# Standards for Covered Clearing Agencies > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3AR1-2014-05806 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** May 22, 2014 - **Citation:** 79 FR 29508 ## Text 17 CFR Part 240 Standards for Covered Clearing Agencies; Proposed Rule; Republication Federal Register / Vol. 79, No. 99 / Thursday, May 22, 2014 / Proposed Rules [[Page 29508]] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34-71699; File No. S7-03-14] RIN 3235-AL48 Standards for Covered Clearing Agencies Republication Editorial Note: Proposed rule document 2014-05806 was originally published on pages 16865 through 16975 in the issue of Wednesday, March 26, 2014. In that publication the footnotes contained erroneous entries. The corrected document is republished in its entirety. AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. ----------------------------------------------------------------------- SUMMARY: The Securities and Exchange Commission (``SEC'' or ``Commission'') proposes to amend Rule 17Ad-22 and add Rule 17Ab2-2 pursuant to Section 17A of the Securities Exchange Act of 1934 (``Exchange Act'') and the Payment, Clearing, and Settlement Supervision Act of 2010 (``Clearing Supervision Act''), adopted in Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-Frank Act''). Among other things, the proposed rules would establish standards for the operation and governance of certain types of registered clearing agencies that meet the definition of a ``covered clearing agency.'' DATES: Submit comments on or before May 27, 2014. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or Send an email to [email protected]. Please include File Number S7-03-14 on the subject line; or Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments. Paper Comments Send paper comments to Kevin M. O'Neill, Deputy Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090. All submissions should refer to File Number S7-03-14. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Katherine Martin, Senior Special Counsel; Stephanie Park, Special Counsel; Mark Saltzburg, Special Counsel; Matthew Lee, Attorney-Adviser; and Abraham Jacob, Attorney- Adviser; Office of Clearance and Settlement, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010, at (202) 551-5710. SUPPLEMENTARY INFORMATION: The Commission proposes to amend Rule 17Ad- 22 to add new Rule 17Ad-22(e) to establish requirements for risk management, operations, and governance of registered clearing agencies that meet the definition of a ``covered clearing agency.'' Covered clearing agencies would include registered clearing agencies that (i) have been designated as systemically important by the Financial Stability Oversight Council (``FSOC'') and for which the Commission is the supervisory agency, pursuant to the Clearing Supervision Act (``designated clearing agencies''), (ii) provide central counterparty (``CCP'') services for security-based swaps or are involved in activities the Commission determines to have a more complex risk profile, where in either case the Commodity Futures Trading Commission (``CFTC'') is not the supervisory agency for such clearing agency as defined in Section 803(8) of the Clearing Supervision Act, or (iii) are otherwise determined to be covered clearing agencies by the Commission. The Commission also proposes to add new Rule 17Ad-22(f) to codify the Commission's statutory authority and new Rule 17Ab2-2 to establish procedures for making determinations regarding covered clearing agencies under proposed Rule 17Ad-22(e). The Commission also proposes to amend existing Rule 17Ad-22(d) to limit its application to clearing agencies other than covered clearing agencies and to revise existing Rule 17Ad-22(a) to add 15 new definitions. The Commission has begun, and intends to continue, consultation with the FSOC and the Board of Governors of the Federal Reserve System (``the Board'') and has considered the relevant international standards as required by Section 805(a)(2)(A) of the Clearing Supervision Act.\1\ --------------------------------------------------------------------------- \1\ See Committee on Payment and Settlement Systems and Technical Committee of the International Organization of Securities Commissions (``CPSS-IOSCO''), Principles for Financial Market Infrastructures (Apr. 16, 2012), available at http://www.bis.org/publ/cpss101a.pdf (``PFMI Report''). --------------------------------------------------------------------------- Table of Contents I. Current Regulatory Framework for Clearing Agencies A. Section 17A of the Exchange Act B. OTC Swaps Clearing and the Dodd-Frank Act 1. Title VII of the Dodd-Frank Act 2. Title VIII of the Dodd-Frank Act C. Rule 17Ad-22 Under the Exchange Act D. Relevant International Standards II. Discussion of the Proposed Amendments To Rule 17AD-22 and Proposed Rule 17AB2-2 A. Overview 1. Scope of Proposed Rule 17Ad-22(e) 2. Role of Written Policies and Procedures 3. Frequency of Review Required Under Certain Policies and Procedures 4. Anticipated Impact of Proposed Rule 17Ad-22(e) 5. General Request for Comments B. Proposed Rule 17Ad-22(e) 1. Proposed Rule 17Ad-22(e)(1): Legal Risk 2. Proposed Rule 17Ad-22(e)(2): Governance 3. Proposed Rule 17Ad-22(e)(3): Framework for the Comprehensive Management of Risks a. Policies and Procedures Requirements, Periodic Review, and Annual Board Approval b. Recovery and Orderly Wind-Down Plans c. Risk Management and Internal Audit d. Request for Comments 4. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk Management a. Overview of Financial Risks Faced by Clearing Agencies b. Current Financial Risk Management Requirements for CCPs c. Proposed Rule 17Ad-22(e)(4): Credit Risk i. Prefunded Financial Resources ii. Combined or Separately Maintained Clearing or Guaranty Funds iii. Testing the Sufficiency of Financial Resources iv. Annual Conforming Model Validation d. Proposed Rule 17Ad-22(e)(5): Collateral e. Proposed Rule 17Ad-22(e)(6): Margin i. Active Management of Model Risk ii. Collection of Margin iii. Ninety-Nine Percent Confidence Level iv. Price Data Source v. Method for Measuring Credit Exposure vi. Backtesting and Sensitivity Analysis vii. Annual Conforming Model Validation f. Proposed Rule 17Ad-22(e)(7): Liquidity Risk [[Page 29509]] i. Sufficient Liquid Resources ii. Qualifying Liquid Resources iii. Access to Account Services at a Federal Reserve Bank or Other Relevant Central Bank iv. Liquidity Providers v. Maintenance and Annual Testing of Liquidity Provider Procedures and Operational Capacity vi. Testing the Sufficiency of Liquid Resources vii. Annual Conforming Model Validation viii. Address Liquidity Shortfalls and Seek to Avoid Unwinding Settlement ix. Replenishment of Liquid Resources x. Feasibility Analysis for ``Cover Two'' g. Request for Comments 5. Proposed Rule 17Ad-22(e)(8): Settlement Finality 6. Proposed Rule 17Ad-22(e)(9): Money Settlements 7. Proposed Rule 17Ad-22(e)(10): Physical Delivery Risks 8. Proposed Rule 17Ad-22(e)(11): Central Securities Depositories a. Controls to Safeguard the Rights of Securities Issuers and Holders and Prevent the Unauthorized Creation or Deletion of Securities b. Periodic and At Least Daily Reconciliation of Securities Maintained c. Protect Assets against Custody Risk d. Request for Comments 9. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems 10. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures a. Address Allocation of Credit Losses b. Describe Replenishment of Financial Resources c. Test Default Procedures Annually and Following Material Changes d. Request for Comments 11. Proposed Rule 17Ad-22(e)(14): Segregation and Portability 12. Proposed Rule 17Ad-22(e)(15): General Business Risk a. Determining Liquid Net Assets for Recovery and an Orderly Wind-Down b. Requirements for Liquid Net Assets c. Plan for Raising Additional Equity d. Request for Comments 13. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks 14. Proposed Rule 17Ad-22(e)(17): Operational Risk Management 15. Proposed Rule 17Ad-22(e)(18): Access and Participation Requirements 16. Proposed Rule 17Ad-22(e)(19): Tiered Participation Agreements 17. Proposed Rule 17Ad-22(e)(20): Links 18. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness 19. Proposed Rule 17Ad-22(e)(22): Communication Procedures and Standards 20. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures, and Market Data a. Comprehensive Public Disclosure b. Updates to the Comprehensive Public Disclosure c. Request for Comments C. Proposed Rule 17Ab2-2 1. Determination that a Registered Clearing Agency is a Covered Clearing Agency 2. Determination that a Covered Clearing Agency Is Systemically Important in Multiple Jurisdictions 3. Determination that a Clearing Agency Has a More Complex Risk Profile 4. Request for Comments D. Proposed Rule 17Ad-22(f) E. Proposed Amendment to Rule 17Ad-22(d) III. Paperwork Reduction Act A. Overview and Organization B. Summary of Collection of Information and Proposed Use of Information for Proposed Rule 17Ad-22(e) and Proposed Rule 17Ab2-2 1. Proposed Rules 17Ad-22(e)(1) through (3): General Organization a. Proposed Rule 17Ad-22(e)(1) b. Proposed Rule 17Ad-22(e)(2) c. Proposed Rule 17Ad-22(e)(3) 2. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk Management a. Proposed Rule 17Ad-22(e)(4) b. Proposed Rule 17Ad-22(e)(5) c. Proposed Rule 17Ad-22(e)(6) d. Proposed Rule 17Ad-22(e)(7) 3. Proposed Rules 17Ad-22(e)(8) through (10): Settlement a. Proposed Rule 17Ad-22(e)(8) b. Proposed Rule 17Ad-22(e)(9) c. Proposed Rule 17Ad-22(e)(10) 4. Proposed Rules 17Ad-22(e)(11) through (12): CSDs and Exchange-of-Value Settlement Systems a. Proposed Rule 17Ad-22(e)(11) b. Proposed Rule 17Ad-22(e)(12) 5. Proposed Rules 17Ad-22(e)(13) through (14): Default Management a. Proposed Rule 17Ad-22(e)(13) b. Proposed Rule 17Ad-22(e)(14) 6. Proposed Rules 17Ad-22(e)(15) through (17): General Business and Operational Risk Management a. Proposed Rule 17Ad-22(e)(15) b. Proposed Rule 17Ad-22(e)(16) c. Proposed Rule 17Ad-22(e)(17) 7. Proposed Rules 17Ad-22(e)(18) through (20): Access a. Proposed Rule 17Ad-22(e)(18) b. Proposed Rule 17Ad-22(e)(19) c. Proposed Rule 17Ad-22(e)(20) 8. Proposed Rules 17Ad-22(e)(21) through (22): Efficiency a. Proposed Rule 17Ad-22(e)(21) b. Proposed Rule 17Ad-22(e)(22) 9. Proposed Rule 17Ad-22(e)(23): Disclosure 10. Proposed Rule 17Ab2-2 C. Respondents D. Total Annual Reporting and Recordkeeping Burden for Proposed Rule 17Ad-22(e) 1. Proposed Rules 17Ad-22(e)(1) through (3): General Organization a. Proposed Rule 17Ad-22(e)(1) b. Proposed Rule 17Ad-22(e)(2) c. Proposed Rule 17Ad-22(e)(3) 2. