. Proposed Rule 17Ad-22(e)(10)

4. Proposed Rules 17Ad-22(e)(11) Through (12): CSDs and Exchange-of-Value Settlement Systems

a. Proposed Rule 17Ad-22(e)(11)

b. Proposed Rule 17Ad-22(e)(12)

5. Proposed Rules 17Ad-22(e)(13) Through (14): Default Management

a. Proposed Rule 17Ad-22(e)(13)

b. Proposed Rule 17Ad-22(e)(14)

6. Proposed Rules 17Ad-22(e)(15) Through (17): General Business and Operational Risk Management

a. Proposed Rule 17Ad-22(e)(15)

b. Proposed Rule 17Ad-22(e)(16)

c. Proposed Rule 17Ad-22(e)(17)

7. Proposed Rules 17Ad-22(e)(18) Through (20): Access

a. Proposed Rule 17Ad-22(e)(18)

b. Proposed Rule 17Ad-22(e)(19)

c. Proposed Rule 17Ad-22(e)(20)

8. Proposed Rules 17Ad-22(e)(21) Through (22): Efficiency

a. Proposed Rule 17Ad-22(e)(21)

b. Proposed Rule 17Ad-22(e)(22)

9. Proposed Rule 17Ad-22(e)(23): Disclosure

10. Proposed Rule 17Ab2-2

C. Respondents

D. Total Annual Reporting and Recordkeeping Burden for Proposed Rule 17Ad-22(e)

1. Proposed Rules 17Ad-22(e)(1) Through (3): General Organization

a. Proposed Rule 17Ad-22(e)(1)

b. Proposed Rule 17Ad-22(e)(2)

c. Proposed Rule 17Ad-22(e)(3)

2. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management

a. Proposed Rule 17Ad-22(e)(4)

b. Proposed Rule 17Ad-22(e)(5)

c. Proposed Rule 17Ad-22(e)(6)

d. Proposed Rule 17Ad-22(e)(7)

3. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement

a. Proposed Rule 17Ad-22(e)(8)

b. Proposed Rule 17Ad-22(e)(9)

c. Proposed Rule 17Ad-22(e)(10)

4. Proposed Rules 17Ad-22(e)(11) Through (12): CSDs and Exchange-of-Value Settlement Systems

a. Proposed Rule 17Ad-22(e)(11)

b. Proposed Rule 17Ad-22(e)(12)

5. Proposed Rules 17Ad-22(e)(13) Through (14): Default Management

a. Proposed Rule 17Ad-22(e)(13)

b. Proposed Rule 17Ad-22(e)(14)

6. Proposed Rules 17Ad-22(e)(15) Through (17): General Business and Operational Risk Management

a. Proposed Rule 17Ad-22(e)(15)

b. Proposed Rule 17Ad-22(e)(16)

c. Proposed Rule 17Ad-22(e)(17)

7. Proposed Rules 17Ad-22(e)(18) Through (20): Access

a. Proposed Rule 17Ad-22(e)(18)

b. Proposed Rule 17Ad-22(e)(19)

c. Proposed Rule 17Ad-22(e)(20)

8. Proposed Rules 17Ad-22(e)(21) Through (22): Efficiency

a. Proposed Rule 17Ad-22(e)(21)

b. Proposed Rule 17Ad-22(e)(22)

9. Proposed Rule 17Ad-22(e)(23): Disclosure

10. Total Burden for Proposed Rule 17Ad-22(e)

E. Total Annual Reporting and Recordkeeping Burden for Proposed Rule 17Ab2-2

F. Collection of Information is Mandatory

G. Confidentiality

H. Request for Comments

IV. Economic Analysis

A. Introduction

B. Economic Baseline

1. Overview

2. Current Regulatory Framework for Clearing Agencies

a. Basel III Capital Requirements

b. Other Regulatory Efforts

3. Current Practices

a. General Organization

i. Legal Risk

ii. Governance

iii. Framework for the Comprehensive Management of Risks

b. Financial Risk Management

i. Credit Risk

ii. Collateral and Margin

iii. Liquidity Risk

c. Settlement

d. CSDs and Exchange-of-Value Settlement Systems

i. CSDs

ii. Exchange-of-Value Settlement Systems

e. Default Management

i. Participant-Default Rules and Procedures

ii. Segregation and Portability

f. General Business and Operational Risk Management

i. General Business Risk

ii. Custody and Investment Risks

iii. Operational Risk

g. Access

i. Access and Participation Requirements

ii. Tiered Participation Arrangements

iii. Links

h. Efficiency

i. Efficiency and Effectiveness

ii. Communication Procedures and Standards

i. Transparency

4. Determinations by the Commission

C. Consideration of Benefits, Costs, and the Effect on Competition, Efficiency, and Capital Formation

1. General Economic Considerations

a. Systemic Risk

b. Discretion

c. Market Integrity

d. Concentration

e. Qualifying CCP Status and Externalities on Clearing Members

2. Effect on Competition, Efficiency, and Capital Formation

a. Competition

b. Efficiency

c. Capital Formation

3. Effect of Proposed Amendments to Rule 17Ad-22 and Proposed Rule 17Ab2-2

a. Proposed Rule 17Ad-22(e)

i. Proposed Rule 17Ad-22(e)(1): Legal Risk

ii. Proposed Rule 17Ad-22(e)(2): Governance

iii. Proposed Rule 17Ad-22(e)(3): Comprehensive Framework for the Management of Risks

iv. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management

(1) Proposed Rule 17Ad-22(e)(4): Credit Risk

(2) Proposed Rule 17Ad-22(e)(5): Collateral

(3) Proposed Rule 17Ad-22(e)(6): Margin

(4) Proposed Rule 17Ad-22(e)(7): Liquidity Risk

(5) Testing and Validation of Risk Models

v. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement and Physical Delivery

vi. Proposed Rule 17Ad-22(e)(11): CSDs

vii. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems

viii. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures

ix. Proposed Rule 17Ad-22(e)(14): Segregation and Portability

x. Proposed Rule 17Ad-22(e)(15): General Business Risk

xi. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks

xii. Proposed Rule 17Ad-22(e)(17): Operational Risk Management

xiii. Proposed Rules 17Ad-22(e)(18) Through (20): Membership Requirements, Tiered Participation, and Linkages

(1) Proposed Rule 17Ad-22(e)(18): Member Requirements

(2) Proposed Rule 17Ad-22(e)(19): Tiered Participation Arrangements

(3) Proposed Rule 17Ad-22(e)(20): Links

xiv. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness

xv. Proposed Rule 17Ad-22(e)(22): Communication Procedures and Standards

xvi. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures, and Market Data

b. Proposed Rule 17Ab2-2

c. Proposed Rule 17Ad-22(f)

d. Quantifiable Costs and Benefits

D. Request for Comments

V. Regulatory Flexibility Act Certification

A. Registered Clearing Agencies

B. Certification

VI. Small Business Regulatory Enforcement Fairness Act

VII. Statutory Authority and Text of Amended Rule 17AD-22 and Proposed Rule 17AB2-2

I. Current Regulatory Framework for Clearing Agencies

A. Section 17A of the Exchange Act

When Congress added Section 17A to the Exchange Act as part of the Securities Acts Amendments of 1975, it directed the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions.

In Section 17A of the Exchange Act, Congress directed the Commission to have due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and maintenance of fair competition among brokers and dealers, clearing agencies, and transfer agents.

The Commission's ability to achieve these goals and its supervision of securities clearance and settlement systems is based upon the regulation of clearing agencies registered with the Commission (“registered clearing agencies”). Clearing agencies are broadly defined under the Exchange Act and undertake a variety of functions.

One such function is to act as a CCP, which is an entity that interposes itself between the counterparties to a trade.

Over the years, registered clearing agencies have become an essential part of the infrastructure of the U.S. securities markets.

Registered clearing agencies help reduce the costs and increase the safety and efficiency of securities trading and are required to be structured to manage and reduce counterparty risk.

See

15 U.S.C. 78q-1; Report of the Senate Committee on Banking, Housing & Urban Affairs, S. Rep. No. 94-75, at 4 (1975) (urging that “[t]he Committee believes the banking and security industries must move quickly toward the establishment of a fully integrated national system for the prompt and accurate processing and settlement of securities transactions”).

See

15 U.S.C. 78q-1(a)(2)(A).

Section 3(a)(23)(A) of the Exchange Act defines the term “clearing agency” to mean any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for the comparison of data regarding the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned or pledged by bookkeeping entry without physical delivery of securities certificates, or otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates.

See

15 U.S.C. 78c(a)(23)(A).

See id.; see also

Exchange Act Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219, 66221-22 (Nov. 2, 2012) (“Clearing Agency Standards Release”). An entity that acts as a CCP for securities transactions is a clearing agency as defined in the Exchange Act and is required to register with the Commission. For further discussion of the economic effects of CCPs, see

infra

notes 19, 563, and accompanying text.

See

Risk Management Supervision of Designated Clearing Entities (July 2011), Report by the Commission, the Board & CFTC to the Senate Committees on Banking, Housing & Urban Affairs and Agriculture in fulfillment of Section 813 of Title VIII of the Dodd-Frank Act, at 3 (stating that designated clearing entities “play a vital role in the proper functioning of financial markets and are increasingly important given the mandated central clearing of certain swaps and security-based swaps that is required by the [Dodd-Frank] Act”) (“Risk Management Supervision Report”).

See id.

at 12 (describing the risk management practices of designated clearing entities and the economic and legal incentives for sound risk management).

Section 17A of the Exchange Act and Rule 17Ab2-1 require entities to register with the Commission prior to performing the functions of a clearing agency.

Under the statute, the Commission is not permitted to grant registration unless it determines that the rules and operations of the clearing agency meet the standards set forth in Section 17A of the Exchange Act.

If the Commission registers a clearing agency, the Commission oversees the clearing agency to facilitate compliance with the Exchange Act using various tools that include, among other things, the rule filing process for self-regulatory organizations (“SROs”) and on-site examinations by Commission staff.

The Commission also oversees registered clearing agencies through regular contact, including onsite visits, by Commission staff with clearing agency senior management and other personnel and ongoing interactions of Commission staff with the registered

clearing agencies regarding current and expected proposed rule changes under Section 19(b) of the Exchange Act.

See

15 U.S.C. 78q-1(b) and 17 CFR 240.17Ab2-1 thereunder;

see also infra

notes 20-23 and accompanying text (noting that the Dodd-Frank Act also added new paragraphs (g), (i), and (j) to Section 17A of the Exchange Act to establish requirements for any entity that performs the functions of a clearing agency for security-based swaps).

A clearing agency can be registered with the Commission only if the Commission makes a determination that the clearing agency satisfies the requirements set forth in Section 17A(b)(3)(A) through (I) of the Exchange Act.

See

15 U.S.C. 78q-1(b)(3)(A) through (I). In 1980, the Commission published a statement of the views and positions of the Commission staff regarding the requirements of Section 17A in its Announcement of Standards for the Registration of Clearing Agencies.

See

Exchange Act Release No. 34-16900 (June 17, 1980), 45 FR 41920 (June 23, 1980).

Under the Clearing Supervision Act, the supervisory agency must consult annually with the Board regarding the scope and methodology of on-site examinations of designated FMUs, and those examinations may include participation by the Board, if requested.

See infra

note 32 and accompanying text;

see also

15 U.S.C. 78u(a) (providing the Commission with authority to initiate and conduct investigations to identify potential violations of the federal securities laws); 15 U.S.C. 78s(h) (providing the Commission with authority to institute civil actions seeking injunctive and other equitable remedies and/or administrative proceedings).

B. OTC Swaps Clearing and the Dodd-Frank Act

The Commission drew on its experience regulating clearing agencies to address recent developments in the over-the-counter (“OTC”) derivatives markets. In December 2008, the Commission acted to facilitate the central clearing of credit default swaps (“CDS”) by permitting certain entities that performed CCP services to clear and settle CDS on a temporary, conditional basis.

Consequently, some CDS transactions were centrally cleared prior to the enactment of the Dodd-Frank Act.

The Commission authorized five entities to clear CDS.

See

Exchange Act Release Nos. 60372 (July 23, 2009), 74 FR 37748 (July 29, 2009), 61973 (Apr. 23, 2010), 75 FR 22656 (Apr. 29, 2010) and 63389 (Nov. 29, 2010), 75 FR 75520 (Dec. 3, 2010) (CDS clearing by ICE Clear Europe Limited); 60373 (July 23, 2009), 74 FR 37740 (July 29, 2009), 61975 (Apr. 23, 2010), 75 FR 22641 (Apr. 29, 2010) and 63390 (Nov. 29, 2010), 75 FR 75518 (Dec. 3, 2010) (CDS clearing by Eurex Clearing AG); 59578 (Mar. 13, 2009), 74 FR 11781 (Mar. 19, 2009), 61164 (Dec. 14, 2009), 74 FR 67258 (Dec. 18, 2009), 61803 (Mar. 30, 2010), 75 FR 17181 (Apr. 5, 2010) and 63388 (Nov. 29, 2010), 75 FR 75522 (Dec. 3, 2010) (CDS clearing by Chicago Mercantile Exchange, Inc.); 59527 (Mar. 6, 2009), 74 FR 10791 (Mar. 12, 2009), 61119 (Dec. 4, 2009), 74 FR 65554 (Dec. 10, 2009), 61662 (Mar. 5, 2010), 75 FR 11589 (Mar. 11, 2010) and 63387 (Nov. 29, 2010), 75 FR 75502 (Dec. 3, 2010) (CDS clearing by ICE Trust US LLC); 59164 (Dec. 24, 2008), 74 FR 139 (Jan. 2, 2009) (temporary CDS clearing by LIFFE A&M and LCH.Clearnet Ltd.) (collectively “CDS clearing exemption orders”). LIFFE A&M and LCH.Clearnet Ltd. allowed their orders to lapse without seeking renewal.

On July 21, 2010, President Barack Obama signed the Dodd-Frank Act into law.

The Dodd-Frank Act was enacted, among other reasons, to promote the financial stability of the United States by improving accountability and transparency in the financial system.

It is intended, among other things, to bolster the existing regulatory structure and provide regulatory tools to address risks in the OTC derivatives markets, which have experienced dramatic growth in recent years and are capable of affecting significant sectors of the U.S. economy.

See

Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376 (2010).

See id.

From their beginnings in the early 1980s, the notional value of these markets grew to approximately $693 trillion globally by June 2013.