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk Management a. Proposed Rule 17Ad-22(e)(4) b. Proposed Rule 17Ad-22(e)(5) c. Proposed Rule 17Ad-22(e)(6) d. Proposed Rule 17Ad-22(e)(7) 3. Proposed Rules 17Ad-22(e)(8) through (10): Settlement a. Proposed Rule 17Ad-22(e)(8) b. Proposed Rule 17Ad-22(e)(9) c. Proposed Rule 17Ad-22(e)(10) 4. Proposed Rules 17Ad-22(e)(11) through (12): CSDs and Exchange-of-Value Settlement Systems a. Proposed Rule 17Ad-22(e)(11) b. Proposed Rule 17Ad-22(e)(12) 5. Proposed Rules 17Ad-22(e)(13) through (14): Default Management a. Proposed Rule 17Ad-22(e)(13) b. Proposed Rule 17Ad-22(e)(14) 6. Proposed Rules 17Ad-22(e)(15) through (17): General Business and Operational Risk Management a. Proposed Rule 17Ad-22(e)(15) b. Proposed Rule 17Ad-22(e)(16) c. Proposed Rule 17Ad-22(e)(17) 7. Proposed Rules 17Ad-22(e)(18) through (20): Access a. Proposed Rule 17Ad-22(e)(18) b. Proposed Rule 17Ad-22(e)(19) c. Proposed Rule 17Ad-22(e)(20) 8. Proposed Rules 17Ad-22(e)(21) through (22): Efficiency a. Proposed Rule 17Ad-22(e)(21) b. Proposed Rule 17Ad-22(e)(22) 9. Proposed Rule 17Ad-22(e)(23): Disclosure 10. Total Burden for Proposed Rule 17Ad-22(e) E. Total Annual Reporting and Recordkeeping Burden for Proposed Rule 17Ab2-2 F. Collection of Information is Mandatory G. Confidentiality H. Request for Comments IV. Economic Analysis A. Introduction B. Economic Baseline 1. Overview 2. Current Regulatory Framework for Clearing Agencies a. Basel III Capital Requirements b. Other Regulatory Efforts 3. Current Practices a. General Organization i. Legal Risk ii. Governance iii. Framework for the Comprehensive Management of Risks b. Financial Risk Management i. Credit Risk ii. Collateral and Margin iii. Liquidity Risk c. Settlement d. CSDs and Exchange-of-Value Settlement Systems i. CSDs ii. Exchange-of-Value Settlement Systems e. Default Management i. Participant-Default Rules and Procedures ii. Segregation and Portability f. General Business and Operational Risk Management i. General Business Risk ii. Custody and Investment Risks iii. Operational Risk g. Access i. Access and Participation Requirements ii. Tiered Participation Arrangements iii. Links h. Efficiency i. Efficiency and Effectiveness ii. Communication Procedures and Standards i. Transparency [[Page 29510]] 4. Determinations by the Commission C. Consideration of Benefits, Costs, and the Effect on Competition, Efficiency, and Capital Formation 1. General Economic Considerations a. Systemic Risk b. Discretion c. Market Integrity d. Concentration e. Qualifying CCP Status and Externalities on Clearing Members 2. Effect on Competition, Efficiency, and Capital Formation a. Competition b. Efficiency c. Capital Formation 3. Effect of Proposed Amendments to Rule 17Ad-22 and Proposed Rule 17Ab2-2 a. Proposed Rule 17Ad-22(e) i. Proposed Rule 17Ad-22(e)(1): Legal Risk ii. Proposed Rule 17Ad-22(e)(2): Governance iii. Proposed Rule 17Ad-22(e)(3): Comprehensive Framework for the Management of Risks iv. Proposed Rules 17Ad-22(e)(4) through (7): Financial Risk Management (1) Proposed Rule 17Ad-22(e)(4): Credit Risk (2) Proposed Rule 17Ad-22(e)(5): Collateral (3) Proposed Rule 17Ad-22(e)(6): Margin (4) Proposed Rule 17Ad-22(e)(7): Liquidity Risk (5) Testing and Validation of Risk Models v. Proposed Rules 17Ad-22(e)(8) through (10): Settlement and Physical Delivery vi. Proposed Rule 17Ad-22(e)(11): CSDs vii. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems viii. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures ix. Proposed Rule 17Ad-22(e)(14): Segregation and Portability x. Proposed Rule 17Ad-22(e)(15): General Business Risk xi. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks xii. Proposed Rule 17Ad-22(e)(17): Operational Risk Management xiii. Proposed Rules 17Ad-22(e)(18) through (20): Membership Requirements, Tiered Participation, and Linkages (1) Proposed Rule 17Ad-22(e)(18): Member Requirements (2) Proposed Rule 17Ad-22(e)(19): Tiered Participation Arrangements (3) Proposed Rule 17Ad-22(e)(20): Links xiv. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness xv. Proposed Rule 17Ad-22(e)(22): Communication Procedures and Standards xvi. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures, and Market Data b. Proposed Rule 17Ab2-2 c. Proposed Rule 17Ad-22(f) d. Quantifiable Costs and Benefits D. Request for Comments V. Regulatory Flexibility Act Certification A. Registered Clearing Agencies B. Certification VI. Small Business Regulatory Enforcement Fairness Act VII. Statutory Authority and Text of Amended Rule 17AD-22 and Proposed Rule 17AB2-2 I. Current Regulatory Framework for Clearing Agencies A. Section 17A of the Exchange Act When Congress added Section 17A to the Exchange Act as part of the Securities Acts Amendments of 1975, it directed the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions.\2\ In Section 17A of the Exchange Act, Congress directed the Commission to have due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and maintenance of fair competition among brokers and dealers, clearing agencies, and transfer agents.\3\ The Commission's ability to achieve these goals and its supervision of securities clearance and settlement systems is based upon the regulation of clearing agencies registered with the Commission (``registered clearing agencies''). Clearing agencies are broadly defined under the Exchange Act and undertake a variety of functions.\4\ One such function is to act as a CCP, which is an entity that interposes itself between the counterparties to a trade.\5\ Over the years, registered clearing agencies have become an essential part of the infrastructure of the U.S. securities markets.\6\ Registered clearing agencies help reduce the costs and increase the safety and efficiency of securities trading and are required to be structured to manage and reduce counterparty risk.\7\ --------------------------------------------------------------------------- \2\ See 15 U.S.C. 78q-1; Report of the Senate Committee on Banking, Housing & Urban Affairs, S. Rep. No. 94-75, at 4 (1975) (urging that ``[t]he Committee believes the banking and security industries must move quickly toward the establishment of a fully integrated national system for the prompt and accurate processing and settlement of securities transactions''). \3\ See 15 U.S.C. 78q-1(a)(2)(A). \4\ Section 3(a)(23)(A) of the Exchange Act defines the term ``clearing agency'' to mean any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for the comparison of data regarding the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned or pledged by bookkeeping entry without physical delivery of securities certificates, or otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates. See 15 U.S.C. 78c(a)(23)(A). \5\ See id.; see also Exchange Act Release No. 34-68080 (Oct. 22, 2012), 77 FR 66219, 66221-22 (Nov. 2, 2012) (``Clearing Agency Standards Release''). An entity that acts as a CCP for securities transactions is a clearing agency as defined in the Exchange Act and is required to register with the Commission. For further discussion of the economic effects of CCPs, see infra notes 19, 563, and accompanying text. \6\ See Risk Management Supervision of Designated Clearing Entities (July 2011), Report by the Commission, the Board & CFTC to the Senate Committees on Banking, Housing & Urban Affairs and Agriculture in fulfillment of Section 813 of Title VIII of the Dodd- Frank Act, at 3 (stating that designated clearing entities ``play a vital role in the proper functioning of financial markets and are increasingly important given the mandated central clearing of certain swaps and security-based swaps that is required by the [Dodd-Frank] Act'') (``Risk Management Supervision Report''). \7\ See id. at 12 (describing the risk management practices of designated clearing entities and the economic and legal incentives for sound risk management). --------------------------------------------------------------------------- Section 17A of the Exchange Act and Rule 17Ab2-1 require entities to register with the Commission prior to performing the functions of a clearing agency.\8\ Under the statute, the Commission is not permitted to grant registration unless it determines that the rules and operations of the clearing agency meet the standards set forth in Section 17A of the Exchange Act.\9\ If the Commission registers a clearing agency, the Commission oversees the clearing agency to facilitate compliance with the Exchange Act using various tools that include, among other things, the rule filing process for self- regulatory organizations (``SROs'') and on-site examinations by Commission staff.\10\ The Commission also oversees registered clearing agencies through regular contact, including onsite visits, by Commission staff with clearing agency senior management and other personnel and ongoing interactions of Commission staff with the registered [[Page 29511]] clearing agencies regarding current and expected proposed rule changes under Section 19(b) of the Exchange Act. --------------------------------------------------------------------------- \8\ See 15 U.S.C. 78q-1(b) and 17 CFR 240.17Ab2-1 thereunder; see also infra notes 20-23 and accompanying text (noting that the Dodd-Frank Act also added new paragraphs (g), (i), and (j) to Section 17A of the Exchange Act to establish requirements for any entity that performs the functions of a clearing agency for security-based swaps). \9\ A clearing agency can be registered with the Commission only if the Commission makes a determination that the clearing agency satisfies the requirements set forth in Section 17A(b)(3)(A) through (I) of the Exchange Act. See 15 U.S.C. 78q-1(b)(3)(A) through (I). In 1980, the Commission published a statement of the views and positions of the Commission staff regarding the requirements of Section 17A in its Announcement of Standards for the Registration of Clearing Agencies. See Exchange Act Release No. 34-16900 (June 17, 1980), 45 FR 41920 (June 23, 1980). \10\ Under the Clearing Supervision Act, the supervisory agency must consult annually with the Board regarding the scope and methodology of on-site examinations of designated FMUs, and those examinations may include participation by the Board, if requested. See infra note 32 and accompanying text; see also 15 U.S.C. 78u(a) (providing the Commission with authority to initiate and conduct investigations to identify potential violations of the federal securities laws); 15 U.S.C. 78s(h) (providing the Commission with authority to institute civil actions seeking injunctive and other equitable remedies and/or administrative proceedings). --------------------------------------------------------------------------- B. OTC Swaps Clearing and the Dodd-Frank Act The Commission drew on its experience regulating clearing agencies to address recent developments in the over-the-counter (``OTC'') derivatives markets. In December 2008, the Commission acted to facilitate the central clearing of credit default swaps (``CDS'') by permitting certain entities that performed CCP services to clear and settle CDS on a temporary, conditional basis.\11\ Consequently, some CDS transactions were centrally cleared prior to the enactment of the Dodd-Frank Act. --------------------------------------------------------------------------- \11\ The Commission authorized five entities to clear CDS. See Exchange Act Release Nos. 60372 (July 23, 2009), 74 FR 37748 (July 29, 2009), 61973 (Apr. 23, 2010), 75 FR 22656 (Apr. 29, 2010) and 63389 (Nov. 29, 2010), 75 FR 75520 (Dec. 3, 2010) (CDS clearing by ICE Clear Europe Limited); 60373 (July 23, 2009), 74 FR 37740 (July 29, 2009), 61975 (Apr. 23, 2010), 75 FR 22641 (Apr. 29, 2010) and 63390 (Nov. 29, 2010), 75 FR 75518 (Dec. 3, 2010) (CDS clearing by Eurex Clearing AG); 59578 (Mar. 13, 2009), 74 FR 11781 (Mar. 19, 2009), 61164 (Dec. 14, 2009), 74 FR 67258 (Dec. 18, 2009), 61803 (Mar. 30, 2010), 75 FR 17181 (Apr. 5, 2010) and 63388 (Nov. 29, 2010), 75 FR 75522 (Dec. 3, 2010) (CDS clearing by Chicago Mercantile Exchange, Inc.); 59527 (Mar. 6, 2009), 74 FR 10791 (Mar. 12, 2009), 61119 (Dec. 4, 2009), 74 FR 65554 (Dec. 10, 2009), 61662 (Mar. 5, 2010), 75 FR 11589 (Mar. 11, 2010) and 63387 (Nov. 29, 2010), 75 FR 75502 (Dec. 3, 2010) (CDS clearing by ICE Trust US LLC); 59164 (Dec. 24, 2008), 74 FR 139 (Jan. 2, 2009) (temporary CDS clearing by LIFFE A&M and LCH.Clearnet Ltd.) (collectively ``CDS clearing exemption orders''). LIFFE A&M and LCH.Clearnet Ltd. allowed their orders to lapse without seeking renewal. --------------------------------------------------------------------------- On July 21, 2010, President Barack Obama signed the Dodd-Frank Act into law.\12\ The Dodd-Frank Act was enacted, among other reasons, to promote the financial stability of the United States by improving accountability and transparency in the financial system.\13\ It is intended, among other things, to bolster the existing regulatory structure and provide regulatory tools to address risks in the OTC derivatives markets, which have experienced dramatic growth in recent years and are capable of affecting significant sectors of the U.S. economy.\14\ --------------------------------------------------------------------------- \12\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376 (2010). \13\ See id. \14\ From their beginnings in the early 1980s, the notional value of these markets grew to approximately $693 trillion globally by June 2013. See Bank for International Settlements (``BIS''), Statistical Release: OTC Derivatives Statistics at End-June 2013, at 2 (Nov. 2013), available at http://www.bis.org/publ/otc_hy1311.pdf. --------------------------------------------------------------------------- 1. Title VII of the Dodd-Frank Act Title VII of the Dodd-Frank Act (``Title VII'') provides the Commission and the CFTC with enhanced authority to regulate certain OTC derivatives in response to the 2008 financial crisis.\15\ Title VII provides that the CFTC will regulate ``swaps,'' the Commission will regulate ``security-based swaps,'' and both the CFTC and the Commission will regulate ``mixed swaps.'' \16\ Title VII provides the Commission with new regulatory authority over security-based swaps by requiring, among other things, that security-based swaps generally be cleared and that clearing agencies for security-based swaps register with the Commission. --------------------------------------------------------------------------- \15\ See Dodd-Frank Act, 124 Stat. at 1641-1802. \16\ Section 712(d) of the Dodd-Frank Act provides that the Commission and the CFTC, in consultation with the Board, shall further define the terms ``swap,'' ``security-based swap,'' ``swap dealer,'' ``security-based swap dealer,'' ``major swap participant,'' ``major security-based swap participant,'' ``eligible contract participant,'' and ``security-based swap agreement.'' 124 Stat. at 1644. The Commission and the CFTC jointly adopted rules to further define the terms ``swap dealer,'' ``security-based swap dealer,'' ``major swap participant,'' ``major security-based swap participant,'' and ``eligible contract participant,'' as well as rules to further define the terms ``swap,'' ``security-based swap,'' and ``security-based swap agreement'' and to govern the regulation of mixed swaps. See Exchange Act Release Nos. 34-67453 (July 18, 2012), 77 FR 48208 (Aug. 13, 2012); 34-66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012). --------------------------------------------------------------------------- The swap and security-based swap markets traditionally have been characterized by privately negotiated transactions entered into by two counterparties, in which each assumes the credit risk of the other counterparty.\17\ Title VII amended the Exchange Act to require that transactions in security-based swaps be cleared through a clearing agency if they are of a type that the Commission determines must be cleared, unless an exemption from mandatory clearing applies.\18\ When structured and operated appropriately, clearing agencies may improve the management of counterparty risk in security-based swap markets and may provide additional benefits, such as the multilateral netting of trades.\19\ --------------------------------------------------------------------------- \17\ See, e.g., Exchange Act Release No. 34-60372 (July 23, 2009), 74 FR 37748 (July 29, 2009), at 37748 n.2 (discussing credit default swaps). \18\ See 15 U.S.C. 78c-3; see also Exchange Act Release No. 34- 67286 (June 28, 2012), 77 FR 41602 (July 13, 2012) (adopting rules establishing a process for submissions for review of security-based swaps for mandatory clearing); Exchange Act Release No. 34-63556 (Dec. 15, 2010), 75 FR 79992 (Dec. 21, 2010) (proposing an end-user exception to the mandatory clearing requirement). \19\ See Stephen G. Cecchetti, Jacob Gyntelberg & Marc Hollanders, Central Counterparties for Over-the-Counter Derivatives, BIS Q. Rev., Sept. 2009, at 46, available at http://www.bis.org/publ/qtrpdf/r_qt0909f.pdf (stating that the structure of a CCP ``has three clear benefits. First, it improves the management of counterparty risk. Second, it allows the CCP to perform multilateral netting of exposures as well as payments. Third, it increases transparency by making information on market activity and exposures--both prices and quantities--available to regulators and the public'') (emphasis omitted); see also Exchange Act Release No. 34-60372, supra note 17, at 37749 (discussing the benefits of using well-regulated CCPs to clear transactions in credit default swaps). But see infra note 563 and accompanying text (discussing the limits of clearing through central counterparties). --------------------------------------------------------------------------- Title VII also added new provisions to the Exchange Act that require entities performing the functions of a clearing agency with respect to security-based swaps (``security-based swap clearing agencies'') to register with the Commission and require the Commission to adopt rules with respect to security-based swap clearing agencies.\20\ Specifically, new Section 17A(j) requires the Commission to adopt rules governing security-based swap clearing agencies, and new Section 17A(i) gives the Commission authority to promulgate rules that establish standards for security-based swap clearing agencies.\21\ Compliance with any such rules is a prerequisite to the registration of a clearing agency that clears security-based swaps with the Commission and is also a condition to maintain its continued registration.\22\ Section 17A(i) also provides that the Commission, in establishing clearing agency standards and in its oversight of clearing agencies, may conform such standards and such oversight to reflect evolving international standards.\23\ Before commencing any rulemaking regarding, among other things, security-based swap clearing agencies, Title VII provides that the Commission shall consult and coordinate, to the extent possible, with the CFTC and the prudential regulators for the purpose of assuring regulatory consistency and comparability, to the extent possible.\24\ --------------------------------------------------------------------------- \20\ See 15 U.S.C. 78q-1(g); Dodd-Frank Act, Sec. 763(b), Public Law 111-203, 124 Stat. 1376, 1768 (2010) (adding paragraph (g) to Section 17A of the Exchange Act). Pursuant to Section 774 of the Dodd-Frank Act, the requirement in Section 17A(g) of the Exchange Act for security-based swap clearing agencies to be registered with the Commission took effect on July 16, 2011. See 124 Stat. at 1802. \21\ See 15 U.S.C. 78q-1(i), (j); Dodd-Frank Act, Sec. 763(b), 124 Stat. at 1768-69 (adding paragraphs (i) and (j) to Section 17A of the Exchange Act). \22\ See supra note 9 (describing the requirements under Section 17A(b)(3) of the Exchange Act, 15 U.S.C. 78q-1(b)(3)). \23\ See 15 U.S.C. 78q-1(i) (stating that, in establishing standards for security-based swap clearing agencies, and in the exercise of its oversight of such a clearing agency pursuant to this title, the Commission may conform such standards or oversight to reflect evolving United States and international standards). \24\ See Dodd-Frank Act, Sec. 712(a)(2), 124 Stat. at 1641-42. --------------------------------------------------------------------------- Title VII further provides that some of the entities that the Commission permitted to clear and settle CDS on a temporary, conditional basis prior to the [[Page 29512]] July 21, 2010 enactment of the Dodd-Frank Act are deemed under the Dodd-Frank Act to be registered clearing agencies (the ``deemed registered provision'').\25\ As a result, the Chicago Mercantile Exchange, Inc. (``CME''), ICE Clear Credit LLC (``ICE''), and ICE Clear Europe LLC (``ICEEU'') became clearing agencies deemed registered with the Commission on July 16, 2011, solely for the purpose of clearing security-based swaps. --------------------------------------------------------------------------- \25\ See 15 U.S.C. 78q-1(l). The deemed registered provision applies to certain depository institutions that cleared swaps as multilateral clearing organizations and certain derivatives clearing organizations (``DCOs'') that cleared swaps pursuant to an exemption from registration as a clearing agency before the date of enactment of the Dodd-Frank Act. Under the deemed registered provision, such a clearing agency is deemed registered for the purpose of clearing security-based swaps and is therefore required to comply with all requirements of the Exchange Act, and the rules thereunder, applicable to registered clearing agencies, including, for example, the obligation to file proposed rule changes under Section 19(b) of the Exchange Act. See infra note 96 (describing the requirements in Section 19(b) of the Exchange Act). --------------------------------------------------------------------------- 2. Title VIII of the Dodd-Frank Act The Clearing Supervision Act, adopted in Title VIII of the Dodd- Frank Act (``Title VIII''), provides for enhanced regulation of financial market utilities (``FMUs''), such as clearing agencies that manage or operate a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the FMU.\26\ The enhanced regulatory regime in Title VIII applies only to FMUs that the FSOC designates as systemically important (or likely to become systemically important) in accordance with Section 804 of the Clearing Supervision Act.