See

Bank for International Settlements (“BIS”), Statistical Release: OTC Derivatives Statistics at End-June 2013, at 2 (Nov. 2013),

available at http://www.bis.org/publ/otc_hy1311.pdf

1. Title VII of the Dodd-Frank Act

Title VII of the Dodd-Frank Act (“Title VII”) provides the Commission and the CFTC with enhanced authority to regulate certain OTC derivatives in response to the 2008 financial crisis.

Title VII provides that the CFTC will regulate “swaps,” the Commission will regulate “security-based swaps,” and both the CFTC and the Commission will regulate “mixed swaps.”

Title VII provides the Commission with new regulatory authority over security-based swaps by requiring, among other things, that security-based swaps generally be cleared and that clearing agencies for security-based swaps register with the Commission.

See

Dodd-Frank Act, 124 Stat. at 1641-1802.

Section 712(d) of the Dodd-Frank Act provides that the Commission and the CFTC, in consultation with the Board, shall further define the terms “swap,” “security-based swap,” “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” “eligible contract participant,” and “security-based swap agreement.” 124 Stat. at 1644. The Commission and the CFTC jointly adopted rules to further define the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant,” as well as rules to further define the terms “swap,” “security-based swap,” and “security-based swap agreement” and to govern the regulation of mixed swaps.

See

Exchange Act Release Nos. 34-67453 (July 18, 2012), 77 FR 48208 (Aug. 13, 2012); 34-66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012).

The swap and security-based swap markets traditionally have been characterized by privately negotiated transactions entered into by two counterparties, in which each assumes the credit risk of the other counterparty.

Title VII amended the Exchange Act to require that transactions in security-based swaps be cleared through a clearing agency if they are of a type that the Commission determines must be cleared, unless an exemption from mandatory clearing applies.

When structured and operated appropriately, clearing agencies may improve the management of counterparty risk in security-based swap markets and may provide additional benefits, such as the multilateral netting of trades.

See, e.g.,

Exchange Act Release No. 34-60372 (July 23, 2009), 74 FR 37748 (July 29, 2009), at 37748 n.2 (discussing credit default swaps).

See

15 U.S.C. 78c-3;

see also

Exchange Act Release No. 34-67286 (June 28, 2012), 77 FR 41602 (July 13, 2012) (adopting rules establishing a process for submissions for review of security-based swaps for mandatory clearing); Exchange Act Release No. 34-63556 (Dec. 15, 2010), 75 FR 79992 (Dec. 21, 2010) (proposing an end-user exception to the mandatory clearing requirement).

See

Stephen G. Cecchetti, Jacob Gyntelberg & Marc Hollanders, Central Counterparties for Over-the-Counter Derivatives, BIS Q. Rev., Sept. 2009, at 46,

available at http://www.bis.org/publ/qtrpdf/r_qt0909f.pdf

(stating that the structure of a CCP “has three clear benefits. First, it improves the management of counterparty risk. Second, it allows the CCP to perform multilateral netting of exposures as well as payments. Third, it increases transparency by making information on market activity and exposures—both prices and quantities—available to regulators and the public”) (emphasis omitted);

see also

Exchange Act Release No. 34-60372, supra note 17, at 37749 (discussing the benefits of using well-regulated CCPs to clear transactions in credit default swaps).

But see infra

note 563 and accompanying text (discussing the limits of clearing through central counterparties).

Title VII also added new provisions to the Exchange Act that require entities performing the functions of a clearing agency with respect to security-based swaps (“security-based swap clearing agencies”) to register with the Commission and require the Commission to adopt rules with respect to security-based swap clearing agencies.

Specifically, new Section 17A(j) requires the Commission to adopt rules governing security-based swap clearing agencies, and new Section 17A(i) gives the Commission authority to promulgate rules that establish standards for security-based swap clearing agencies.

Compliance with any such rules is a prerequisite to the registration of a clearing agency that clears security-based swaps with the Commission and is also a condition to maintain its continued registration.

Section 17A(i) also provides that the Commission, in establishing clearing agency standards and in its oversight of clearing agencies, may conform such standards and such oversight to reflect evolving international standards.

Before commencing any rulemaking regarding, among other things, security-based swap clearing agencies, Title VII provides that the Commission shall consult and coordinate, to the extent possible, with the CFTC and the prudential regulators for the purpose of assuring regulatory consistency and comparability, to the extent possible.

See

15 U.S.C. 78q-1(g); Dodd-Frank Act, Sec. 763(b), Public Law 111-203, 124 Stat. 1376, 1768 (2010) (adding paragraph (g) to Section 17A of the Exchange Act). Pursuant to Section 774 of the Dodd-Frank Act, the requirement in Section 17A(g) of the Exchange Act for security-based swap clearing agencies to be registered with the Commission took effect on July 16, 2011.

See

124 Stat. at 1802.

See

15 U.S.C. 78q-1(i), (j); Dodd-Frank Act, Sec. 763(b), 124 Stat. at 1768-69 (adding paragraphs (i) and (j) to Section 17A of the Exchange Act).

See supra

note 9 (describing the requirements under Section 17A(b)(3) of the Exchange Act, 15 U.S.C. 78q-1(b)(3)).

See

15 U.S.C. 78q-1(i) (stating that, in establishing standards for security-based swap clearing agencies, and in the exercise of its oversight of such a clearing agency pursuant to this title, the Commission may conform such standards or oversight to reflect evolving United States and international standards).

See

Dodd-Frank Act, Sec. 712(a)(2), 124 Stat. at 1641-42.

Title VII further provides that some of the entities that the Commission permitted to clear and settle CDS on a temporary, conditional basis prior to the

July 21, 2010 enactment of the Dodd-Frank Act are deemed under the Dodd-Frank Act to be registered clearing agencies (the “deemed registered provision”).

As a result, the Chicago Mercantile Exchange, Inc. (“CME”), ICE Clear Credit LLC (“ICE”), and ICE Clear Europe LLC (“ICEEU”) became clearing agencies deemed registered with the Commission on July 16, 2011, solely for the purpose of clearing security-based swaps.

See

15 U.S.C. 78q-1(l). The deemed registered provision applies to certain depository institutions that cleared swaps as multilateral clearing organizations and certain derivatives clearing organizations (“DCOs”) that cleared swaps pursuant to an exemption from registration as a clearing agency before the date of enactment of the Dodd-Frank Act. Under the deemed registered provision, such a clearing agency is deemed registered for the purpose of clearing security-based swaps and is therefore required to comply with all requirements of the Exchange Act, and the rules thereunder, applicable to registered clearing agencies, including, for example, the obligation to file proposed rule changes under Section 19(b) of the Exchange Act.

See infra

note 96 (describing the requirements in Section 19(b) of the Exchange Act).

2. Title VIII of the Dodd-Frank Act

The Clearing Supervision Act, adopted in Title VIII of the Dodd-Frank Act (“Title VIII”), provides for enhanced regulation of financial market utilities (“FMUs”), such as clearing agencies that manage or operate a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the FMU.

The enhanced regulatory regime in Title VIII applies only to FMUs that the FSOC designates as systemically important (or likely to become systemically important) in accordance with Section 804 of the Clearing Supervision Act.

On July 11, 2011, the FSOC published a final rule concerning its authority to designate FMUs as systemically important.

The definition of “financial market utility” in Section 803(6) of the Clearing Supervision Act contains a number of exclusions that include, but are not limited to, certain designated contract markets, registered futures associations, swap data repositories, swap execution facilities, national securities exchanges, national securities associations, alternative trading systems, security-based swap data repositories, security-based swap execution facilities, brokers, dealers, transfer agents, investment companies and futures commission merchants.

See

12 U.S.C. 5462(6)(B).

Pursuant to Section 803(9) of the Clearing Supervision Act, an FMU is systemically important if the failure of or a disruption to the functioning of such FMU could create or increase the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the U.S. financial system.

See

12 U.S.C. 5462(9).

See

76 FR 44763 (July 27, 2011). Under Section 804 of the Clearing Supervision Act, the FSOC has the authority, on a non-delegable basis and by a vote of no fewer than two-thirds of the members then serving, including the affirmative vote of its chairperson, to designate those FMUs that the FSOC determines are, or are likely to become, systemically important.

See

12 U.S.C. 5463. The FSOC may, using the same procedures as discussed above, rescind such designation if it determines that the FMU no longer meets the standards for systemic importance. Before making either determination, the FSOC is required to consult with the Board and the relevant supervisory agency (as determined in accordance with Section 803(8) of the Clearing Supervision Act).

See id.

Finally, Section 804 of the Clearing Supervision Act sets forth the procedures for giving entities a 30-day notice and the opportunity for a hearing prior to a designation or rescission of the designation of systemic importance.

See id.

Section 806(e) of the Clearing Supervision Act requires FMUs designated as systemically important to file 60 days advance notice of changes to its rules, procedures, or operations that could materially affect the nature or level of risk presented by the FMU (“Advance Notice”).

In addition, Section 806(e) requires each supervisory agency to adopt rules, in consultation with the Board, that define and describe when a designated FMU is required to file an Advance Notice with its supervisory agency.

The Commission published a final rule concerning the Advance Notice process for designated clearing agencies on June 28, 2012.

In evaluating an Advance Notice filed with the Commission, the Commission would assess, among other things, the consistency of the Advance Notice with the rules proposed herein, if adopted.

See

12 U.S.C. 5465(e)(1)(A).

Section 803(8) of the Clearing Supervision Act defines the term “supervisory agency” in reference to the primary regulatory authority for the FMU. For example, it provides that the Commission is the supervisory agency for any FMU that is a registered clearing agency.

See

12 U.S.C. 5462(8). To the extent that an entity is both a clearing agency registered with the Commission and registered with another agency, such as a DCO registered with the CFTC, the statute requires the two agencies to agree on one agency to act as the supervisory agency, and if the agencies cannot agree on which agency has primary jurisdiction, the FSOC shall decide which agency is the supervisory agency for purposes of the Clearing Supervision Act.

See

12 U.S.C. 5462(8).

See

Exchange Act Release No. 34-67286 (June 28, 2012), 77 FR 41602 (July 13, 2012).

The Clearing Supervision Act also provides for enhanced coordination between the Commission, the Board, and the CFTC by facilitating examinations and information sharing. Under Section 807 of the Clearing Supervision Act, the Commission and the CFTC must consult annually with the Board regarding the scope and methodology of any examination of a designated FMU, and the Board is authorized to participate in any such examination.

Section 809 of the Clearing Supervision Act authorizes the Commission, the Board, and the CFTC to disclose to each other copies of examination reports or similar reports regarding any designated FMU.

It further authorizes the Commission, the Board, and the CFTC to promptly notify each other of material concerns about a designated FMU and share appropriate reports, information, or data relating to such concerns.

Section 813 of the Clearing Supervision Act requires the Commission and the CFTC to coordinate with the Board to develop risk management supervision programs for designated clearing agencies.

See

12 U.S.C. 5466.

See

12 U.S.C. 5468.

See id.

See

12 U.S.C. 5472;

see also

Risk Management Supervision Report, supra note 6.

Section 805(a) of the Clearing Supervision Act

also provides that the Commission may prescribe risk management standards governing the operations related to payment, clearing, and settlement activities (“PCS activities”) of designated FMUs for which it acts as the supervisory agency, in consultation with the FSOC and the Board and taking into consideration relevant international standards and existing prudential requirements.

12 U.S.C. 5464(a).

See

12 U.S.C. 5464(a)(2) (stating that these regulations may govern the operations related to payment, clearing, and settlement activities of such designated clearing entities, and the conduct of designated activities by such financial institutions). PCS activities are defined in Section 803(7) of the Clearing Supervision Act.

See

12 U.S.C. 5462(7).

On July 18, 2012, the FSOC designated as systemically important the following registered clearing agencies: CME, The Depository Trust Company (“DTC”), Fixed Income Clearing Corporation (“FICC”), ICE, National Securities Clearing Corporation (“NSCC”), and The Options Clearing Corporation (“OCC”).

Under the Clearing Supervision Act, the Commission is the supervisory agency for DTC, FICC, NSCC, and OCC.

The

Commission jointly regulates DTC with the Board and OCC with the CFTC.

The Commission also jointly regulates CME and ICE with the CFTC, which serves as their supervisory agency.

See

U.S. Treasury Dep't, Financial Stability Oversight Council Makes First Designations in Effort To Protect Against Future Financial Crises (July 18, 2012),

http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx

;

see also

12 U.S.C. 5321 (establishing the FSOC and designating its voting and non-voting members); 12 U.S.C. 5463 (describing the designation of systemic importance by the FSOC);

supra

note 28 (describing the process by which the FSOC would make or rescind a designation of systemic importance). Section 804 of the Clearing Supervision Act, 12 U.S.C. 5463, further sets forth procedures that give entities 30 days advance notice and an opportunity for a hearing prior to being designated as systemically important.

See

FSOC, 2012 Annual Report, at app. A,

available at

http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf

See supra

note 30 (discussing designation as the supervisory agency);

see also

FSOC, 2013 Annual Report, at 99-101, 113 (further discussing the same),

available at

http://www.treasury.gov/initiatives/fsoc/Documents/FSOC%202013%20Annual%20Report.pdf

As a member of the U.S. Federal Reserve System and a limited purpose trust company under New York State banking law, DTC is subject to regulation by the Board.

In addition, the Commission jointly regulates ICEEU, which is not currently designated as systemically important by the FSOC, with the CFTC and the Bank of England.

C. Rule 17Ad-22 Under the Exchange Act

On October 22, 2012, the Commission adopted Rule 17Ad-22 under the Exchange Act.

Through Rule 17Ad-22, the Commission sought to strengthen the substantive regulation of registered clearing agencies, promote the safe and reliable operation of registered clearing agencies, and improve efficiency, transparency, and access to registered clearing agencies by establishing minimum requirements with due consideration given to observed practices and international standards.

At that time, the Commission noted that the implementation of Rule 17Ad-22 would be an important first step in developing the regulatory changes contemplated by Titles VII and VIII of the Dodd-Frank Act.

Rule 17Ad-22 requires all registered clearing agencies to establish, implement, maintain and enforce written policies and procedures that are reasonably designed to meet certain minimum requirements for their operations and risk management practices on an ongoing basis.

These requirements are designed to work in tandem with the SRO rule filing process and the requirement in Section 17A of the Exchange Act that the Commission must make certain determinations regarding a clearing agency's rules and operations for purposes of initial and ongoing registration.