\27\ On July 11, 2011, the FSOC published a final rule concerning its authority to designate FMUs as systemically important.\28\ --------------------------------------------------------------------------- \26\ The definition of ``financial market utility'' in Section 803(6) of the Clearing Supervision Act contains a number of exclusions that include, but are not limited to, certain designated contract markets, registered futures associations, swap data repositories, swap execution facilities, national securities exchanges, national securities associations, alternative trading systems, security-based swap data repositories, security-based swap execution facilities, brokers, dealers, transfer agents, investment companies and futures commission merchants. See 12 U.S.C. 5462(6)(B). \27\ Pursuant to Section 803(9) of the Clearing Supervision Act, an FMU is systemically important if the failure of or a disruption to the functioning of such FMU could create or increase the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the U.S. financial system. See 12 U.S.C. 5462(9). \28\ See 76 FR 44763 (July 27, 2011). Under Section 804 of the Clearing Supervision Act, the FSOC has the authority, on a non- delegable basis and by a vote of no fewer than two-thirds of the members then serving, including the affirmative vote of its chairperson, to designate those FMUs that the FSOC determines are, or are likely to become, systemically important. See 12 U.S.C. 5463. The FSOC may, using the same procedures as discussed above, rescind such designation if it determines that the FMU no longer meets the standards for systemic importance. Before making either determination, the FSOC is required to consult with the Board and the relevant supervisory agency (as determined in accordance with Section 803(8) of the Clearing Supervision Act). See id. Finally, Section 804 of the Clearing Supervision Act sets forth the procedures for giving entities a 30-day notice and the opportunity for a hearing prior to a designation or rescission of the designation of systemic importance. See id. --------------------------------------------------------------------------- Section 806(e) of the Clearing Supervision Act requires FMUs designated as systemically important to file 60 days advance notice of changes to its rules, procedures, or operations that could materially affect the nature or level of risk presented by the FMU (``Advance Notice'').\29\ In addition, Section 806(e) requires each supervisory agency to adopt rules, in consultation with the Board, that define and describe when a designated FMU is required to file an Advance Notice with its supervisory agency.\30\ The Commission published a final rule concerning the Advance Notice process for designated clearing agencies on June 28, 2012.\31\ In evaluating an Advance Notice filed with the Commission, the Commission would assess, among other things, the consistency of the Advance Notice with the rules proposed herein, if adopted. --------------------------------------------------------------------------- \29\ See 12 U.S.C. 5465(e)(1)(A). \30\ Section 803(8) of the Clearing Supervision Act defines the term ``supervisory agency'' in reference to the primary regulatory authority for the FMU. For example, it provides that the Commission is the supervisory agency for any FMU that is a registered clearing agency. See 12 U.S.C. 5462(8). To the extent that an entity is both a clearing agency registered with the Commission and registered with another agency, such as a DCO registered with the CFTC, the statute requires the two agencies to agree on one agency to act as the supervisory agency, and if the agencies cannot agree on which agency has primary jurisdiction, the FSOC shall decide which agency is the supervisory agency for purposes of the Clearing Supervision Act. See 12 U.S.C. 5462(8). \31\ See Exchange Act Release No. 34-67286 (June 28, 2012), 77 FR 41602 (July 13, 2012). --------------------------------------------------------------------------- The Clearing Supervision Act also provides for enhanced coordination between the Commission, the Board, and the CFTC by facilitating examinations and information sharing. Under Section 807 of the Clearing Supervision Act, the Commission and the CFTC must consult annually with the Board regarding the scope and methodology of any examination of a designated FMU, and the Board is authorized to participate in any such examination.\32\ Section 809 of the Clearing Supervision Act authorizes the Commission, the Board, and the CFTC to disclose to each other copies of examination reports or similar reports regarding any designated FMU.\33\ It further authorizes the Commission, the Board, and the CFTC to promptly notify each other of material concerns about a designated FMU and share appropriate reports, information, or data relating to such concerns.\34\ Section 813 of the Clearing Supervision Act requires the Commission and the CFTC to coordinate with the Board to develop risk management supervision programs for designated clearing agencies.\35\ --------------------------------------------------------------------------- \32\ See 12 U.S.C. 5466. \33\ See 12 U.S.C. 5468. \34\ See id. \35\ See 12 U.S.C. 5472; see also Risk Management Supervision Report, supra note 6. --------------------------------------------------------------------------- Section 805(a) of the Clearing Supervision Act \36\ also provides that the Commission may prescribe risk management standards governing the operations related to payment, clearing, and settlement activities (``PCS activities'') of designated FMUs for which it acts as the supervisory agency, in consultation with the FSOC and the Board and taking into consideration relevant international standards and existing prudential requirements.\37\ --------------------------------------------------------------------------- \36\ 12 U.S.C. 5464(a). \37\ See 12 U.S.C. 5464(a)(2) (stating that these regulations may govern the operations related to payment, clearing, and settlement activities of such designated clearing entities, and the conduct of designated activities by such financial institutions). PCS activities are defined in Section 803(7) of the Clearing Supervision Act. See 12 U.S.C 5462(7). --------------------------------------------------------------------------- On July 18, 2012, the FSOC designated as systemically important the following registered clearing agencies: CME, The Depository Trust Company (``DTC''), Fixed Income Clearing Corporation (``FICC''), ICE, National Securities Clearing Corporation (``NSCC''), and The Options Clearing Corporation (``OCC'').\38\ Under the Clearing Supervision Act, the Commission is the supervisory agency for DTC, FICC, NSCC, and OCC.\39\ The [[Page 29513]] Commission jointly regulates DTC with the Board and OCC with the CFTC.\40\ The Commission also jointly regulates CME and ICE with the CFTC, which serves as their supervisory agency.\41\ --------------------------------------------------------------------------- \38\ See U.S. Treasury Dep't, Financial Stability Oversight Council Makes First Designations in Effort to Protect Against Future Financial Crises (July 18, 2012), http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx; see also 12 U.S.C. 5321 (establishing the FSOC and designating its voting and non-voting members); 12 U.S.C. 5463 (describing the designation of systemic importance by the FSOC); supra note 28 (describing the process by which the FSOC would make or rescind a designation of systemic importance). Section 804 of the Clearing Supervision Act, 12 U.S.C. 5463, further sets forth procedures that give entities 30 days advance notice and an opportunity for a hearing prior to being designated as systemically important. See FSOC, 2012 Annual Report, at app. A, available at http://www.treasury.gov/initiatives/fsoc/Documents/2012%20Annual%20Report.pdf. \39\ See supra note 30 (discussing designation as the supervisory agency); see also FSOC, 2013 Annual Report, at 99-101, 113 (further discussing the same), available at http://www.treasury.gov/initiatives/fsoc/Documents/FSOC%202013%20Annual%20Report.pdf. \40\ As a member of the U.S. Federal Reserve System and a limited purpose trust company under New York State banking law, DTC is subject to regulation by the Board. \41\ In addition, the Commission jointly regulates ICEEU, which is not currently designated as systemically important by the FSOC, with the CFTC and the Bank of England. --------------------------------------------------------------------------- C. Rule 17Ad-22 Under the Exchange Act On October 22, 2012, the Commission adopted Rule 17Ad-22 under the Exchange Act.\42\ Through Rule 17Ad-22, the Commission sought to strengthen the substantive regulation of registered clearing agencies, promote the safe and reliable operation of registered clearing agencies, and improve efficiency, transparency, and access to registered clearing agencies by establishing minimum requirements with due consideration given to observed practices and international standards.\43\ At that time, the Commission noted that the implementation of Rule 17Ad-22 would be an important first step in developing the regulatory changes contemplated by Titles VII and VIII of the Dodd-Frank Act.\44\ Rule 17Ad-22 requires all registered clearing agencies to establish, implement, maintain and enforce written policies and procedures that are reasonably designed to meet certain minimum requirements for their operations and risk management practices on an ongoing basis.\45\ These requirements are designed to work in tandem with the SRO rule filing process and the requirement in Section 17A of the Exchange Act that the Commission must make certain determinations regarding a clearing agency's rules and operations for purposes of initial and ongoing registration.\46\ Rule 17Ad-22 does not apply to entities that are operating pursuant to an exemption from registration as a clearing agency granted by the Commission,\47\ and it does not give particular consideration to issues relevant to clearing agencies designated as systemically important FMUs. --------------------------------------------------------------------------- \42\ See Clearing Agency Standards Release, supra note 5. \43\ See id. at 66225, 66263-64. \44\ See Clearing Agency Standards Release, supra note 5, at 66225. \45\ Rules 17Ad-22(b)(1) through (4) contain several requirements that address risk management practices by registered clearing agencies that provide CCP services. Rules 17Ad-22(b)(5) through (7) establish certain requirements regarding access to registered clearing agencies that provide CCP services. Rule 17Ad- 22(c) requires that a registered clearing agency providing CCP services calculate and maintain a record of its financial resources and requires each registered clearing agency to publish annual audited financial statements. Rule 17Ad-22(d) sets forth certain minimum standards for the operations of registered clearing agencies providing CCP or central securities depository (``CSD'') services. See infra Part II.B.4.b (discussing the current requirements for CCPs under Rule 17Ad-22); see also Clearing Agency Standards Release, supra note 5 (adopting the existing standards under Rule 17Ad-22). \46\ See supra note 9 (describing the requirements under Section 17A(b)(3) of the Exchange Act, 15 U.S.C. 78q-1(b)(3)) and infra note 96 (further describing the Commission's framework for regulation of SROs and the SRO rule filing process). \47\ See, e.g., Exchange Act Release No. 34-44188 (Apr. 17, 2001), 66 FR 20494 (Apr. 23, 2011) (the Omgeo exemption); Exchange Act Release No. 34-39643 (Feb. 11, 1998), 63 FR 8232 (Feb. 18, 1998) (the Euroclear exemption); Exchange Act Release No 34-38328 (Feb. 24, 1997), 62 FR 9225 (Feb. 28, 1997) (the Clearstream exemption). --------------------------------------------------------------------------- D. Relevant International Standards In proposing amendments to Rule 17Ad-22, the Commission considered international standards, as required by Section 805(a) of the Clearing Supervision Act, that are relevant to its supervision of covered clearing agencies.\48\ CPSS-IOSCO published in April 2012 the PFMI Report \49\ to replace previous standards applicable to clearing agencies contained in two earlier reports: Recommendations for Securities Settlement Systems (2001) (``RSSS'') and Recommendations for Central Counterparties (2004) (``RCCP'') (collectively ``CPSS-IOSCO Recommendations'').\50\ Commission staff participated in the development and drafting of the PFMI Report,\51\ and the Commission believes that the standards set forth in the PFMI Report are generally consistent with the requirements applicable to clearing agencies set forth in the Exchange Act.\52\ Regulatory authorities around the world are in various stages of updating their regulatory regimes to adopt measures that are in line with the standards set forth in the PFMI Report.\53\ The rule [[Page 29514]] proposals set forth below are a continuation of the Commission's active efforts to foster the development of the national clearance and settlement system. --------------------------------------------------------------------------- \48\ See supra note 36. In addition, the Basel Committee on Banking Supervision (``BCBS''), the international body that sets standards for the regulation of banks, published in July 2012 the Capital Requirements for Bank Exposures to Central Counterparties (``Basel III capital requirements''). The Basel III capital requirements set forth interim rules governing the capital charges arising from bank exposures to CCPs related to OTC derivatives, exchange-traded derivatives, and securities financing transactions (which term, as used throughout this release, refers generally to repurchase agreements and securities lending). Among other things, the Basel III framework imposes lower capital requirements on CCPs that obtain ``qualifying CCP'' (``QCCP'') status and would apply QCCP status only to CCPs that are subject to a regulatory framework consistent with the standards set forth in the PFMI Report. See BCBS, Capital Requirements for Bank Exposures to Central Counterparties (July 2012), available at http://www.bis.org/publ/bcbs227.pdf (setting forth he interim requirements set forth in this report, currently under revision by the BCBS, in consultation with CPSS and IOSCO). See also BCBS, Capital Treatment of Bank Exposures to Central Counterparties: Consultative Document (rev. July 2013), available at http://www.bis.org/publ/bcbs253.pdf; BIS, Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems (rev. June 2011), available at http://www.bis.org/publ/bcbs189.htm (``Basel III framework''). The Basel III capital requirements are one component of the Basel III framework. \49\ See supra note 1. The PFMI Report defines a ``financial market infrastructure'' (``FMI'') as a multilateral system among participating institutions, including the operator of the system, used for the purposes of clearing, settling, or recording payments, securities, derivatives, or other financial transactions. See id. at 7; FMIs include CCPs, CSDs, securities settlement systems (``SSSs''), and trade repositories (``TRs''). Cf. 12 U.S.C. 5462(6)(B), supra note 30 (defining ``financial market utility'' under the Clearing Supervision Act). The PFMI Report presumes that all CSDs, SSSs, CCPs, and TRs are systemically important in their home jurisdiction. See PFMI Report, supra note 1, at 131 & n.177 (noting the ``presumption . . . that all CSDs, SSSs, CCPs, and TRs are systemically important because of their critical roles in the markets they serve,'' but also noting that ultimately ``national law will dictate the criteria to determine whether an FMI is systemically important''). The Commission notes that the PFMI Report's definition of ``financial market infrastructure'' is consistent with the Commission's prior use of the term. See Study of Unsafe and Unsound Practices of Brokers and Dealers, H.R. Doc. No. 231, 92d Cong., 1st Sess. 13 (1971) (defining ``financial market infrastructure'' as a multilateral system among participating institutions, including the operator of the system, used for the purposes of clearing, settling, or recording payments, securities, derivatives, or other financial transactions). \50\ The CPSS-IOSCO Recommendations are available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD123.pdf and http://www.iosco.org/library/pubdocs/pdf/IOSCPD176.pdf. The Board applies these standards in its supervisory process and expects systemically important FMUs, as determined by the Board and subject to its authority, to complete a self-assessment against the standards set forth in the policy. See Financial Market Utilities, 77 FR 45907 (Aug. 2, 2012) (the Board adopting Regulation HH for FMUs) (``Reg. HH''); Policy on Payments System Risk, 72 FR 2518 (Jan. 12, 2007). The Board has proposed to amend the standards in Regulation HH to replace the current standards for payment systems with standards based those set forth in the PFMI Report. It has also proposed to amend its Policy on Payments System Risk. See infra note 53. \51\ Commission staff co-chaired the Editorial Team, a working group within CPSS-IOSCO that drafted both the consultative and final versions of the PFMI Report. \52\ See 15 U.S.C. 78q-1; 15 U.S.C. 78s(b). \53\ See CPSS-IOSCO, Implementation Monitoring of PFMIs--Level 1 Assessment Report (Aug. 2013), available at http://www.bis.org/publ/cpss111.pdf (describing efforts by various jurisdictions to adopt standards for FMIs in line with the PFMI Report) (``PFMI Implementation Monitoring Report''); see also Reg. HH, supra note 50; Financial Market Utilities, 79 FR 3665 (Jan. 22, 2014) (the Board proposing to amend Reg. HH) (``proposed Reg. HH''); Policy on Payment System Risk, 79 FR 2838 (Jan. 16, 2014) (the Board proposing to amend its Federal Reserve Policy on Payments System Risk) (``proposed PSR Policy''); Derivatives Clearing Organizations and International Standards, 78 FR 72475 (Dec. 2, 2013) (CFTC adopting rules for DCOs in line with international standards) (``DCO Int'l Standards Release''); Enhanced Risk Management Standards for Systemically Important Derivatives Clearing Organizations, 78 FR 49663 (Aug. 15, 2013) (CFTC adopting rules for systemically important DCOs) (``SIDCO Release''); Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 2011) (CFTC adopting rules for DCOs); (``DCO Principles Release''). In addition, the Board and the Office of the Comptroller of the Currency have adopted rules implementing the material elements of the BCBS interim framework for capitalization of bank exposures to CCPs. See Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 76 FR 62017, 62099 (Oct. 11, 2013) (``Regulatory Capital Rules''). The Board also noted the ongoing international discussions on this topic and stated that it intends to revisit its rules once the Basel III capital framework is revised. See id. The Board and the Office of the Comptroller of the Currency's final rules define ``QCCP'' to mean, among other things, a designated FMU under the Clearing Supervision Act. See 12 CFR 217.2; see also Regulatory Capital Rules, supra, at 62100. --------------------------------------------------------------------------- II. Discussion of the Proposed Amendments to Rule 17Ad-22 and Proposed Rule 17Ab2-2 The Commission is proposing to amend Rule 17Ad-22 and add Rule 17Ab2-2 pursuant to Section 17A of the Exchange Act and the Clearing Supervision Act to provide a new regulatory framework for ``covered clearing agencies,'' as defined below. Generally, Section 17A directs the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions, having due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and the maintenance of fair competition among brokers and dealers.\54\ It further requires that a clearing agency be so organized and have the capacity and rules designed to, among other things, facilitate the prompt and accurate clearance and settlement of securities transactions, and to comply with the provisions of the Exchange Act and the rules and regulations thereunder.\55\ In establishing a regulatory framework for clearance and settlement, the Exchange Act requires that a registered clearing agency's rules not impose any burden on competition not necessary or appropriate in the furtherance of the purposes of the Exchange Act.\56\ --------------------------------------------------------------------------- \54\ See 15 U.S.C. 78q-1(a)(2)(A). \55\ See 15 U.S.C. 78q-1(a)(3)(A), (F). \56\ See 15 U.S.C. 78q-1(b)(3)(I). --------------------------------------------------------------------------- Consistent with these statutory objectives, the Commission previously adopted Rule 17Ad-22(d) to establish minimum requirements for registered clearing agencies and indicated that it might consider further rulemaking at a later date.\57\ In furtherance of the provisions of Section 17A of the Exchange Act and the Clearing Supervision Act described above and as previously considered by the Commission, the Commission is proposing Rule 17Ad-22(e) to establish new requirements for covered clearing agencies, which the Commission preliminarily believes are appropriate given the risks that their size, operation, and importance pose to the U.S. securities markets, the risks inherent in the products they clear, and the goals of Title VII and the Exchange Act.\58\ In connection with its supervision of registered clearing agencies under Section 17A of the Exchange Act, including after the adoption of Rule 17Ad-22,\59\ the Commission has considered whether enhanced requirements for covered clearing agencies could contribute to the stability of U.S. securities markets, as described further in Part IV, and has determined to issue this proposal for comment. --------------------------------------------------------------------------- \57\ See Clearing Agency Standards Release, supra note 5, at 66224-25. \58\ See id. (contemplating future Commission action on clearing agency standards). \59\ See Clearing Agency Standards Release, supra note 5, at 66227 (stating that Rule 17Ad-22 generally codifies existing practices that reflect the CPSS-IOSCO Recommendations published in 2001 and 2004). --------------------------------------------------------------------------- The Commission has preliminarily chosen to retain Rule 17Ad-22(d) and to continue to apply it to registered clearing agencies that are not covered clearing agencies.