Rule 17Ad-22 does not apply to entities that are operating pursuant to an exemption from registration as a clearing agency granted by the Commission,

and it does not give particular consideration to issues relevant to clearing agencies designated as systemically important FMUs.

See

Clearing Agency Standards Release,

supra

note 5.

See id.

at 66225, 66263-64.

See

Clearing Agency Standards Release,

supra

note 5, at 66225.

Rules 17Ad-22(b)(1) through (4) contain several requirements that address risk management practices by registered clearing agencies that provide CCP services. Rules 17Ad-22(b)(5) through (7) establish certain requirements regarding access to registered clearing agencies that provide CCP services. Rule 17Ad-22(c) requires that a registered clearing agency providing CCP services calculate and maintain a record of its financial resources and requires each registered clearing agency to publish annual audited financial statements. Rule 17Ad-22(d) sets forth certain minimum standards for the operations of registered clearing agencies providing CCP or central securities depository (“CSD”) services.

See infra

Part 0 (discussing the current requirements for CCPs under Rule 17Ad-22);

see also

Clearing Agency Standards Release,

supra

note 5 (adopting the existing standards under Rule 17Ad-22).

See supra

note 9 (describing the requirements under Section 17A(b)(3) of the Exchange Act, 15 U.S.C. 78q-1(b)(3)) and

infra

note 96 (further describing the Commission's framework for regulation of SROs and the SRO rule filing process).

See, e.g.,

Exchange Act Release No. 34-44188 (Apr. 17, 2001), 66 FR 20494 (Apr. 23, 2011) (the Omgeo exemption); Exchange Act Release No. 34-39643 (Feb. 11, 1998), 63 FR 8232 (Feb. 18, 1998) (the Euroclear exemption); Exchange Act Release No 34-38328 (Feb. 24, 1997), 62 FR 9225 (Feb. 28, 1997) (the Clearstream exemption).

D. Relevant International Standards

In proposing amendments to Rule 17Ad-22, the Commission considered international standards, as required by Section 805(a) of the Clearing Supervision Act, that are relevant to its supervision of covered clearing agencies.

CPSS-IOSCO published in April 2012 the PFMI Report

to replace previous standards applicable to clearing agencies contained in two earlier reports:

Recommendations for Securities Settlement Systems

(2001) (“RSSS”) and

Recommendations for Central Counterparties

(2004) (“RCCP”) (collectively “CPSS-IOSCO Recommendations”).

Commission staff participated in the development and drafting of the PFMI Report,

and the Commission believes that the standards set forth in the PFMI Report are generally consistent with the requirements applicable to clearing agencies set forth in the Exchange Act.

Regulatory authorities around the world are in various stages of updating their regulatory regimes to adopt measures that are in line with the standards set forth in the PFMI Report.

The rule

proposals set forth below are a continuation of the Commission's active efforts to foster the development of the national clearance and settlement system.

See supra

note 36. In addition, the Basel Committee on Banking Supervision (“BCBS”), the international body that sets standards for the regulation of banks, published in July 2012 the

Capital Requirements for Bank Exposures to Central Counterparties

(“Basel III capital requirements”). The Basel III capital requirements set forth interim rules governing the capital charges arising from bank exposures to CCPs related to OTC derivatives, exchange-traded derivatives, and securities financing transactions (which term, as used throughout this release, refers generally to repurchase agreements and securities lending). Among other things, the Basel III framework imposes lower capital requirements on CCPs that obtain “qualifying CCP” (“QCCP”) status and would apply QCCP status only to CCPs that are subject to a regulatory framework consistent with the standards set forth in the PFMI Report.

See

BCBS, Capital Requirements for Bank Exposures to Central Counterparties (July 2012),

available at

http://www.bis.org/publ/bcbs227.pdf

(setting forth he interim requirements set forth in this report, currently under revision by the BCBS, in consultation with CPSS and IOSCO).

See

also BCBS, Capital Treatment of Bank Exposures to Central Counterparties: Consultative Document (rev. July 2013),

available at

http://www.bis.org/publ/bcbs253.pdf

;

BIS, Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems (rev. June 2011),

available at

http://www.bis.org/publ/bcbs189.htm

(“Basel III framework”). The Basel III capital requirements are one component of the Basel III framework.

See supra

note 1.

The PFMI Report defines a “financial market infrastructure” (“FMI”) as a multilateral system among participating institutions, including the operator of the system, used for the purposes of clearing, settling, or recording payments, securities, derivatives, or other financial transactions.

See id.

at 7; FMIs include CCPs, CSDs, securities settlement systems (“SSSs”), and trade repositories (“TRs”).

Cf.

12 U.S.C. 5462(6)(B),

supra

note 30 (defining “financial market utility” under the Clearing Supervision Act).

The PFMI Report presumes that all CSDs, SSSs, CCPs, and TRs are systemically important in their home jurisdiction.

See

PFMI Report,

supra

note 1, at 131 & n.177 (noting the “presumption . . . that all CSDs, SSSs, CCPs, and TRs are systemically important because of their critical roles in the markets they serve,” but also noting that ultimately “national law will dictate the criteria to determine whether an FMI is systemically important”).

The Commission notes that the PFMI Report's definition of “financial market infrastructure” is consistent with the Commission's prior use of the term.

See

Study of Unsafe and Unsound Practices of Brokers and Dealers, H.R. Doc. No. 231, 92d Cong., 1st Sess. 13 (1971) (defining “financial market infrastructure” as a multilateral system among participating institutions, including the operator of the system, used for the purposes of clearing, settling, or recording payments, securities, derivatives, or other financial transactions).

The CPSS-IOSCO Recommendations are available at

http://www.iosco.org/library/pubdocs/pdf/IOSCOPD123.pdf

and

http://www.iosco.org/library/pubdocs/pdf/IOSCPD176.pdf

The Board applies these standards in its supervisory process and expects systemically important FMUs, as determined by the Board and subject to its authority, to complete a self-assessment against the standards set forth in the policy.

See

Financial Market Utilities, 77 FR 45907 (Aug. 2, 2012) (the Board adopting Regulation HH for FMUs) (“Reg. HH”); Policy on Payments System Risk, 72 FR 2518 (Jan. 12, 2007).

The Board has proposed to amend the standards in Regulation HH to replace the current standards for payment systems with standards based those set forth in the PFMI Report. It has also proposed to amend its Policy on Payments System Risk.

See infra

note 53.

Commission staff co-chaired the Editorial Team, a working group within CPSS-IOSCO that drafted both the consultative and final versions of the PFMI Report.

See

15 U.S.C. 78q-1; 15 U.S.C. 78s(b).

See

CPSS-IOSCO, Implementation Monitoring of PFMIs—Level 1 Assessment Report (Aug. 2013),

available at

http://www.bis.org/publ/cpss111.pdf

(describing efforts by various jurisdictions to adopt standards for FMIs in line with the PFMI Report) (“PFMI Implementation Monitoring Report”);

see also

Reg. HH,

supra

note 50; Financial Market Utilities, 79 FR 3665 (Jan. 22, 2014) (the Board proposing to amend Reg. HH) (“proposed Reg. HH”); Policy on Payment System Risk, 79 FR 2838 (Jan. 16, 2014) (the Board proposing to amend its Federal Reserve Policy on Payments System Risk) (“proposed PSR Policy”); Derivatives Clearing Organizations and International Standards, 78 FR 72475 (Dec. 2, 2013) (CFTC adopting rules for DCOs

in line with international standards) (“DCO Int'l Standards Release”); Enhanced Risk Management Standards for Systemically Important Derivatives Clearing Organizations, 78 FR 49663 (Aug. 15, 2013) (CFTC adopting rules for systemically important DCOs) (“SIDCO Release”); Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 2011) (CFTC adopting rules for DCOs); (“DCO Principles Release”).

In addition, the Board and the Office of the Comptroller of the Currency have adopted rules implementing the material elements of the BCBS interim framework for capitalization of bank exposures to CCPs.

See

Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 76 FR 62017, 62099 (Oct. 11, 2013) (“Regulatory Capital Rules”). The Board also noted the ongoing international discussions on this topic and stated that it intends to revisit its rules once the Basel III capital framework is revised.

See id.

The Board and the Office of the Comptroller of the Currency's final rules define “QCCP” to mean, among other things, a designated FMU under the Clearing Supervision Act.

See

12 CFR 217.2;

see also

Regulatory Capital Rules,

supra,

at 62100.

II. Discussion of the Proposed Amendments to Rule 17Ad-22 and Proposed Rule 17Ab2-2

The Commission is proposing to amend Rule 17Ad-22 and add Rule 17Ab2-2 pursuant to Section 17A of the Exchange Act and the Clearing Supervision Act to provide a new regulatory framework for “covered clearing agencies,” as defined below.

Generally, Section 17A directs the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions, having due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and the maintenance of fair competition among brokers and dealers.

It further requires that a clearing agency be so organized and have the capacity and rules designed to, among other things, facilitate the prompt and accurate clearance and settlement of securities transactions, and to comply with the provisions of the Exchange Act and the rules and regulations thereunder.

In establishing a regulatory framework for clearance and settlement, the Exchange Act requires that a registered clearing agency's rules not impose any burden on competition not necessary or appropriate in the furtherance of the purposes of the Exchange Act.

See

15 U.S.C. 78q-(a)(2)(A).

See

15 U.S.C. 78q-1(a)(3)(A), (F).

See

15 U.S.C. 78q-1(b)(3)(I).

Consistent with these statutory objectives, the Commission previously adopted Rule 17Ad-22(d) to establish minimum requirements for registered clearing agencies and indicated that it might consider further rulemaking at a later date.

In furtherance of the provisions of Section 17A of the Exchange Act and the Clearing Supervision Act described above and as previously considered by the Commission, the Commission is proposing Rule 17Ad-22(e) to establish new requirements for covered clearing agencies, which the Commission preliminarily believes are appropriate given the risks that their size, operation, and importance pose to the U.S. securities markets, the risks inherent in the products they clear, and the goals of Title VII and the Exchange Act.

In connection with its supervision of registered clearing agencies under Section 17A of the Exchange Act, including after the adoption of Rule 17Ad-22,

the Commission has considered whether enhanced requirements for covered clearing agencies could contribute to the stability of U.S. securities markets, as described further in Part IV, and has determined to issue this proposal for comment.

See

Clearing Agency Standards Release,

supra

note 5, at 66224-25.

See id.

(contemplating future Commission action on clearing agency standards).

See

Clearing Agency Standards Release,

supra

note 5, at 66227 (stating that Rule 17Ad-22 generally codifies existing practices that reflect the CPSS-IOSCO Recommendations published in 2001 and 2004).

The Commission has preliminarily chosen to retain Rule 17Ad-22(d) and to continue to apply it to registered clearing agencies that are not covered clearing agencies.

The Commission preliminarily believes that retaining Rule 17Ad-22(d) ensures that clear, comprehensive, and transparent standards for registered clearing agencies that are not covered clearing agencies will continue to exist and, because they are narrower in scope, would thereby provide a more flexible regime for new entrants seeking to establish and operate registered clearing agencies, consistent with the continuing development of the national system for clearance and settlement, than would otherwise be the case with a single regime under proposed Rule 17Ad-22(e).

See infra

Part 0 (discussing the proposed language amending Rule 17Ad-22(d) to apply to registered clearing agencies that are not covered clearing agencies).

The Commission notes that it is not proposing to alter the existing requirements under Rule 17Ad-22(b), which establishes risk-management and participant access requirements for registered clearing agencies that perform CCP services for security-based swaps, or Rule 17Ad-22(c), which requires registered clearing agencies that provide CCP services to maintain a record of financial resources and all registered clearing agencies to post on their Web sites annual audited financial statements.

These requirements continue to be appropriate for all registered clearing agencies because they promote prompt and accurate clearance and settlement of securities and security-based swap transactions. Notably, Rule 17Ad-22(b) reduces the likelihood, in a participant default scenario, that losses from default would disrupt the operations of the clearing agency, and Rule 17Ad-22(c) provides an additional layer of information about the activities and financial strength of a registered clearing agency that market participants may find useful in assessing their use of the registered clearing agency's services while also assisting the Commission in its oversight of registered clearing agencies' compliance with Rule 17Ad-22 by providing a clear record of the method used by the clearing agency to, among other things, maintain sufficient financial resources.

The standards in Rules 17Ad-22(b) and (c) were also adopted by the Commission in 2012.

See

17 CFR 240.17Ad-22(b), (c);

see also

Clearing Agency Standards Release,

supra

note 5.

The Commission is proposing to revise Rule 17Ad-22(a) to account for new proposed definitions.

See

proposed revision of Rule 17Ad-22(a),

infra

Part 0. The existing definitions in 17 CFR 240.17Ad-22(a) would be renumbered to account for new terms. In addition, the definition of “participant family” would be amended to include references to its use in proposed paragraphs (e)(4) and (e)(7).

See

proposed Rule 17Ad-22(a)(13),

infra

Part 0.

See

Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR 14474, 14477-83 (Mar. 16, 2011);

see also

Clearing Agency Standards Release,

supra

note 5, at 66244.

A. Overview

The Commission is proposing Rule 17Ad-22(e) to establish requirements for covered clearing agencies with respect to general organization,

financial risk management,

settlement,

CSDs and exchange-of-

value settlement systems,

default management,

general business risk and operational risk management,

access,

efficiency,

and transparency.

The discussion below provides greater detail regarding each respective requirement in proposed Rule 17Ad-22(e). Several aspects of proposed Rule 17Ad-22(e) are similar to existing Rule 17Ad-22(d),

but in general the Commission preliminarily notes that certain requirements under proposed Rule 17Ad-22(e) would require covered clearing agencies to consider and adopt policies and procedures more closely tailored to the risks that are posed by covered clearing agencies, which the Commission preliminarily identified as appropriate in connection with its experience in supervising registered clearing agencies under Section 17A of the Exchange Act, including since the adoption of Rule 17Ad-22.

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(1) (legal risk), 17Ad-22(e)(2) (governance), and 17Ad-22(e)(3) (framework for the comprehensive management of risk)).

See infra

Part 0 (discussing proposed Rules 17Ad-22(e)(4) (credit risk), 17Ad-22(e)(5) (collateral), 17Ad-22(e)(6) (margin), and 17Ad-22(e)(7) (liquidity risk)).

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(8) (settlement finality), 17Ad-22(e)(9)

(money settlements), and 17Ad-22(e)(10) (physical delivery risks)).

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(11) (CSDs) and 17Ad-22(e)(12) (exchange-of-value settlement systems)).

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(13) (participant-default rules and procedures) and 17Ad-22(e)(14) (segregation and portability)).

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(15) (general business risk), 17Ad-22(e)(16) (custody and investment risk), and 17Ad-22(e)(17) (operational risk management)).

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(18) (access and participation requirements), 17Ad-22(e)(19) (tiered participation arrangements), and 17Ad-22(e)(20) (links)).

See infra

Parts 0-0 (discussing proposed Rules 17Ad-22(e)(21) (efficiency and effectiveness) and 17Ad-22(e)(22) (communication procedures and standards)).

See infra

Part 0 (discussing proposed Rule 17Ad-22(e)(23) (disclosure of rules, key procedures, and market data)).

See infra

Part 0 (discussing the anticipated impact of proposed Rule 17Ad-22(e) given the existing requirements for registered clearing agencies under Rule 17Ad-22).

The Commission preliminarily believes that the requirements of proposed Rule 17Ad-22(e) would help promote governance, operations, and risk management practices more closely tailored to the risks raised by registered clearing agencies that have been designated systemically important, are engaged in activities with a more complex risk profile, or are determined to be covered clearing agencies by the Commission, consistent with Section 17A of the Exchange Act. The Commission preliminarily believes these requirements would also enable consistent supervision of designated FMUs and would reflect the Commission's consideration of international standards, as contemplated by Section 17A(i) and the Clearing Supervision Act.

While the Commission has made its own determination to issue the proposed rules for comment, the Commission preliminarily believes that generally updating its rules, where appropriate, to take into account the standards set forth in the PFMI Report would contribute to the efforts of regulators around the world, described above,

to implement consistent standards for FMIs.

The Commission also preliminarily believes that Rule 17Ad-22(e) would provide an additional benefit of providing support for a determination by foreign bank regulators that covered clearing agencies providing CCP services for derivatives and securities financing transactions meet the requirements for QCCP status under the Basel III framework and could therefore help reduce competitive frictions among CCPs in different jurisdictions.

See supra

Part 0, in particular notes 36-37 and accompanying text (discussing the requirements under Section 17A(i) of the Exchange Act, 15 U.S.C. 78q-1(i), and Section 805(a) of the Clearing Supervision Act, 12 U.S.C. 5464(a)).

See supra

note 53 and accompanying text.

See infra

Part 0 (further discussing the economic effects of obtaining QCCP status under the Basel III capital requirements);

see also

12 U.S.C. 5462(6) (defining “financial market utility” pursuant to the Clearing Supervision Act);

supra

note 26 (providing further explanation of “financial market utility”).

See

proposed Rule 17Ad-22(a)(8),

infra

Part 0.

Rule 17Ad-22 does not currently apply to entities operating pursuant to an exemption from clearing agency registration. The proposed amendments to Rule 17Ad-22 would not broaden the scope of Rule 17Ad-22 to an entity operating pursuant to an exemption from registration as a clearing agency granted by the Commission.

See

proposed Rule 17Ad-22(a)(4),

infra

Part 0.

The Commission is proposing Rule 17Ab2-2 to establish a process for making determinations regarding clearing agencies involved in activities with a more complex risk profile.

See infra

Part 0 (further discussing the purpose, scope, and application of proposed Rule 17Ab2-2) and Part 0 (proposed text of Rule 17Ab2-2).

The Commission is also proposing Rule 17Ad-22(a)(16) to define “security-based swap” to mean security-based swap as defined in Section 3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68).

See infra

Part 0.

See

proposed Rule 17Ad-22(a)(4),

infra

Part 0.

The Commission preliminarily believes there could be several different bases under which registered clearing agencies would be required to comply with proposed Rule 17Ad-22(e). For instance, because DTC, FICC, NSCC, and OCC are registered clearing agencies pursuant to Section 17A of the Exchange Act and are designated clearing agencies for which the Commission is the supervisory agency under the Clearing Supervision Act,

they would be covered clearing agencies under proposed Rule 17Ad-22(a)(7) and would be subject to the requirements for covered clearing agencies in proposed Rule 17Ad-22(e). In addition, because ICEEU provides CCP services for security-based swaps and has been deemed registered with the Commission as a security-based swap clearing agency,

it would be a complex risk profile clearing agency under proposed Rule 17Ad-22(a)(4) and also subject to the requirements for covered clearing agencies proposed in Rule 17Ad-22(e).

See supra

Part 0.

See supra

note 41 and accompanying text.

By comparison, CME and ICE would not be subject to the proposed requirements for covered clearing agencies in Rule 17Ad-22(e) because (i) they have been designated as systemically important FMUs under Section 804 of the Clearing Supervision Act;

(ii) they are each dually registered with the Commission and the CFTC as a clearing agency and DCO, respectively; and (iii) the CFTC is their supervisory agency under the Clearing Supervision Act.

The Commission preliminarily believes that, because CME and ICE would be subject to the CFTC's requirements for systemically important DCOs,

applying proposed Rule 17Ad-22(e) to them could impose duplicative requirements. Given the Commission's existing regulatory authority under Section 17A(l) of the Exchange Act,

however, CME and ICE would remain subject to the continuing requirements for registered clearing agencies in Rules 17Ad-22(b) through (d).

See

12 U.S.C. 5463.

See supra

Part 0;

see also

FSOC, 2013 Annual Report,

supra

note 39, at 100.

See supra

note 41 and accompanying text.

See

15 U.S.C. 78q-1(l).

Two dormant clearing agencies, the Stock Clearing Corporation of Philadelphia (“SCCP”) and the Boston Stock Exchange Clearing Corporation (“BSECC”), have not been designated systemically important by the FSOC and are not involved in activities with a more complex risk profile.

Accordingly, each would also remain subject to the requirements in Rules 17Ad-22(b) through (d).

In 2008, NASDAQ OMX Group, Inc. acquired SCCP and BSECC.

See

Exchange Act Release No. 34-58324 (Aug. 7, 2008), 73 FR 46936 (Aug. 12, 2008) (order approving acquisition of BSECC); Exchange Act Release No. 34-58180 (July 17, 2008), 73 FR 42890 (July 23, 2008) (order approving acquisition of SCCP).

Both SCCP and BSECC are currently registered with the Commission as clearing agencies but conduct no clearing or settlement activities.

See

Exchange Act Release No. 34-63629 (Jan. 3, 2011), 76 FR 1473 (Jan. 10, 2011); Exchange Act Release No. 34-63268 (Nov. 8, 2010), 75 FR 69730 (Nov. 15, 2010).

Further, proposed Rule 17Ab2-2 would provide the Commission flexibility to determine that the operations or circumstances of a registered clearing agency, including a registered clearing agency that is exempt from certain requirements applicable to registered clearing agencies generally, warrant designation as a covered clearing agency.

It would also provide flexibility to make determinations regarding newly registered clearing agencies.

See infra

Parts 0 and 0 (discussing determinations under proposed Rule 17Ab2-2 and providing rule text, respectively).

The Commission preliminarily believes the requirements proposed in Rule 17Ad-22(e) aid the regulation of covered clearing agencies by, as noted above, establishing requirements more closely tailored to the risks they pose to the U.S. securities markets. For example, designated clearing agencies are systemically important because of their significance to the U.S. financial system and the risk that the failure of, or a disruption to, their functioning would increase the risk of significant liquidity or credit problems spreading among financial institutions, thereby threatening the stability of the U.S. financial system.

Similarly, the Commission preliminarily believes that complex risk profile clearing agencies, such as those providing CCP services for security-based swaps, subject the U.S. securities markets to a material level of systemic risk due to the nature of the products that they clear.

The requirements proposed in Rule 17Ad-22(e) are intended to ensure that covered clearing agencies have robust policies and procedures that help promote sound governance, operations, and risk management.

See supra

note 27 and accompanying text.

See generally

Gov't Accountability Office, Systemic Risk: Regulatory Oversight and Recent Initiatives to Address Risk Posed by Credit Default Swaps (Mar. 2009),

available at http://www.gao.gov/new.items/d09397t.pdf

As noted above,

the Commission preliminarily believes that establishing separate rules for covered clearing agencies and registered clearing agencies that are not covered clearing agencies is appropriate given the Commission's goals to facilitate the development of a national system for the prompt and accurate clearance and settlement of securities consistent with Section 17A of the Exchange Act and to mitigate systemic risk consistent with Titles VII and VIII of the Dodd-Frank Act.

In this regard, the Commission intends that Rule 17Ad-22(d) would continue to provide minimum requirements for the operation and governance of registered clearing agencies that also facilitate the entrance of new participants, as appropriate, into the market for clearance and settlement services.

The Commission preliminarily believes that Rule 17Ad-22(e) would establish new requirements for established participants in the market for clearance and settlement services commensurate to the risks that their size, operation, and importance pose to the U.S. securities markets.

See supra

notes 54-61 and accompanying text.

See supra

notes 2, 13-14, and accompanying text (noting the goals of, respectively, Section 17A of the Exchange Act and the Dodd-Frank Act).

See supra

note 43 and accompanying text (noting the Commission's intent in adopting Rule 17Ad-22 in the Clearing Agency Standards Release).

See supra

note 44 and accompanying text (noting further that the requirements adopted under Rule 17Ad-22 constituted an important first step to enhance the substantive regulation of registered clearing agencies pursuant to the Dodd-Frank Act);

see also infra

Part 0 (addressing systemic risk in the context of discussing the general economic considerations undertaken by the Commission in proposing Rule 17Ad-22(e)).

Request for Comments.

The Commission generally requests comments on all aspects of the scope of proposed Rule 17Ad-22(e), the relationship between proposed Rule 17Ad-22(e) and Rule 17Ad-22(d), and on proposed Rules 17Ad-22(a)(4), (7), (8), and (9). In addition, the Commission requests comments on the following specific issues:

• Is the scope of proposed Rule 17Ad-22(e) appropriate? Why or why not? Is the scope sufficiently clear? Why or why not? Has the Commission provided sufficient guidance regarding the scope of the proposed rule? Are there aspects of the scope of the proposed rule for which the Commission should consider providing additional guidance? If so, please explain.

• Given that all non-dormant registered clearing agencies would either be covered clearing agencies subject to Commission supervision or be subject to CFTC regulation as designated clearing entities for which the CFTC is the supervisory agency, should the Commission replace the existing requirements under Rule 17Ad-22(d) with the requirements proposed under Rule 17Ad-22(e)? Why or why not?

• Is the Commission's proposed definition of “financial market utility” appropriate and sufficiently clear given the proposed requirements? Why or why not? Should the definition be modified? If so, how? Is there an

alternative definition the Commission should consider?

• Is the Commission's proposed definition of “designated clearing agency” appropriate and sufficiently clear given the requirements proposed? Why or why not? Should the definition be modified? If so, how? Is there an alternative definition the Commission should consider?

• Is the Commission's proposed definition of “clearing agency involved in activities with a more complex risk profile” appropriate and sufficiently clear given the requirements proposed? Why or why not? Should the definition be modified? If so, how? Is there an alternative definition the Commission should consider?

• Is the Commission's proposed definition of “covered clearing agency” appropriate and sufficiently clear given the requirements proposed? Why or why not? Should the definition be modified? If so, how? Is there an alternative definition the Commission should consider?

• Are the requirements in proposed Rule 17Ad-22(e) necessary, or do the existing provisions in Rule 17Ad-22(d) already sufficiently address the issues identified in this release as justification for increased regulation?

2. Role of Written Policies and Procedures

Proposed Rule 17Ad-22(e) would require covered clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, fulfill the requirements set forth in paragraphs (e)(1) through (23) of the proposed rule. The Commission preliminarily believes that this approach would facilitate the Commission's supervision of covered clearing agencies, is appropriate given their role as SROs,

and is consistent with the approach taken by the Commission elsewhere in Rule 17Ad-22.

The Commission preliminarily believes that, by requiring written policies and procedures and, where appropriate, their disclosure, proposed Rule 17Ad-22(e) should help promote the development of improved standards for clearing agencies by allowing market participants to compare certain of the operations of covered clearing agencies with those of other clearing entities, which choose to make their policies and procedures publicly available or are required to do so by equivalent regulatory standards.

Registered clearing agencies are SROs as defined in Section 3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26). After a clearing agency has been registered with the Commission, the clearing agency, as an SRO, must submit most proposed rule changes to the Commission, for approval pursuant to Rule 19b-4 under the Exchange Act. A stated policy, practice, or interpretation of an SRO, such as a clearing agency's written policies and procedures, would generally be deemed to be a proposed rule change.

See

17 CFR 240.19b-4.

See

Clearing Agency Standards Release,

supra

note 5, at 66228-29 (describing the scope of Rule 17Ad-22 at adoption).

Compare

proposed Rule 17Ad-22(e)(23),

infra

Part 0 (requiring public disclosure of, among other things, a covered clearing agency's rules, policies, and procedures)

with

proposed Reg. HH,

supra

note 53, at 3666-67, 3686-88, 3693 (the Board proposing disclosure requirements intended to be in line with the PFMI Report in Sec. 234.3(a)(23)); DCO Int'l Standards Release,

supra

note 53, at 72493-94, 72521 (CFTC adopting disclosure requirements intended to be in line with the PFMI Report in Sec. 39.37).

The Commission is proposing to require policies and procedures developed by each covered clearing agency to fulfill the requirements of proposed Rule 17Ad-22(e) because the Commission preliminarily believes that it is important to allow covered clearing agencies enough flexibility to use their market experience and understanding of their institutions to shape the rules, policies, and procedures implementing proposed Rule 17Ad-22(e). This proposed approach is consistent with the Commission's established approach for supervising SROs, and the Commission preliminarily believes continuing this practice under Rule 17Ad-22(e) will allow the Commission to continue to perform its supervisory function through the SRO rule filing process under Section 19(b) of the Exchange Act and Rule 19b-4,

periodic inspections and examinations, other monitoring of the activities of registered clearing agencies, and other established supervisory processes. Because of the importance the Commission gives to both maintaining clearing agency flexibility and to existing oversight mechanisms, the Commission preliminarily believes that the proposed approach is appropriate.

See supra

note 96 (describing requirements for SROs under the Exchange Act and Rule 19b-4).