\60\ The Commission preliminarily believes that retaining Rule 17Ad-22(d) ensures that clear, comprehensive, and transparent standards for registered clearing agencies that are not covered clearing agencies will continue to exist and, because they are narrower in scope, would thereby provide a more flexible regime for new entrants seeking to establish and operate registered clearing agencies, consistent with the continuing development of the national system for clearance and settlement, than would otherwise be the case with a single regime under proposed Rule 17Ad-22(e). --------------------------------------------------------------------------- \60\ See infra Part II.E (discussing the proposed language amending Rule 17Ad-22(d) to apply to registered clearing agencies that are not covered clearing agencies). --------------------------------------------------------------------------- The Commission notes that it is not proposing to alter the existing requirements under Rule 17Ad-22(b), which establishes risk-management and participant access requirements for registered clearing agencies that perform CCP services for security-based swaps, or Rule 17Ad-22(c), which requires registered clearing agencies that provide CCP services to maintain a record of financial resources and all registered clearing agencies to post on their Web sites annual audited financial statements.\61\ These requirements continue to be appropriate for all registered clearing agencies because they promote prompt and accurate clearance and settlement of securities and security-based swap transactions. Notably, Rule 17Ad-22(b) reduces the likelihood, in a participant default scenario, that losses from default would disrupt the operations of the clearing agency, and Rule 17Ad-22(c) provides an additional layer of information about the activities and financial strength of a registered clearing agency that market participants may find useful in assessing their use of the registered clearing agency's services while also assisting the Commission in its oversight of registered clearing agencies' compliance with Rule 17Ad-22 by providing a clear record of the method used by the clearing agency to, among other things, maintain sufficient financial resources.\62\ --------------------------------------------------------------------------- \61\ The standards in Rules 17Ad-22(b) and (c) were also adopted by the Commission in 2012. See 17 CFR 240.17Ad-22(b), (c); see also Clearing Agency Standards Release, supra note 5. The Commission is proposing to revise Rule 17Ad-22(a) to account for new proposed definitions. See proposed revision of Rule 17Ad- 22(a), infra Part VII. The existing definitions in 17 CFR 240.17Ad- 22(a) would be renumbered to account for new terms. In addition, the definition of ``participant family'' would be amended to include references to its use in proposed paragraphs (e)(4) and (e)(7). See proposed Rule 17Ad-22(a)(13), infra Part VII. \62\ See Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR 14474, 14477-83 (Mar. 16, 2011); see also Clearing Agency Standards Release, supra note 5, at 66244. --------------------------------------------------------------------------- A. Overview The Commission is proposing Rule 17Ad-22(e) to establish requirements for covered clearing agencies with respect to general organization,\63\ financial risk management,\64\ settlement,\65\ CSDs and exchange-of- [[Page 29515]] value settlement systems,\66\ default management,\67\ general business risk and operational risk management,\68\ access,\69\ efficiency,\70\ and transparency.\71\ The discussion below provides greater detail regarding each respective requirement in proposed Rule 17Ad-22(e). Several aspects of proposed Rule 17Ad-22(e) are similar to existing Rule 17Ad-22(d),\72\ but in general the Commission preliminarily notes that certain requirements under proposed Rule 17Ad-22(e) would require covered clearing agencies to consider and adopt policies and procedures more closely tailored to the risks that are posed by covered clearing agencies, which the Commission preliminarily identified as appropriate in connection with its experience in supervising registered clearing agencies under Section 17A of the Exchange Act, including since the adoption of Rule 17Ad-22. --------------------------------------------------------------------------- \63\ See infra Parts II.B.1-3 (discussing proposed Rules 17Ad- 22(e)(1) (legal risk), 17Ad-22(e)(2) (governance), and 17Ad-22(e)(3) (framework for the comprehensive management of risk)). \64\ See infra Part II.B.4 (discussing proposed Rules 17Ad- 22(e)(4) (credit risk), 17Ad-22(e)(5) (collateral), 17Ad-22(e)(6) (margin), and 17Ad-22(e)(7) (liquidity risk)). \65\ See infra Parts II.B.5-7 (discussing proposed Rules 17Ad- 22(e)(8) (settlement finality), 17Ad-22(e)(9) (money settlements), and 17Ad-22(e)(10) (physical delivery risks)). \66\ See infra Parts II.B.8-9 (discussing proposed Rules 17Ad- 22(e)(11) (CSDs) and 17Ad-22(e)(12) (exchange-of-value settlement systems)). \67\ See infra Parts II.B.10-11 (discussing proposed Rules 17Ad- 22(e)(13) (participant-default rules and procedures) and 17Ad- 22(e)(14) (segregation and portability)). \68\ See infra Parts II.B.12-14 (discussing proposed Rules 17Ad- 22(e)(15) (general business risk), 17Ad-22(e)(16) (custody and investment risk), and 17Ad-22(e)(17) (operational risk management)). \69\ See infra Parts II.B.15-17 (discussing proposed Rules 17Ad- 22(e)(18) (access and participation requirements), 17Ad-22(e)(19) (tiered participation arrangements), and 17Ad-22(e)(20) (links)). \70\ See infra Parts II.B.18-19 (discussing proposed Rules 17Ad- 22(e)(21) (efficiency and effectiveness) and 17Ad-22(e)(22) (communication procedures and standards)). \71\ See infra Part II.B.20 (discussing proposed Rule 17Ad- 22(e)(23) (disclosure of rules, key procedures, and market data)). \72\ See infra Part II.A.4 (discussing the anticipated impact of proposed Rule 17Ad-22(e) given the existing requirements for registered clearing agencies under Rule 17Ad-22). --------------------------------------------------------------------------- The Commission preliminarily believes that the requirements of proposed Rule 17Ad-22(e) would help promote governance, operations, and risk management practices more closely tailored to the risks raised by registered clearing agencies that have been designated systemically important, are engaged in activities with a more complex risk profile, or are determined to be covered clearing agencies by the Commission, consistent with Section 17A of the Exchange Act. The Commission preliminarily believes these requirements would also enable consistent supervision of designated FMUs and would reflect the Commission's consideration of international standards, as contemplated by Section 17A(i) and the Clearing Supervision Act.\73\ While the Commission has made its own determination to issue the proposed rules for comment, the Commission preliminarily believes that generally updating its rules, where appropriate, to take into account the standards set forth in the PFMI Report would contribute to the efforts of regulators around the world, described above,\74\ to implement consistent standards for FMIs.\75\ The Commission also preliminarily believes that Rule 17Ad- 22(e) would provide an additional benefit of providing support for a determination by foreign bank regulators that covered clearing agencies providing CCP services for derivatives and securities financing transactions meet the requirements for QCCP status under the Basel III framework and could therefore help reduce competitive frictions among CCPs in different jurisdictions. --------------------------------------------------------------------------- \73\ See supra Part I.B.2, in particular notes 36-37 and accompanying text (discussing the requirements under Section 17A(i) of the Exchange Act, 15 U.S.C. 78q-1(i), and Section 805(a) of the Clearing Supervision Act, 12 U.S.C. 5464(a)). \74\ See supra note 53 and accompanying text. \75\ See infra Part IV.C.1.e (further discussing the economic effects of obtaining QCCP status under the Basel III capital requirements); see also supra note 48. --------------------------------------------------------------------------- Part II.A first discusses the scope of proposed Rule 17Ad-22(e), the role that written policies and procedures play in framing the proposed rule, and the reasons for imposing certain frequency of review requirements throughout the proposed rules. It then discusses the anticipated impact of the proposed rules given the existing requirements applicable to registered clearing agencies under Rules 17Ad-22(b) through (d), with which a covered clearing agency must already be in compliance. Part II.B next discusses the proposed rules under Rule 17Ad-22(e). Finally, Parts II.C, D, and E discuss, in turn, proposed Rule 17Ab2-2, proposed Rule 17Ad-22(f), and the proposed amendment to Rule 17Ad- 22(d). 1. Scope of Proposed Rule 17Ad-22(e) The Commission is proposing to add four terms to Rule 17Ad-22(a) to identify the registered clearing agencies that would be subject to proposed Rule 17Ad-22(e). First, the Commission is proposing to add Rule 17Ad-22(a)(9) to define ``financial market utility'' (``FMU'') as defined in Section 803(6) of the Clearing Supervision Act.\76\ Second, the Commission is proposing Rule 17Ad-22(a)(8) to define ``designated clearing agency.'' \77\ A designated clearing agency would mean a clearing agency registered with the Commission under Section 17A of the Exchange Act that has been designated as a systemically important FMU by the FSOC and for which the Commission is the supervisory agency as defined in Section 803(8) of the Clearing Supervision Act.\78\ Third, the Commission is proposing to add Rule 17Ad-22(a)(4) to define ``clearing agency involved in activities with a more complex risk profile'' \79\ to mean a clearing agency registered with the Commission under Section 17A of the Exchange Act that either (i) provides central counterparty services for security-based swaps or (ii) has been determined by the Commission to be involved in activities with a more complex risk profile (``complex risk profile clearing agency''), either at the time of its initial registration or upon a subsequent determination by the Commission pursuant to proposed Rule 17Ab2-2.\80\ Fourth, the Commission is proposing to add Rule 17Ad-22(a)(7) to define a ``covered clearing agency'' as a designated clearing agency, a complex risk profile clearing agency, or any clearing agency determined to be a covered clearing agency by the Commission pursuant to proposed Rule 17Ab2-2.