The Commission anticipates that a covered clearing agency's rules, policies, and procedures will need to evolve over time so that it can adequately respond to changes in technology, legal requirements, the needs of its members and their customers, trading volumes, trading practices, linkages between financial markets, and the financial instruments traded in the markets that a covered clearing agency serves. Accordingly, the Commission preliminarily believes that covered clearing agencies should continually evaluate and make appropriate updates and improvements to their operations and risk management practices to facilitate prompt and accurate clearance and settlement.

3. Frequency of Review Required Under Certain Policies and Procedures

Many of the policies and procedures requirements proposed in Rule 17Ad-22(e) specify a frequency of review. Generally, the proposed regularity of review falls into three categories— daily, monthly, or annually—and is based on the Commission's understanding of the current review practices generally at covered clearing agencies. The Commission's rationale for these differences is as follows:

•

Daily:

For those activities that the Commission understands to be directly related to the day-to-day operations of a covered clearing agency,

100

such as activities related to the calculation and collection of margin, the Commission preliminarily believes that a covered clearing agency should undertake a daily review and make decisions on a daily basis;

100

See

proposed Rules 17Ad-22(e)(4)(vi)(A); 17Ad-22(e)(6)(ii); 17Ad-22(e)(6)(vi)(A); 17Ad-22(e)(7); 17Ad-22(e)(7)(vi)(A); and 17Ad-22(e)(11)(ii),

infra

Part 0.

•

Monthly:

For those activities that the Commission understands to coincide with and complement the review and reporting cycles of the governance structures related to the risk management function of the covered clearing agency,

101

the Commission preliminarily believes that a covered clearing agency should undertake a monthly review; based on its supervisory experience, the Commission notes that well-functioning risk management committees of the board and similar management committees or other board or management committees commonly meet or receive reports and other risk management information from management on a monthly basis and the monthly requirement would be consistent with such meeting and reporting frequency;

101

See

proposed Rules 17Ad-22(e)(4)(vi)(B); 17Ad-22(e)(4)(vi)(C); 17Ad-22(e)(6)(vi)(B); 17Ad-22(e)(6)(vi)(C); 17Ad-22(e)(7)(vi)(B); and 17Ad-22(e)(7)(vi)(C),

infra

Part 0.

•

Annually:

For those activities that are less integral to day-to-day operations, involve issues that merit review of information collected over longer time periods, or require more high-level review and consideration by, for example, the full board of directors of a clearing agency,

102

the Commission

preliminarily believes that a covered clearing agency should undertake an annual review; additionally, the Commission preliminary believes that an annual cycle is appropriate in certain instances because other major reviews such as auditing of the financial statements of registered clearing agencies and their disclosure are required to occur on an annual basis.

102

See

proposed Rules 17Ad-22(e)(3)(i); 17Ad-22(e)(4)(vii); 17Ad-22(e)(5); 17Ad-22(e)(6)(vii); 17Ad-22(e)(7)(v); 17Ad-22(e)(7)(vii); 17Ad-22(e)(7)(x); 17Ad-22(e)(13)(iii); and 17Ad-22(e)(15)(iii),

infra

Part 0.

Request for Comments.

The Commission generally requests comments on all aspects of the frequency of review that would be required to be included in a covered clearing agency's policies and procedures under each of the requirements in proposed Rule 17Ad-22(e). In addition, the Commission requests comments on whether its assessment of daily, monthly, and annual activities at covered clearing agencies is accurate and appropriate given the proposed rules. The Commission also requests comment on what factors should be considered in determining the nature, timing, and extent of the required reviews and whether other frequencies of review might be appropriate under some or all of the proposed rules.

4. Anticipated Impact of Proposed Rule 17Ad-22(e)

Based on the Commission's experience supervising registered clearing agencies, and given the current requirements applicable to registered clearing agencies under Rule 17Ad-22, the Commission preliminarily anticipates that the degree of changes that covered clearing agencies may need to make to their policies and procedures to satisfy the proposed requirements of Rule 17Ad-22(e) would vary among the particular provisions of the proposed rule and depend in part on the business model and operations of the clearing agency itself, as discussed below. The Commission preliminarily believes that, for the provisions in its proposal where a similar existing requirement has been identified, covered clearing agencies may need to make only limited changes to update their policies and procedures, and the table below provides summary information regarding the Commission's preliminary assessment of the impact of the proposed rules:

Proposed requirement

Existing requirement

Rule 17Ad-22(e)(1)

Rule 17Ad-22(d)(1).

Rule 17Ad-22(e)(2)

Rule 17Ad-22(d)(8).

Rule 17Ad-22(e)(3)

None.

Rule 17Ad-22(e)(4)

Rules 17Ad-22(b)(1), (b)(3), (d)(14).

103

Rule 17Ad-22(e)(5)

None.

Rule 17Ad-22(e)(6)

Rules 17Ad-22(b)(2), (b)(4).

104

Rule 17Ad-22(e)(7)

None.

Rule 17Ad-22(e)(8)

Rule 17Ad-22(d)(12).

Rule 17Ad-22(e)(9)

Rule 17Ad-22(d)(5).

Rule 17Ad-22(e)(10)

Rule 17Ad-22(d)(15).

Rule 17Ad-22(e)(11)

Rule 17Ad-22(d)(10).

Rule 17Ad-22(e)(12)

Rule 17Ad-22(d)(13).

Rule 17Ad-22(e)(13)

Rule 17Ad-22(d)(11).

Rule 17Ad-22(e)(14)

None.

Rule 17Ad-22(e)(15)

None.

Rule 17Ad-22(e)(16)

Rule 17Ad-22(d)(3).

Rule 17Ad-22(e)(17)

Rule 17Ad-22(d)(4).

Rule 17Ad-22(e)(18)

Rules 17Ad-22(b)(5) through (7), (d)(2).

Rule 17Ad-22(e)(19)

None.

Rule 17Ad-22(e)(20)

Rule 17Ad-22(d)(7).

Rule 17Ad-22(e)(21)

Rule 17Ad-22(d)(6).

Rule 17Ad-22(e)(22)

None.

Rule 17Ad-22(e)(23)

Rule 17Ad-22(d)(9).

103

The Commission notes that requirements under Rules 17Ad-22(b) apply only to registered clearing agencies that provide CCP services, the “cover two” requirement under Rule 17Ad-22(b)(3) applies only to registered clearing agencies that provide CCP services for security-based swaps, and requirements under Rule 17Ad-22(d)(14) apply only to registered clearing agencies that provide CSD services.

See infra

Part 0 (discussing, among other things, the relationship between existing requirements under Rule 17Ad-22 and proposed Rule 17Ad-22(e)(4));

see also

17 CFR 240.17Ad-22; Clearing Agency Standards Release,

supra

note 5.

104

The Commission notes that the relevant requirement in Rule 17Ad-22(b)(4) concerns policies and procedures regarding an annual model validation for margin models while proposed Rule 17Ad-22(e)(6) would impose, in addition to requiring policies and procedures regarding an annual model validation for margin models, additional requirements that do not appear in Rule 17Ad-22(b)(4).

See infra

Part 0 (discussing the requirements under proposed Rule 17Ad-22(e)(6)).

With respect to the provisions in its proposal where no similar existing requirement has been identified, the Commission preliminarily anticipates that covered clearing agencies may need to make more extensive changes to their policies and procedures (or implement new policies and procedures), and may need to take other steps, to satisfy the proposed requirements of Rule 17Ad-22(e).

For further discussion of the anticipated impact and costs and benefits of proposed Rule 17Ad-22(e), see Part IV.C.

5. General Request for Comments

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(e) and on all aspects of the definitions included in proposed Rule 17Ad-22(a), as discussed in more detail in Part II.B.

105

In addition, the Commission requests comments on the following issues:

105

Part 0 also contains additional requests for comments on each proposed rule regarding particular issues specific to each proposed rule.

• Is each aspect of proposed Rules 17Ad-22(e)(1) through (23), including any terms used therein, sufficiently clear given the proposed requirements? Why or why not? Has the Commission provided sufficient guidance as to the meaning of each provision of the proposed rules? Are there aspects of the proposed rules for which the Commission should consider providing additional guidance? If so, please explain.

• Are the Commission's definitions in proposed Rule 17Ad-22(a) accurate, appropriate, and sufficiently clear? Why or why not? Should the definitions be

modified? If so, how? Should the Commission adopt alternative definitions than those proposed? Are there additional terms used in Rule 17Ad-22(e) that should be defined? Please explain.

• Is the Commission's use of certain terms it believes to be commonly understood (

e.g.,

“high degree of confidence” or “due diligence”) appropriate and accurate? Why or why not?

• Would the proposed rules require covered clearing agencies to change their current practices? If so, how? What are the expected costs and benefits to covered clearing agencies in connection with adding or revising their current practices with respect to the implementation of the Commission's proposed rules?

106

For a complete discussion of the anticipated economic effect of the proposed rules, see Part 0.

• Should the Commission consider an alternative approach with respect to written policies and procedures included in the proposed rules? Why or why not? If so, what alternative approaches should the Commission consider? Please explain in detail.

• Should the Commission's proposed rules be less or more prescriptive? Why or why not? If so, what alternative approaches should the Commission consider? Please explain in detail.

• Are there any other factors that the Commission should take into consideration with respect to the requirements of the proposed rules?

• Should there be a phase-in period with respect to any of the requirements of proposed Rule 17Ad-22(e)? If so, what should the phase-in periods be? What facts and circumstances should the Commission consider in evaluating whether to adopt a potential phase-in period? Please explain in detail.

• Could the proposed rules affect the ability of covered clearing agencies to compete for certain types of business either within the United States or internationally? If so, how? Please provide specific examples and data.

• Are there significant operational or legal impediments to implementing the proposed rules? Would the proposed rules impact the ability of covered clearing agencies to clear certain products? Are any additional rules or regulations needed to facilitate compliance with the proposed rules?

• Are there any requirements under existing Rule 17Ad-22 that could be viewed as being consistent with the PFMI standards without being supplemented or replaced by new requirements in proposed Rule 17Ad-22(e)? Please explain in detail.

B. Proposed Rule 17Ad-22(e)

1. Proposed Rule 17Ad-22(e)(1): Legal Risk

Proposed Rule 17Ad-22(e)(1) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions.

107

Rule 17Ad-22(d)(1) currently requires a registered clearing agency's policies and procedures to meet substantially the same requirement.

108

Because the requirements under Rule 17Ad-22(d)(1) and proposed Rule 17Ad-22(e)(1) are substantially the same, the Commission anticipates that covered clearing agencies may need to make only limited changes to update their policies and procedures to comply with the proposed rule.

109

107

See

proposed Rule 17Ad-22(e)(1),

infra

Part 0.

The Commission preliminarily believes that (i) the United States is the relevant jurisdiction for covered clearing agencies that perform the functions of a clearing agency in the United States for purposes of Rule 17Ad-22(e)(1), and (ii) that covered clearing agencies operating in multiple jurisdictions would be required to address any conflicts of laws issues that they may encounter.

108

Rule 17Ad-22(d)(1) requires a registered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for a well-founded, transparent, and enforceable legal framework for each aspect of its activities in all relevant jurisdictions.

See

17 CFR 240.17Ad-22(d)(1);

see also

Clearing Agency Standards Release,

supra

note 5, at 66245-46.

109

See supra

Part 0.

Consistent with the Exchange Act requirements discussed above,

110

the Commission is proposing Rule 17Ad-22(e)(1) to require that a covered clearing agency have a legal basis for each aspect of its activities in all relevant jurisdictions. The legal framework for a particular clearing agency may cover a broad array of areas and issues, in particular including but not limited to its (i) organizational and governance documents, such as its charter, bylaws, and any charters for board and management committees;

111

(ii) rules, policies, and procedures,

112

including those regarding settlement finality, netting,

113

default of a member, margin, collateral,

114

payments, obligations to the participant or default fund, eligibility and participation requirements for members, and recovery and wind-down plans; (iii) contracts (notably including with service providers, settlement banks and liquidity providers); (vi) its use of novation or similar legal devices;

115

and (vii) service restrictions that may be imposed on participants such as restrictions on activities or access.

110

See

notes 54-56 and accompanying text;

see also

Parts 0 and 0 (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act).

111

The role of governance arrangements in promoting effective risk management has also been a focus of rules proposed by the Commission to mitigate conflicts of interest at certain registered clearing agencies.

See

Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011) (proposing Rule 17Ad-23 to address conflicts of interest and Rule 17Ad-26 to require standards for board members or board committee directors at registered clearing agencies); Exchange Act Release No. 34-63107 (Oct. 14, 2010), 75 FR 65881, 65893 (Oct. 26, 2010) (proposing Regulation MC to mitigate conflicts of interest at security-based swap clearing agencies).

112

See supra

note 96 (describing the requirements in Section 19(b) of the Exchange Act).

113

Netting offsets obligations between or among participants in the netting arrangement, thereby reducing the number and value of payments or deliveries needed to settle a set of transactions. Netting can reduce potential losses in the event of a participant default and may reduce the probability of a default. Netting arrangements can differ as to both timing and the parties to the arrangement: (i) Certain netting arrangements net payments or other contractual obligations resulting from market trades (or both) on a continuous basis, while others close-out payments or obligations when an event such as insolvency occurs; and (ii) netting arrangement may net obligations bilaterally among two parties or multilaterally among multiple parties.

114

Collateral arrangements may involve either a pledge or a title transfer. Therefore, regarding pledged assets, a covered clearing agency would examine the degree of legal certainty that a pledge has been validly created in the relevant jurisdiction and, as appropriate, validly perfected. Regarding transfer of title to assets, a covered clearing agency would examine the degree of legal certainty that the transfer is validly created in the relevant jurisdiction and will be enforced.

115

Novation enables a clearing agency to act as a CCP. In novation, the original contract between the buyer and seller is discharged and two new contracts are created, one between the CCP and the buyer and the other between the CCP and the seller. The CCP thereby assumes the original parties' contractual obligations to each other. Legal certainty regarding novation may reinforce market participants' confidence regarding CCP support for or guarantee of the transaction.

In addition, the Commission is proposing to add Rule 17Ad-22(a)(20) to define “transparent” to mean, for proposed Rules 17Ad-22(e)(1), (2), and (10), that relevant documentation is disclosed, as appropriate, to the Commission and other relevant authorities, clearing members and customers of clearing members, the owners of the covered clearing agency, and the public, to the extent consistent with other statutory and Commission requirements.