\81\ --------------------------------------------------------------------------- \76\ See proposed Rule 17Ad-22(a)(9), infra Part VII; see also 12 U.S.C. 5462(6) (defining ``financial market utility'' pursuant to the Clearing Supervision Act); supra note 26 (providing further explanation of ``financial market utility''). \77\ See proposed Rule 17Ad-22(a)(8), infra Part VII. \78\ Rule 17Ad-22 does not currently apply to entities operating pursuant to an exemption from clearing agency registration. The proposed amendments to Rule 17Ad-22 would not broaden the scope of Rule 17Ad-22 to an entity operating pursuant to an exemption from registration as a clearing agency granted by the Commission. \79\ See proposed Rule 17Ad-22(a)(4), infra Part VII. \80\ The Commission is proposing Rule 17Ab2-2 to establish a process for making determinations regarding clearing agencies involved in activities with a more complex risk profile. See infra Part II.C (further discussing the purpose, scope, and application of proposed Rule 17Ab2-2) and Part VII (proposed text of Rule 17Ab2-2). The Commission is also proposing Rule 17Ad-22(a)(16) to define ``security-based swap'' to mean security-based swap as defined in Section 3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68). See infra Part VII. \81\ See proposed Rule 17ad-22(a)(7), infra Part VII. --------------------------------------------------------------------------- The Commission preliminarily believes there could be several different bases under which registered clearing agencies would be required to comply with proposed Rule 17Ad-22(e). For instance, because DTC, FICC, NSCC, and OCC are registered clearing agencies pursuant to Section 17A of the Exchange Act and are designated clearing agencies for which the Commission is the supervisory agency [[Page 29516]] under the Clearing Supervision Act,\82\ they would be covered clearing agencies under proposed Rule 17Ad-22(a)(7) and would be subject to the requirements for covered clearing agencies in proposed Rule 17Ad-22(e). In addition, because ICEEU provides CCP services for security-based swaps and has been deemed registered with the Commission as a security- based swap clearing agency,\83\ it would be a complex risk profile clearing agency under proposed Rule 17Ad-22(a)(4) and also subject to the requirements for covered clearing agencies proposed in Rule 17Ad- 22(e). --------------------------------------------------------------------------- \82\ See supra Part I.B.2. \83\ See supra note 41 and accompanying text. --------------------------------------------------------------------------- By comparison, CME and ICE would not be subject to the proposed requirements for covered clearing agencies in Rule 17Ad-22(e) because (i) they have been designated as systemically important FMUs under Section 804 of the Clearing Supervision Act; \84\ (ii) they are each dually registered with the Commission and the CFTC as a clearing agency and DCO, respectively; and (iii) the CFTC is their supervisory agency under the Clearing Supervision Act.\85\ The Commission preliminarily believes that, because CME and ICE would be subject to the CFTC's requirements for systemically important DCOs,\86\ applying proposed Rule 17Ad-22(e) to them could impose duplicative requirements. Given the Commission's existing regulatory authority under Section 17A(l) of the Exchange Act,\87\ however, CME and ICE would remain subject to the continuing requirements for registered clearing agencies in Rules 17Ad- 22(b) through (d). --------------------------------------------------------------------------- \84\ See 12 U.S.C. 5463. \85\ See supra Part I.B.2; see also FSOC, 2013 Annual Report, supra note 39, at 100. \86\ See supra note 41 and accompanying text. \87\ See 15 U.S.C. 78q-1(l). --------------------------------------------------------------------------- Two dormant clearing agencies, the Stock Clearing Corporation of Philadelphia (``SCCP'') and the Boston Stock Exchange Clearing Corporation (``BSECC''), have not been designated systemically important by the FSOC and are not involved in activities with a more complex risk profile.\88\ Accordingly, each would also remain subject to the requirements in Rules 17Ad-22(b) through (d). --------------------------------------------------------------------------- \88\ In 2008, NASDAQ OMX Group, Inc. acquired SCCP and BSECC. See Exchange Act Release No. 34-58324 (Aug. 7, 2008), 73 FR 46936 (Aug. 12, 2008) (order approving acquisition of BSECC); Exchange Act Release No. 34-58180 (July 17, 2008), 73 FR 42890 (July 23, 2008) (order approving acquisition of SCCP). Both SCCP and BSECC are currently registered with the Commission as clearing agencies but conduct no clearing or settlement activities. See Exchange Act Release No. 34-63629 (Jan. 3, 2011), 76 FR 1473 (Jan. 10, 2011); Exchange Act Release No. 34-63268 (Nov. 8, 2010), 75 FR 69730 (Nov. 15, 2010). --------------------------------------------------------------------------- Further, proposed Rule 17Ab2-2 would provide the Commission flexibility to determine that the operations or circumstances of a registered clearing agency, including a registered clearing agency that is exempt from certain requirements applicable to registered clearing agencies generally, warrant designation as a covered clearing agency.\89\ It would also provide flexibility to make determinations regarding newly registered clearing agencies. --------------------------------------------------------------------------- \89\ See infra Parts II.C and VII (discussing determinations under proposed Rule 17Ab2-2 and providing rule text, respectively). --------------------------------------------------------------------------- The Commission preliminarily believes the requirements proposed in Rule 17Ad-22(e) aid the regulation of covered clearing agencies by, as noted above, establishing requirements more closely tailored to the risks they pose to the U.S. securities markets. For example, designated clearing agencies are systemically important because of their significance to the U.S. financial system and the risk that the failure of, or a disruption to, their functioning would increase the risk of significant liquidity or credit problems spreading among financial institutions, thereby threatening the stability of the U.S. financial system.\90\ Similarly, the Commission preliminarily believes that complex risk profile clearing agencies, such as those providing CCP services for security-based swaps, subject the U.S. securities markets to a material level of systemic risk due to the nature of the products that they clear.\91\ The requirements proposed in Rule 17Ad-22(e) are intended to ensure that covered clearing agencies have robust policies and procedures that help promote sound governance, operations, and risk management. --------------------------------------------------------------------------- \90\ See supra note 27 and accompanying text. \91\ See generally Gov't Accountability Office, Systemic Risk: Regulatory Oversight and Recent Initiatives to Address Risk Posed by Credit Default Swaps (Mar. 2009), available at http://www.gao.gov/new.items/d09397t.pdf. --------------------------------------------------------------------------- As noted above,\92\ the Commission preliminarily believes that establishing separate rules for covered clearing agencies and registered clearing agencies that are not covered clearing agencies is appropriate given the Commission's goals to facilitate the development of a national system for the prompt and accurate clearance and settlement of securities consistent with Section 17A of the Exchange Act and to mitigate systemic risk consistent with Titles VII and VIII of the Dodd-Frank Act.\93\ In this regard, the Commission intends that Rule 17Ad-22(d) would continue to provide minimum requirements for the operation and governance of registered clearing agencies that also facilitate the entrance of new participants, as appropriate, into the market for clearance and settlement services.\94\ The Commission preliminarily believes that Rule 17Ad-22(e) would establish new requirements for established participants in the market for clearance and settlement services commensurate to the risks that their size, operation, and importance pose to the U.S. securities markets.\95\ --------------------------------------------------------------------------- \92\ See supra notes 54-61 and accompanying text. \93\ See supra notes 2, 13-14, and accompanying text (noting the goals of, respectively, Section 17A of the Exchange Act and the Dodd-Frank Act). \94\ See supra note 43 and accompanying text (noting the Commission's intent in adopting Rule 17Ad-22 in the Clearing Agency Standards Release). \95\ See supra note 44 and accompanying text (noting further that the requirements adopted under Rule 17Ad-22 constituted an important first step to enhance the substantive regulation of registered clearing agencies pursuant to the Dodd-Frank Act); see also infra Part IV.C.1.a (addressing systemic risk in the context of discussing the general economic considerations undertaken by the Commission in proposing Rule 17Ad-22(e)). --------------------------------------------------------------------------- Request for Comments. The Commission generally requests comments on all aspects of the scope of proposed Rule 17Ad-22(e), the relationship between proposed Rule 17Ad-22(e) and Rule 17Ad-22(d), and on proposed Rules 17Ad-22(a)(4), (7), (8), and (9). In addition, the Commission requests comments on the following specific issues: Is the scope of proposed Rule 17Ad-22(e) appropriate? Why or why not? Is the scope sufficiently clear? Why or why not? Has the Commission provided sufficient guidance regarding the scope of the proposed rule? Are there aspects of the scope of the proposed rule for which the Commission should consider providing additional guidance? If so, please explain. Given that all non-dormant registered clearing agencies would either be covered clearing agencies subject to Commission supervision or be subject to CFTC regulation as designated clearing entities for which the CFTC is the supervisory agency, should the Commission replace the existing requirements under Rule 17Ad-22(d) with the requirements proposed under Rule 17Ad-22(e)? Why or why not? Is the Commission's proposed definition of ``financial market utility'' appropriate and sufficiently clear given the proposed requirements? Why or why not? Should the definition be modified? If so, how? Is there an [[Page 29517]] alternative definition the Commission should consider? Is the Commission's proposed definition of ``designated clearing agency'' appropriate and sufficiently clear given the requirements proposed? Why or why not? Should the definition be modified? If so, how? Is there an alternative definition the Commission should consider? Is the Commission's proposed definition of ``clearing agency involved in activities with a more complex risk profile'' appropriate and sufficiently clear given the requirements proposed? Why or why not? Should the definition be modified? If so, how? Is there an alternative definition the Commission should consider? Is the Commission's proposed definition of ``covered clearing agency'' appropriate and sufficiently clear given the requirements proposed? Why or why not? Should the definition be modified? If so, how? Is there an alternative definition the Commission should consider? Are the requirements in proposed Rule 17Ad-22(e) necessary, or do the existing provisions in Rule 17Ad-22(d) already sufficiently address the issues identified in this release as justification for increased regulation? 