116

In proposing this

definition, the Commission recognizes that certain types of information, such as confidential information, may not be appropriate for public disclosure or disclosure to certain third parties. Confidential information might include, for instance, policies and procedures with respect to the security of information technology or other critical systems or governance arrangements relating to the creation of special advisory committees by the board of directors. With regard to public disclosures contemplated by proposed Rule 17Ad-22(a)(20), a covered clearing agency could comply with the proposed requirement by posting the relevant documentation to a covered clearing agency's Web site. The Commission preliminarily believes that these disclosures would support a participant's ability to evaluate the risks associated with participating in the covered clearing agency. For example, disclosures that facilitate market participants' understanding of the legal basis for a covered clearing agency's activities and its governance arrangements may encourage participation in the covered clearing agency (with respect to prospective clearing members) and may encourage trading in the United States that would result in clearance and settlement through the covered clearing agency (with respect to prospective investors).

116

See

proposed Rule 17Ad-22(a)(20),

infra

Part 0;

see also

Parts 0 and 0 (discussing proposed Rules 17Ad-22(e)(2) and (10), respectively).

Separately, the Commission has proposed rules to require policies and procedures to protect the confidentiality of trading information and procedures.

See

Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011) (proposing Rule 17Ad-23).

As was the case when the Commission considered Rule 17Ad-22(d)(1), where a clearing agency is faced with significant uncertainty regarding legal risk, the Commission preliminary believes this uncertainty may undermine a covered clearing agency's ability to provide prompt and accurate clearance and settlement, to safeguard securities and funds and to provide fair procedures, as required under Section 17A of the Exchange Act. For example, where a covered clearing agency's procedures addressing a participant default and establishing a security interest in collateral lack clarity or there is significant uncertainty regarding enforceability, there is a risk the clearing agency may face claims to void, stay or reverse its actions, which could be made by a bankruptcy trustee or other type of receiver in an insolvency of a participant, undermining the clearing agency's ability to safeguard securities and funds. As a similar example, if covered clearing agency netting activities are voided or reversed on legal grounds, which could involve a participant's insolvency, clearing and settlement could be disrupted as participant accounts are rebalanced. Also, for example, if a covered clearing agency's plan for recovery and wind-down is subject to legal uncertainty, the covered clearing agency or governmental authorities may be delayed in or prevented from taking appropriate actions, resulting in disorder that may undermine the provision of prompt and accurate clearance and settlement.

117

Issues addressed in such wind-down plans may include termination, netting, and the transfer of securities positions and assets.

Therefore, like Rule 17Ad-22(d)(1), the Commission preliminarily believes that proposed Rule 17Ad-22(e)(1) would support the effectiveness of a covered clearing agency's risk management procedures in two ways. First, by imposing requirements addressing legal risk, it would continue to promote effective risk management at covered clearing agencies. Second, the proposed rule would reinforce covered clearing agency policies and procedures regarding risks other than legal risk, including, among others, credit, liquidity, operational, and general business risk.

118

Cf.

PFMI Report,

supra

note 1, at 21-25 (discussing Principle 1, legal basis).

Request for Comments.

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(e)(1) and proposed Rule 17Ad-22(a)(20). In addition, the Commission requests comments on the following specific issues:

• Should the proposed rule include more specific requirements based on the type of business or the types of services offered by covered clearing agencies and/or whether the covered clearing agency operates in multiple jurisdictions? If so, are there any considerations, such as those concerning compliance with regulations in other jurisdictions, the Commission should take into account for covered clearing agencies operating in multiple jurisdictions?

• Should the Commission adopt more prescriptive or less prescriptive rules to define how covered clearing agencies would provide for a well-founded, clear, transparent, and enforceable legal basis? Why or why not? If so, what would those rules be?

• Should the Commission require a covered clearing agency to maintain documentation to demonstrate the legal adequacy of the mechanisms at the clearing agency that are in place to handle participant defaults? If so, what kinds of documentation should the Commission require?

• In proposing Rule 17Ad-22(a)(20), has the Commission taken the right approach with respect to requiring public disclosures? Why or why not? Should the Commission adopt rules that would require either more or less disclosure? Why or why not?

• What should be the minimum level of public disclosure required of a covered clearing agency? What information should a covered clearing agency be permitted to withhold? What form should that disclosure take? What content should be required? Please explain in detail.

2. Proposed Rule 17Ad-22(e)(2): Governance

Proposed Rules 17Ad-22(e)(2)(i) through (iv) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for governance arrangements that are clear and transparent, clearly prioritize the safety and efficiency of the covered clearing agency, and support the public interest requirements in Section 17A of the Exchange Act and the objectives of owners and participants.

119

The proposed rule contains requirements similar to those currently applicable to registered clearing agencies under Rule 17Ad-22(d)(8), but the proposed rule also requires that a covered clearing agency's policies and procedures provide for governance arrangements that clearly prioritize the safety and efficiency of the covered clearing agency.

120

119

See

proposed Rule 17Ad-22(e)(2),

infra

Part 0. Proposed Rule 17Ad-22(e)(2) would complement other requirements that may apply separately, including requirements in proposed Rules 17Ad-25 and 17Ad-26, and requirements for security-based swap clearing agencies under Section 765 of the Dodd-Frank Act, 12 U.S.C. 8343.

See supra

note 111 (noting rules proposed by the Commission to address potential conflicts of interest).

120

Specifically, Rule 17Ad-22(d)(8) requires a registered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to have governance arrangements that are clear and transparent to fulfill the public interest requirements in Section 17A of the Exchange Act applicable to clearing agencies, to support the objectives of owners and participants, and to promote the effectiveness of the clearing agency's risk management procedures.

See

17 CFR 240.17Ad-22(d)(8);

see also

Clearing Agency Standards Release,

supra

note 5, at 66251-52.

Governance arrangements are critical to the sound operation of SROs, including covered clearing agencies.

121

The Exchange Act explicitly conditions clearing agency registration on a clearing agency having rules that (i) assure a fair representation of shareholders or members and participants in the selection of its directors and administration of affairs, (ii) facilitate prompt and accurate

clearance and settlement, (iii) protect investors and the public interest, (iv) do not permit unfair discrimination in the use of the clearing agency by participants and (v) provide certain fair procedures regarding participants and other interested parties.

122

Accordingly, the proper functioning of registered clearing agencies pursuant to the requirements of the Exchange Act is premised on the existence of a well-organized and operating governance function.

121

See supra

Part 0 and note 96 (describing the Commission's framework for regulation of SROs and the SRO rule filing process).

122

See

15 U.S.C. 78q-1(a)(3)(F), (H).

Consistent with these requirements and the Exchange Act requirements discussed above,

123

the Commission preliminarily believes that the governance requirements proposed in Rule 17Ad-22(e)(2) are appropriate because governance arrangements are fundamental to the functioning of a covered clearing agency pursuant to Section 17A of the Exchange Act.

124

Consistent with the Commission's statutory mandate under the Exchange Act, the proposed rule would specify that governance arrangements also be consistent with the public interest requirements in Section 17A of the Exchange Act as applicable to clearing agencies. Because a covered clearing agency's decisions can have widespread impact, affecting multiple market participants, financial institutions, markets, and jurisdictions, the Commission preliminarily believes it is important that each covered clearing agency place a high priority on the safety and efficiency of its operations and explicitly support the objectives of owners and participants. In addition, supporting the public interest is a broad concept that includes, for example, contributing to the ongoing development of the U.S. financial system, in particular the national clearance and settlement system contemplated by Section 17A of the Exchange Act, and protecting investors and fostering fair and efficient markets. The Commission believes that, by supporting the public interest, market participants can develop common processes that help reduce uncertainty in the market, such as industry standards and market protocols related to clearance and settlement that facilitate a common understanding and interactions among clearing agencies and their members. The Commission preliminarily believes that covered clearing agencies, as SROs, are appropriately positioned to determine, based on their experience in providing clearance and settlement services and based on information obtained from their members and other stakeholders, as appropriate in the circumstances, what governance arrangements appropriately support the public interest requirements in Section 17A applicable to clearing agencies consistent with the expectations of such stakeholders,

125

balancing the potentially competing viewpoints of the various stakeholders. The Commission also preliminarily believes that mechanisms through which a covered clearing agency could support the objectives of owners and participants could potentially include representation on the board of directors, user committees, and various public consultation processes.

123

See

notes 54-56 and accompanying text;

see also

Parts 0 and 0 (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act).

124

See

15 U.S.C. 78q-1(a)(2)(A).

125

See supra

note 95 (describing requirements for SROs under the Exchange Act and Rule 19b-4).

As with Rule 17Ad-22(d)(8), the Commission preliminarily believes that requiring policies and procedures for clear and transparent governance arrangements support accountability in the decisions, rules, policies, and procedures of the covered clearing agency. Such policies and procedures requirements for governance arrangements provide owners, participants, and, if applicable, general members of the public, with an opportunity to comment on or otherwise provide input to governance arrangements and, in turn, provide a covered clearing agency with the opportunity to balance the potentially competing viewpoints of various stakeholders in its decision making.

126

Similarly, these policies and procedures requirements for governance arrangements may promote the effectiveness of a covered clearing agency's risk management procedures by fostering a focus on the critical role that risk management plays in promoting prompt and accurate clearance and settlement.

127

126

See id.

127

See supra

note 111 (discussing rules proposed by the Commission to mitigate conflicts of interest at clearing agencies as part of efforts to promote sound risk management and governance arrangements).

In addition, proposed Rule 17Ad-22(e)(2)(iv) would require that the covered clearing agency establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for governance arrangements establishing that the board of directors and senior management have appropriate experience and skills to discharge their duties and responsibilities.

128

The Commission preliminarily believes that these aspects of a covered clearing agency's governance framework are particularly important and that establishing requirements in these areas would be appropriate given the risks that a covered clearing agency's size, operation, and importance pose to the U.S. securities markets.

129

128

See

proposed Rule 17Ad-22(e)(2),

infra

Part 0.

129

For a discussion of current practices at registered clearing agencies regarding boards of directors and senior management, and the anticipated impact of the proposed requirements for governance, see Parts 0 and 0, respectively.

The Commission preliminarily believes that directors serving on the board and board committees of a clearing agency play an important role in creating a framework that supports prompt and accurate clearance and settlement because of their role in the decision-making process within a clearing agency. Additionally, the Commission preliminarily believes that a covered clearing agency's senior management has an important role in ensuring, under the board's direction, that the clearing agency's activities are consistent with the objectives, strategy, and risk tolerance of the clearing agency, as determined by the board. Accordingly, the expertise and skills of senior management and directors serving on the board of a covered clearing agency are likely to affect its effective operation. For example, a lack of expertise by board members may deter them from challenging decisions by management and lessen the potential that management would escalate appropriate issues to the board for the board's consideration. Similarly, board members and management should not have conflicts of interests that could undermine the decision-making process within a covered clearing agency or interfere with fair representation and equitable treatment of clearing members or other market participants by a covered clearing agency.

The Commission believes that covered clearing agencies are well positioned to determine which individuals would have the appropriate experience, skills, incentives and integrity to discharge their duties and responsibilities that reflect the particular characteristics of each covered clearing agency. Accordingly, the Commission preliminarily believes that the proposed requirement for policies and procedures would provide the covered clearing agency with a process to evaluate the expertise and skills of board members and senior management, consistent with the particular circumstances of the covered

clearing agency. Such policies and procedures may include provisions requiring the covered clearing agency to consider, for example, the specific qualifications, experience, competence, character, skills, incentives, integrity or other relevant attributes to support a conclusion that an individual nominee can appropriately serve as a board member or on senior management. Such policies and procedures could also include, among other things, requirements as to industry experience relevant to the services provided by the covered clearing agency, educational background, the absence of a criminal or disciplinary record, or other factors relevant to the qualifications of nominees being considered.

Request for Comments.

The Commission generally requests comments on all aspects of proposed Rule 17Ad-22(e)(2). In addition, the Commission requests comments on the following specific issues:

• Should the Commission require a covered clearing agency's policies and procedures to provide for governance arrangements that prioritize the safety and efficiency of the covered clearing agency? Why or why not?

• The Commission is not proposing at this time to require a covered clearing agency's policies and procedures provide for governance arrangements that also support the objectives of participants' customers, securities issuers and holders, and other stakeholders. Should the Commission consider such a requirement? Why or why not? Are existing protections under the Exchange Act, such as those in Section 17A(b)(3)(H) (requiring clearing agency rules to provide fair procedures to persons with respect to access to services offered by the clearing agency),

130

Section 17A(b)(5)(B) (establishing requirements for clearing agencies when determining whether a person may be prohibited or limited with respect to services offered),

131

and Section 19(d)(2) (persons aggrieved by SRO actions may apply to the Commission for review)

132

already satisfactory or would additional Commission governance requirements also be appropriate? What would be the possible advantages and disadvantages of expanding the scope of proposed Rule 17Ad-22(e)(2)(iii) to require covered clearing agency policies and procedures to consider the interests of persons other than owners and participants?

130

See

15 U.S.C. 78q-1(b)(3)(H).

131

See

15 U.S.C. 78q-1(b)(5)(B).

132

See

15 U.S.C. 78s(d)(2).

• Should the Commission require a covered clearing agency's policies and procedures to provide for governance arrangements establishing that the board of directors and senior management have appropriate experience and skills to discharge their duties and responsibilities? Why or why not? Has the Commission provided sufficient guidance on what “experience and skills” would require? Why or why not?

• Are there any other requirements that should be included in the rule to promote clear and transparent governance arrangements?

• The Commission is not proposing at this time to require a covered clearing agency's policies and procedures provide for governance arrangements to ensure that lines of responsibility and accountability at the covered clearing agency are clear and direct. Should the Commission consider such a requirement? Why or why not?

• The Commission is not proposing at this time to require a covered clearing agency's policies and procedures provide for governance arrangements that ensure major decisions of the board of directors are disclosed to the public. Should the Commission consider such a requirement? Why or why not?

• Should there be a phase-in period for covered clearing agencies to comply with proposed Rule 17Ad-22(e)(2), such as until the next annual meeting of shareholders of the covered clearing agency or other time period? Why or why not?

• Are the governance requirements in proposed Rule 17Ad-22(e)(2) necessary to achieve the benefits discussed in Part IV.C.3.a.ii? Why or why not? For example, how and why would particular features of the proposed rules, such as expectations that directors and officers of covered clearing agencies have certain skills and experience, contribute to greater market stability and reduced risk of insufficient internal controls endangering broader financial stability? Are there existing requirements under Section 17A of the Exchange Act, such as the “fair representation” requirement in Section 17A(b)(3)(C), rules and regulations adopted by the Commission and applicable to SROs, or relevant interpretations published by the Commission that already provide a clear and sufficient basis for the Commission to supervise covered clearing agencies in the manner contemplated by proposed Rule 17Ad-22(e)(2) without adopting the proposed rule? What are the possible benefits of adopting the rule as proposed and what possible detriments may arise that the Commission should consider?

• Are there disclosures that a covered clearing agency should be required to make with respect to its governance arrangements? Why or why not? If so, what should be the form and content of those disclosures?

• Should the Commission require that the performance of the board of directors and senior management—individually and as a group—are reviewed on a regular basis? If so, how often should this review be conducted? Should this review be conducted independently?

• Should the board of directors of covered clearing agencies include individuals who are not executives, officers, or employees of the covered clearing agency, or an affiliate of the covered clearing agency? Should the board of directors of covered clearing agencies include an independent audit committee?

• Should the Commission be involved in and/or set requirements and standards with respect to board and management governance at covered clearing agencies? Does the Commission have the requisite statutory authority to adopt the rule proposals and matters addressed in the related questions set forth in this release as to governance arrangements, standards, composition, and qualifications of covered clearing agencies' boards and management? Is the Commission's oversight and establishment of corporate governance measures and standards at clearing agencies a proper and good use of Commission resources? What are the potential costs and benefits of these corporate governance provisions?

3. Proposed Rule 17Ad-22(e)(3): Framework for the Comprehensive Management of Risks

Proposed Rule 17Ad-22(e)(3) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain a sound risk management framework for comprehensively managing legal, credit, liquidity, operational, general business, investment, custody, and other risks that arise in or are borne by the covered clearing agency.

133

See

proposed Rule 17Ad-22(e)(3),

infra

Part 0.

Existing Rules 17Ad-22(b) and (d) require registered clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to meet several requirements that address risk management practices by registered clearing agencies that provide CCP services (Rules 17Ad-22(b)(1) through (4)), certain requirements regarding

access to registered clearing agencies that provide CCP services (Rules 17Ad-22(b)(5) through (7)), and certain minimum standards for the operations of registered clearing agencies providing CCP or CSD services.

134

Consistent with these requirements and the Exchange Act requirements discussed above,

135

the Commission preliminarily believes that proposed Rule 17Ad-22(e)(3) is appropriate and would require a covered clearing agency's policies and procedures to take a broader, more comprehensive approach to risk management, which the Commission believes is fundamental to a covered clearing agency's functioning given its size, operation, and importance in the U.S. securities markets. While existing rules under the Exchange Act already target certain aspects of risk management, the Commission preliminarily believes that comprehensive risk management policies and procedures established pursuant to proposed Rule 17Ad-22(e)(3) would further support the examination of risks, the assessment of their probability and impact, and the identification of linkages to other entities that in turn pose risks to the covered clearing agency. The Commission also believes that comprehensive risk management policies and procedures would facilitate the development of mechanisms to better prioritize, manage, and monitor risks, and to measure the covered clearing agency's risk tolerance and capacity. In proposing Rule 17Ad-22(e)(3), the Commission is emphasizing a comprehensive approach to risk management that would require risk management policies and procedures be designed holistically, be consistent with each other, and work effectively together in order to mitigate the risk of financial losses to covered clearing agencies' members and participants in the markets they serve.

134

See

17 CFR 240.17Ad-22(b), (d);

see also

Clearing Agency Standards Release,

supra

note 5, at 66230-43, 66244-58. Specifically, as examples, Rule 17Ad-22(d)(4) requires a registered clearing agency to have policies and procedures reasonably designed to address certain aspects of operational risk, and Rule 17Ad-22(d)(7) requires a registered clearing agency to have policies and procedures reasonably designed to address certain aspects of risks relating to linkages.

See

17 CFR 240.17Ad-22(d)(4), (7).

135

See

notes 54-56 and accompanying text;

see also

Parts 0 and 0 (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act).

In addition, policies and procedures for the comprehensive management of risks have the potential to play an important role in making sure that covered clearing agencies better fulfill the Exchange Act requirements that the rules of a clearing agency be designed to protect investors and the public interest.

136

Similarly, these requirements may promote the effectiveness of a covered clearing agency's risk management procedures by fostering a focus on the critical role that risk management plays in promoting prompt and accurate clearance and settlement. Accordingly, the Commission preliminarily believes that it is important that covered clearing agencies have policies and procedures that enable them to identify, monitor, and manage the range of risks that arise in or are borne by all aspects of their clearance and settlement activities.

136

See

15 U.S.C. 78q-1(a)(2).

In addition, the Commission is proposing the requirements described below, which do not appear in existing Rules 17Ad-22(b) or (d). The Commission preliminarily believes these requirements would be appropriate for covered clearing agencies given the risks that their size, operation, and importance pose to the U.S. securities markets.

a. Policies and Procedures Requirements, Periodic Review, and Annual Board Approval

Proposed Rule 17Ad-22(e)(3)(i) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for risk management policies, procedures, and systems designed to identify, measure, monitor, and manage the range of risks that arise in or are borne by the covered clearing agency, and subject them to review on a specified periodic basis and approval by the board of directors annually.

137

See id.

The Commission preliminarily believes periodic review of the risk management policies and procedures would allow covered clearing agencies to assess whether the risk management policies and procedures should be updated to account for changing factors in the market and to address and codify in a uniform way the approach to new risks taken since the last periodic review. The Commission preliminarily believes that the board of directors of a covered clearing agency should be required to approve the risk management policies and procedures. The Commission preliminarily believes that, in complying with this requirement, a board of directors may want to subject all material components of the covered clearing agency's risk management policies and procedures to review pursuant to Rule 17Ad-22(e)(3)(i) due to the critical role that risk management plays in promoting prompt and accurate clearance and settlement.

b. Recovery and Orderly Wind-Down Plans

Proposed Rule 17Ad-22(e)(3)(ii) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to ensure it establishes plans for the recovery and orderly wind-down of the covered clearing agency necessitated by credit losses, liquidity shortfalls, losses from general business risk, or any other losses.

138

See

proposed Rule 17Ad-22(e)(3),

infra

Part 0.

Securities exchanges, market participants, and investors rely upon the safe, sound, and efficient operations of covered clearing agencies, and accordingly the Commission preliminarily believes that a disorderly wind-down of a covered clearing agency would have systemic consequences.

139

The Commission preliminarily believes that a recovery plan designed to deal with possible scenarios that may threaten or potentially prevent a covered clearing agency from being able to provide its critical operations and services as a going concern and that assesses a full range of options for recovery could mitigate the impact of a near failure of a covered clearing agency.

139

See generally

Clearing Agency Standards Release,

supra

note 5, at 66283 (noting, in discussing Rule 17Ad-22(d)(11), that having policies and procedures “allow[s] a clearing agency to wind down positions in an orderly way and continue to perform its obligations in the event of a participant default, assuring continued functioning of the securities market in times of stress and reducing systemic risk”).

Based on its supervisory experience, the Commission recognizes that covered clearing agencies operating in the market today each have relevant standards and practices relating to recovery and orderly wind-down with differing degrees of formality. The Commission therefore preliminarily expects that Rule 17Ad-22(e)(3)(ii) would require covered clearing agencies to review such standards and practices for sufficiency with respect to the safe operation of the covered clearing agency and revise such practices in a manner consistent with the findings of such review consistent with the proposed rule, if adopted, and the requirements of the Exchange Act.

c. Risk Management and Internal Audit

Proposed Rule 17Ad-22(e)(3)(iii) would require a covered clearing agency

to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide risk management and internal audit personnel with sufficient authority, resources, independence from management, and access to the board of directors. The Commission preliminarily believes that a covered clearing agency could satisfy the policies and procedures requirement for independence from management by, for example, providing reporting lines for risk management functions that are clear and separate from those for other operations and providing for direct reporting to the board of directors or a relevant committee of the board. In that regard, proposed Rule 17Ad-22(e)(3)(iv) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide risk management and internal audit personnel with oversight by and a direct reporting line to a risk management committee and an audit committee of the board of directors, respectively. Furthermore, proposed Rule 17A-22(e)(3)(v) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for an independent audit committee.

The Commission preliminarily believes that a covered clearing agency should have an effective internal audit function in order to provide, among other things, a rigorous and independent assessment of the effectiveness of the clearing agency's risk management and control processes, and should have an independent audit committee overseeing the internal audit function in order to help promote the integrity and efficiency of the audit process and strengthen internal controls. In order to satisfy the independence requirement for an audit committee under proposed Rule 17Ad-22(e)(2), a covered clearing agency could use such independence criteria as are established by its board of directors. The Commission further preliminarily believes that policies and procedures for risk management are important to the effective operation of a covered clearing agency.

d. Request for Comments

The Commission generally requests comments on all aspects of Proposed Rule 17Ad-22(e)(3). In addition, the Commission requests comments on the following specific issues:

• Should the Commission require a covered clearing agency's policies and procedures to maintain a sound risk management framework for comprehensively managing legal, credit, liquidity, operational, general business, investment, custody, and other risks that arise in or are borne by the covered clearing agency? Why or why not?

• Should the Commission require a covered clearing agency's policies and procedures include plans for the recovery and orderly wind-down of the covered clearing agency necessitated by credit losses, liquidity shortfalls, losses from general business risk, or any other losses? Why or why not?

• How and to whom should the board of directors communicate the results of its review of the risk management framework, if at all?

• Are there any other requirements that should be included in the rule to facilitate policies and procedures that maintain a sound risk management framework, including the proposed requirements for policies and procedures regarding board review and approval of risk management policies and policies and procedures with respect to recovery and orderly wind-down plans? Why or why not? For example, should the Commission require a covered clearing agency's policies and procedures to identify, measure, monitor, and manage the material risks that it poses to other entities, such as other financial market utilities, settlement banks, liquidity providers, or service providers, as a result of interdependencies? Why or why not?

• The Commission is not proposing at this time to require a covered clearing agency's policies and procedures to, in its comprehensive risk management framework, provide for criteria for the independence of audit committee members. Should the Commission consider requirements that specify such criteria? Why or why not? If so, should those criteria be similar to the audit committee independence requirements for listed companies in Rule 10A-3 under the Exchange Act?

140

In order to satisfy the policies and procedures requirement for independence of the audit committee under proposed Rule 17Ad-22(e)(3), should a covered clearing agency be allowed to use such independence criteria as are established by its board of directors?

140

See

17 CFR 240.10A-3.

4. Proposed Rules 17Ad-22(e)(4) Through (7): Financial Risk Management

a. Overview of Financial Risks Faced by Clearing Agencies

Covered clearing agencies face a variety of financial risks from their participants and service providers, including credit or counterparty default risk, market risk, and liquidity risk. For example, for clearing agencies that provide CSD services, credit risk arises from the potential that a participant will not pay what it owes for securities that it has purchased or will not deliver securities that it has sold. For clearing agencies that clear and settle derivatives contracts, credit risk arises from the potential that a participant will not meet its margin or settlement obligations or pay any other amounts owed to the covered clearing agency.

141

Credit risk also arises for clearing agencies of any type from commercial banks or custodians that the covered clearing agency uses to effect money transfers among participants, to hold overnight deposits, or to safeguard cash or other collateral.

141

In this context, the clearing agency's credit risk is closely related to the participant's market risk. A participant's ability to meet its obligations to the clearing agency may be affected by the participant's exposure to fluctuations in the market value of the participant's open positions. In addition, fluctuations in the market value of the collateral posted by the participant may require the clearing agency to obtain additional margin from the participant.

Clearing agencies that provide CCP services take offsetting positions as the substituted counterparty to a transaction and, therefore, do not ordinarily face market risk except in the event of a participant default. In such an event, market risk takes two forms. First, the clearing agency may need to liquidate collateral posted by the defaulting participant. The clearing agency is therefore exposed to volatility in the market price of the defaulting participant's non-cash collateral that could result in the clearing agency having insufficient financial resources to cover the losses in the defaulting participant's open positions. Second, a clearing agency providing CCP services is subject to volatility in the market price of the defaulting participant's open positions during the interval between the point at which the clearing agency takes control of those positions and the point at which the clearing agency is able to offset, transfer, or liquidate those positions. A clearing agency faces the risk that its exposure to a participant can change as a result of a change in prices, positions, or both.

A clearing agency must be able to measure the counterparty credit exposures that it is expected to manage effectively. A clearing agency can ascertain its current credit exposure to each participant by marking each participant's outstanding positions to current market prices and (to the extent permitted by a clearing agency's rules

and supported by law) netting any gains against any losses.

In addition to credit risk and market risk, clearing agencies also face liquidity or funding risk. Currently, to complete the settlement process, clearing agencies generally rely on incoming payments from participants in net debit positions in order to make payments to participants in net credit positions. If a participant does not have sufficient funds to make an incoming payment immediately when it is due (even though it may be able to pay at some future time), or if a settlement bank is unable to make an incoming payment on behalf of a participant, the clearing agency faces a funding shortfall. A clearing agency typically holds additional financial resources to cover potential funding shortfalls such as margin collateral or lines of credit. However, if collateral cannot be liquidated within a short time, or if lines of credit are unavailable, liquidity risk would be exacerbated.

b. Current Financial Risk Management Requirements for CCPs

Rules 17Ad-22(b)(1) through (4) concern risk management requirements for clearing agencies that perform CCP services (hereinafter “CCPs” in this part). Rule 17Ad-22(b)(1) requires that CCPs establish, implement, maintain and enforce written policies and procedures reasonably designed to measure their credit exposures at least once per day.

142

Rule 17Ad-22(b)(2) requires that CCPs establish, implement, maintain and enforce written policies and procedures reasonably designed to use margin requirements to limit their exposures to participants.

143

This margin can also be used to reduce a CCP's losses in the event of a participant default. Rule 17Ad-22(b)(3) requires that CCPs establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain sufficient financial resources to withstand, at a minimum, a default by the participant family to which a CCP has the largest exposure in extreme but plausible market conditions, except that CCPs clearing security-based swap transactions must maintain additional financial resources sufficient to withstand the simultaneous default by the two participant families to which a CCP has the largest exposures.

144

Finally, Rule 17Ad-22(b)(4) requires that CCPs establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for an annual model validation that consists of evaluating the performance of a clearing agency's margin models and the related parameters and assumptions associated with such models and that is performed by a qualified person who is free from influence from the persons responsible for development or operation of the models being validated.

145

142

See

17 CFR 240.17Ad-22(b)(1).

143

See

17 CFR 240.17Ad-22(b)(2).

144

See

17 CFR 240.17Ad-22(b)(3).

145

See

17 CFR 240.17Ad-22(b)(4).

c. Proposed Rule 17Ad-22(e)(4): Credit Risk

Proposed Rule 17Ad-22(e)(4) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to effectively identify, measure, monitor, and manage its credit exposures to participants and those exposures arising from its payment, clearing, and settlement processes.

146

The Commission preliminarily believes the proposed rule is consistent with the requirements of the Exchange Act discussed above.

147

146

See

proposed Rules 17Ad-22(e)(4),

infra

Part 0.

147

See

notes 54-56 and accompanying text;

see also

Parts 0 and 0 (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act).

Proposed Rule 17Ad-22(e)(4)(i) would require a covered clearing to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain sufficient financial resources to cover its credit exposure to each participant fully with a high degree of confidence. The Commission's intention in proposing the term “high degree of confidence” is to refer to the statistical meaning of this term.

148

The proposed rule would require a covered clearing agency to use statistical methods to develop models in order to estimate the financial resources required under proposed Rule 17Ad-22(e)(4)(ii) and (iii),

149

and to comply with the requirements of proposed Rules 17Ad-22(e)(4)(ii) and (iii), while recognizing that such an approach is necessarily imprecise to at least some degree.

148

See, e.g.,

Arthur S. Goldberger, A Course in Econometrics 122-23 (Harvard Univ. Press, 2003) (defining confidence intervals for parameter estimates).

149

See supra

Part 0 (noting that a clearing agency must be able to measure the counterparty credit exposures in order to manage risk effectively).

Proposed Rule 17Ad-22(e)(4)(ii) would require a covered clearing agency that provides CCP services, and that is “systemically important in multiple jurisdictions” or “a clearing agency involved in activities with a more complex risk profile,” to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain additional financial resources, to the extent not already maintained pursuant to proposed Rule 17Ad-22(e)(4)(i), at a minimum level necessary to enable it to cover a wide range of foreseeable stress scenarios, including but not limited to the default of the two participant families that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions (hereinafter the “cover two” requirement).

Proposed Rule 17Ad-22(e)(4)(iii) would require a covered clearing agency that is not subject to proposed Rule 17Ad-22(e)(4)(ii) to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain additional financial resources, to the extent not already maintained pursuant to proposed Rule 17Ad-22(e)(4)(i), at the minimum to enable it to cover a wide range of foreseeable stress scenarios, including the default of the participant family that would potentially cause the largest aggregate credit exposure for the covered clearing agency in extreme but plausible market conditions (hereinafter the “cover one” requirement).

150

The Commission notes that the requirement in proposed Rules 17Ad-22(e)(4)(ii) and (iii) to examine exposure under foreseeable stress scenarios including extreme but plausible market conditions means the covered clearing agency may need to use models to determine how its estimated exposure under such conditions differs from its actual exposure to positions of such participants, which it would be required to measure under proposed Rule 17Ad-22(e)(4)(i).

150

The Commission notes that, with the exception of security-based swap clearing agencies, all registered clearing agencies providing CCP services are all currently required to meet a “cover one” standard under Rule 17Ad-22(b)(3), and therefore the Commission anticipates that covered clearing agencies may need to make only limited changes to policies and procedures to satisfy the proposed requirement, if adopted.

See infra

Parts 0 and 0 (discussing current practices at registered clearing agencies relating to credit risk and the anticipated economic effect of the proposed requirement, respectively).

Also, as previously discussed, the Commission is proposing Rule 17Ad-22(a)(4) to define “clearing agency involved in activities with a more complex risk profile.”

151

The Commission is also proposing Rule 17Ad-22(a)(19) to define “systemically important in multiple jurisdictions” to

mean a covered clearing agency that has been determined by the Commission to be systemically important in more than one jurisdiction pursuant to Rule 17Ab2-2.

152

151

See supra

Part 0 (discussing the scope of proposed Rule 17Ad-22(e));

supra

notes 79-80 and accompanying text.

152

See

proposed Rule 17Ad-22(a)(19),

infra

Part 0;

see also infra

Parts 0 and 0 (discussing the determinations process under proposed Rule 17Ab2-2 and providing proposed rule text).

Like the “cover two” requirement in Rule 17Ad-22(b)(3), which applies to registered clearing agencies that provide CCP services for security-based swaps,

153

proposed Rule 17Ad-22(e)(4)(ii) would impose a “cover two” requirement to address credit risk of certain covered clearing agencies: Those systemically important in multiple jurisdictions and those involved in activities with a more complex risk profile. The Commission notes that the set of complex risk profile clearing agencies subject to this requirement would include, as of the date of this proposal, only registered clearing agencies that provide CCP services for security-based swaps, which are already subject to the “cover two” requirement in Rule 17Ad-22(b)(3). In addition, the Commission notes that no covered clearing agency would be systemically important in multiple jurisdictions unless and until the Commission made such a determination pursuant to proposed Rule 17Ab2-2.

154

For any covered clearing agency not currently subject to a “cover two” requirement that could be determined by the Commission in the future to be either systemically important in multiple jurisdictions or involved in activities with a more complex risk profile, the Commission believes that requiring such entities to improve their resilience to offset increased risk and to prepare for extreme but plausible market conditions is appropriate because it could decrease the likelihood that systemic events in other jurisdictions or extreme volatility in more complex financial instruments would result in interruptions to the provision of clearance and settlement services in the U.S. securities markets.

153

See

17 CFR 240.17Ad-22(b)(3);

see also infra

Part 0 (discussing the scope of proposed Rule 17Ad-22(e)); Clearing Agency Standards Release,

supra

note 5, at 66233-36 (discussing proposed Rule 17Ad-22(b)(3)).

154

See infra

Parts 0 and 0 (discussing the determinations process under proposed Rule 17Ab2-2 and providing proposed rule text).

In addition, the Commission is proposing the requirements described below. In discussing these requirements, the below sections describe how they differ from existing requirements in Rules 17Ad-22(b)(1) through (4) applicable to security-based swap clearing agencies, previously discussed above.

155

See supra

Part 0.

i. Prefunded Financial Resources

Proposed Rule 17Ad-22(e)(4)(iv) would require a covered clearing agency providing CCP services that is either systemically important in multiple jurisdictions or a complex risk profile clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to include prefunded financial resources, excluding assessments for additional guaranty fund contributions or other resources that are not prefunded, when calculating the financial resources available to meet the standards under proposed Rules 17Ad-22(e)(4)(i) through (iii), as applicable.

156

The Commission preliminarily believes that prefunding default obligations is appropriate because of the importance of the ability of a covered clearing agency to meet its default resource obligations to the clearance and settlement system, given the risks that its size, operation, and importance pose to the U.S. securities markets.

157

Immediately available financial resources are necessary to ensure that a covered clearing agency can meet its financial obligations on an ongoing basis. Without prefunded financial resources, a covered clearing agency may be unable to meet its financial obligations in stressed market conditions, when clearing members may be unwilling or unable to contribute to the clearing agency's guaranty fund in the event of a member default.

156

See

proposed Rule 17Ad-22(e)(4)(iv),

infra

Part 0.

157

See generally

12 U.S.C. 5461 (Congress finding, among other things, that enhancements to the regulation and supervision of systemically important FMUs and the conduct of systemically important PCS activities by financial institutions are necessary, under Title VIII, to provide consistency, to promote robust risk management and safety and soundness, to reduce systemic risks, and to support the stability of the broader financial system).

The Commission notes that while the ability to assess participants for contributions under applicable covered clearing agency governing documents, rules, or agreements could not be included in this calculation, previously paid-in participant contributions into a covered clearing agency default fund could be counted to the extent the clearing agency's rules, policies, or procedures permit such resources to be used in a manner equivalent to other financial resources in the default fund. Other sources of prefunded resources, such as margin previously posted to the clearing agency by participants, could also be treated in this manner. In addition, while the ability to draw down under a revolving loan facility could not be counted towards prefunded resources because funds from such loan facility would not be in the covered clearing agency's immediate possession, the covered clearing agency could count borrowed funds already drawn down, such as under a term loan or other credit facility.

Existing requirements under Rule 17Ad-22 do not include requirements for prefunded financial resources at registered clearing agencies. The proposed requirement reflects the Commission's recognition of the importance of a covered clearing agency meeting its default resource obligations, given the risks that its size, operation, and importance pose to the U.S. securities markets.

ii. Combined or Separately Maintained Clearing or Guaranty Funds

Proposed Rule 17Ad-22(e)(4)(v) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain the financial resources required under proposed Rules 17Ad-22(e)(4)(i) through (iii) in combined or separately maintained clearing or guaranty funds.

158

The proposed rule makes clear that a covered clearing agency may choose to maintain a separate default fund for purposes of complying with proposed Rules 17Ad-22(e)(4)(i) through (iii).

158

See

proposed Rule 17Ad-22(e)(4)(v),

infra

Part 0.

This requirement would be similar to the requirement in Rule 17Ad-22(b)(3) requiring a security-based swap clearing agency to have policies and procedures reasonably designed to maintain financial resources generally or in separately maintained funds.

159

The Commission believes that this approach facilitates the operations of clearing agencies. For example, clearing agencies may maintain separate default funds for each product or asset type cleared, in order to more appropriately tailor risk management requirements or contain losses from a default to that fund.

159

Rule 17Ad-22(b)(3) currently also permits a security-based swap clearing agency to have policies and procedures reasonably designed to maintain financial resources generally or in separately maintained funds.

See

17 CFR 240.17Ad-22(b)(3);

see also

Clearing Agency Standards Release,

supra

note 5, at 66233-236.

iii. Testing the Sufficiency of Financial Resources

Proposed Rule 17Ad-22(e)(4)(vi) would require a covered clearing agency

to establish, implement, maintain and enforce written policies and procedures reasonably designed to test the sufficiency of its total financial resources available to meet the minimum financial resource requirements under proposed Rules 17Ad-22(e)(4)(i) through (iii), as applicable, by conducting a stress test of its total financial resources at least once each day using standard predetermined parameters and assumptions.

160

Registered clearing agencies are not subject to requirements for testing the sufficiency of their financial resources under existing Rule 17Ad-22.

160

See

proposed Rule 17Ad-22(e)(4)(vi),

infra

Part 0.

The proposed rule would also require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to conduct a comprehensive analysis on at least a monthly basis of the existing stress testing scenarios, models, and underlying parameters and assumptions, and consider modifications to ensure they are appropriate for determining the covered clearing agency's required level of default protection in light of current market conditions. When the products cleared or markets served by a covered clearing agency display high volatility, become less liquid, or when the size or concentration of positions held by the entity's participants increases significantly, the proposed rule would specifically require a covered clearing agency to have policies and procedures for conducting comprehensive analyses of stress testing scenarios, models, and underlying parameters and assumptions more frequently than monthly. The Commission preliminarily believes that what constitutes “high volatility” and “low liquidity” would vary across asset classes that a covered clearing agency might clear. Accordingly, the Commission preliminarily believes that a clearing agency would need flexibility to address changing circumstances and is therefore not proposing to prescribe triggers for any particular circumstance.

The proposed rule would also require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for the reporting of the results of this analysis to the appropriate decision makers at the covered clearing agency, including its risk management committee or board of directors, and to require the use of the results to evaluate the adequacy of and to adjust its margin methodology, model parameters, and any other relevant aspects of its credit risk management policies and procedures, in supporting compliance with the minimum financial resources requirements discussed above.

The Commission is also proposing to add Rule 17Ad-22(a)(18) to define “stress testing” to mean the estimation of credit and liquidity exposures that would result from the realization of extreme but plausible price changes or changes in other valuation inputs and assumptions.

161

The Commission preliminarily believes that stress testing is an important component of the proposed rules because stress testing may enable a covered clearing agency to be prepared for an extreme event that may not be anticipated or expected based solely on current market conditions or from a sample of historical data.

161

See

proposed Rule 17Ad-22(a)(18),

infra

Part 0.

The Commission preliminarily believes that the requirements in proposed Rule 17Ad-22(e)(4)(vi) are appropriate for testing the sufficiency of the financial resources of covered clearing agencies because, in certain market conditions, such as periods of high volatility or diminished liquidity, existing stress scenarios, models, or underlying parameters may no longer be valid or appropriate. Based on its supervisory experience, the Commission believes that certain, but not all, covered clearing agencies adjusted their stress testing scenarios following the 2008 financial crisis to incorporate larger debt, equity, and credit market shocks similar to those experienced during the crisis. Accordingly, the Commission preliminarily believes that specific policies and procedures contemplating actions to be taken by all covered clearing agencies in such circumstances are necessary to ensure the safe functioning of the covered clearing agencies as required by the Exchange Act,

162

and that requiring periodic feedback and analysis on the strength of credit risk management policies and procedures would improve the reliability of those policies and procedures. The Commission also preliminarily believes that the rule would provide a covered clearing agency with the flexibility to use stress scenarios that are appropriately tailored to current market conditions and that can be revised over time as markets change and believes that such flexibility is appropriate to achieve the objectives of the Exchange Act.

162

See

notes 54-56 and accompanying text;

see also

Parts 0 and 0 (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act).

iv. Annual Conforming Model Validation

Proposed Rule 17Ad-22(e)(4)(vii) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to require a conforming model validation for its credit risk models to be performed not less than annually or more frequently as may be contemplated by the covered clearing agency's risk management policies and procedures.

163

The Commission preliminary believes that an annual cycle is appropriate for the reasons described in Part II.A.3. The Commission notes that other important reviews such as auditing of the financial statements of registered clearing agencies and their disclosure are required to occur on an annual basis as well.

164

163

See

proposed Rule 17Ad-22(e)(4)(vii),

infra

Part 0.

164

See

17 CFR 240.17Ad-22(c)(2).

The Commission is proposing to add Rule 17Ad-22(a)(5) to define “conforming model validation” to mean an evaluation of the performance of each material risk management model used by a covered clearing agency, along with the related parameters and assumptions associated with such models.

165

Such model validation would apply to models that would include initial margin models, liquidity risk models, and models used to generate clearing or guaranty fund requirements. A conforming model validation would also require that the model validation be performed by a qualified person who is free from influence from the persons responsible for the development or operation of the models or policies being validated so that credit risk models can be candidly assessed.

166

Generally, the Commission considers that a person is free from influence when that person does not perform functions associated with the cl

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