2. Role of Written Policies and Procedures Proposed Rule 17Ad-22(e) would require covered clearing agencies to establish, implement, maintain and enforce written policies and procedures reasonably designed to, as applicable, fulfill the requirements set forth in paragraphs (e)(1) through (23) of the proposed rule. The Commission preliminarily believes that this approach would facilitate the Commission's supervision of covered clearing agencies, is appropriate given their role as SROs,\96\ and is consistent with the approach taken by the Commission elsewhere in Rule 17Ad-22.\97\ The Commission preliminarily believes that, by requiring written policies and procedures and, where appropriate, their disclosure, proposed Rule 17Ad-22(e) should help promote the development of improved standards for clearing agencies by allowing market participants to compare certain of the operations of covered clearing agencies with those of other clearing entities, which choose to make their policies and procedures publicly available or are required to do so by equivalent regulatory standards.\98\ --------------------------------------------------------------------------- \96\ Registered clearing agencies are SROs as defined in Section 3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26). After a clearing agency has been registered with the Commission, the clearing agency, as an SRO, must submit most proposed rule changes to the Commission, for approval pursuant to Rule 19b-4 under the Exchange Act. A stated policy, practice, or interpretation of an SRO, such as a clearing agency's written policies and procedures, would generally be deemed to be a proposed rule change. See 17 CFR 240.19b-4. \97\ See Clearing Agency Standards Release, supra note 5, at 66228-29 (describing the scope of Rule 17Ad-22 at adoption). \98\ Compare proposed Rule 17Ad-22(e)(23), infra Part VII (requiring public disclosure of, among other things, a covered clearing agency's rules, policies, and procedures) with proposed Reg. HH, supra note 53, at 3666-67, 3686-88, 3693 (the Board proposing disclosure requirements intended to be in line with the PFMI Report in Sec. 234.3(a)(23)); DCO Int'l Standards Release, supra note 53, at 72493-94, 72521 (CFTC adopting disclosure requirements intended to be in line with the PFMI Report in Sec. 39.37). --------------------------------------------------------------------------- The Commission is proposing to require policies and procedures developed by each covered clearing agency to fulfill the requirements of proposed Rule 17Ad-22(e) because the Commission preliminarily believes that it is important to allow covered clearing agencies enough flexibility to use their market experience and understanding of their institutions to shape the rules, policies, and procedures implementing proposed Rule 17Ad-22(e). This proposed approach is consistent with the Commission's established approach for supervising SROs, and the Commission preliminarily believes continuing this practice under Rule 17Ad-22(e) will allow the Commission to continue to perform its supervisory function through the SRO rule filing process under Section 19(b) of the Exchange Act and Rule 19b-4,\99\ periodic inspections and examinations, other monitoring of the activities of registered clearing agencies, and other established supervisory processes. Because of the importance the Commission gives to both maintaining clearing agency flexibility and to existing oversight mechanisms, the Commission preliminarily believes that the proposed approach is appropriate. --------------------------------------------------------------------------- \99\ See supra note 96 (describing requirements for SROs under the Exchange Act and Rule 19b-4). --------------------------------------------------------------------------- The Commission anticipates that a covered clearing agency's rules, policies, and procedures will need to evolve over time so that it can adequately respond to changes in technology, legal requirements, the needs of its members and their customers, trading volumes, trading practices, linkages between financial markets, and the financial instruments traded in the markets that a covered clearing agency serves. Accordingly, the Commission preliminarily believes that covered clearing agencies should continually evaluate and make appropriate updates and improvements to their operations and risk management practices to facilitate prompt and accurate clearance and settlement. 3. Frequency of Review Required Under Certain Policies and Procedures Many of the policies and procedures requirements proposed in Rule 17Ad-22(e) specify a frequency of review. Generally, the proposed regularity of review falls into three categories-- daily, monthly, or annually--and is based on the Commission's understanding of the current review practices generally at covered clearing agencies. The Commission's rationale for these differences is as follows: Daily: For those activities that the Commission understands to be directly related to the day-to-day operations of a covered clearing agency,\100\ such as activities related to the calculation and collection of margin, the Commission preliminarily believes that a covered clearing agency should undertake a daily review and make decisions on a daily basis; --------------------------------------------------------------------------- \100\ See proposed Rules 17Ad-22(e)(4)(vi)(A); 17Ad- 22(e)(6)(ii); 17Ad-22(e)(6)(vi)(A); 17Ad-22(e)(7); 17Ad- 22(e)(7)(vi)(A); and 17Ad-22(e)(11)(ii), infra Part VII. --------------------------------------------------------------------------- Monthly: For those activities that the Commission understands to coincide with and complement the review and reporting cycles of the governance structures related to the risk management function of the covered clearing agency,\101\ the Commission preliminarily believes that a covered clearing agency should undertake a monthly review; based on its supervisory experience, the Commission notes that well-functioning risk management committees of the board and similar management committees or other board or management committees commonly meet or receive reports and other risk management information from management on a monthly basis and the monthly requirement would be consistent with such meeting and reporting frequency; --------------------------------------------------------------------------- \101\ See proposed Rules 17Ad-22(e)(4)(vi)(B); 17Ad- 22(e)(4)(vi)(C); 17Ad-22(e)(6)(vi)(B); 17Ad-22(e)(6)(vi)(C); 17Ad- 22(e)(7)(vi)(B); and 17Ad-22(e)(7)(vi)(C), infra Part VII. --------------------------------------------------------------------------- Annually: For those activities that are less integral to day-to-day operations, involve issues that merit review of information collected over longer time periods, or require more high-level review and consideration by, for example, the full board of directors of a clearing agency,\102\ the Commission [[Page 29518]] preliminarily believes that a covered clearing agency should undertake an annual review; additionally, the Commission preliminary believes that an annual cycle is appropriate in certain instances because other major reviews such as auditing of the financial statements of registered clearing agencies and their disclosure are required to occur on an annual basis. --------------------------------------------------------------------------- \102\ See proposed Rules 17Ad-22(e)(3)(i); 17Ad-22(e)(4)(vii); 17Ad-22(e)(5); 17Ad-22(e)(6)(vii); 17Ad-22(e)(7)(v); 17Ad- 22(e)(7)(vii); 17Ad-22(e)(7)(x); 17Ad-22(e)(13)(iii); and 17Ad- 22(e)(15)(iii), infra Part VII. --------------------------------------------------------------------------- Request for Comments. The Commission generally requests comments on all aspects of the frequency of review that would be required to be included in a covered clearing agency's policies and procedures under each of the requirements in proposed Rule 17Ad-22(e). In addition, the Commission requests comments on whether its assessment of daily, monthly, and annual activities at covered clearing agencies is accurate and appropriate given the proposed rules. The Commission also requests comment on what factors should be considered in determining the nature, timing, and extent of the required reviews and whether other frequencies of review might be appropriate under some or all of the proposed rules. 4. Anticipated Impact of Proposed Rule 17Ad-22(e) Based on the Commission's experience supervising registered clearing agencies, and given the current requirements applicable to registered clearing agencies under Rule 17Ad-22, the Commission preliminarily anticipates that the degree of changes that covered clearing agencies may need to make to their policies and procedures to satisfy the proposed requirements of Rule 17Ad-22(e) would vary among the particular provisions of the proposed rule and depend in part on the business model and operations of the clearing agency itself, as discussed below. The Commission preliminarily believes that, for the provisions in its proposal where a similar existing requirement has been identified, covered clearing agencies may need to make only limited changes to update their policies and procedures, and the table below provides summary information regarding the Commission's preliminary assessment of the impact of the proposed rules: ------------------------------------------------------------------------ Proposed requirement Existing requirement ------------------------------------------------------------------------ Rule 17Ad-22(e)(1)........................ Rule 17Ad-22(d)(1). Rule 17Ad-22(e)(2)........................ Rule 17Ad-22(d)(8). Rule 17Ad-22(e)(3)........................ None. Rule 17Ad-22(e)(4)........................ Rules 17Ad-22(b)(1), (b)(3), (d)(14) \103\. Rule 17Ad-22(e)(5)........................ None. Rule 17Ad-22(e)(6)........................ Rule 17Ad-22(b)(2), (b)(4) \104\. Rule 17Ad-22(e)(7)........................ None. Rule 17Ad-22(e)(8)........................ Rules 17Ad-22(d)(12). Rule 17Ad-22(e)(9)........................ Rule 17Ad-22(d)(5). Rule 17Ad-22(e)(10)....................... Rule 17Ad-22(d)(15). Rule 17Ad-22(e)(11)....................... Rule 17Ad-22(d)(10). Rule 17Ad-22(e)(12)....................... Rule 17Ad-22(d)(13). Rule 17Ad-22(e)(13)....................... Rule 17Ad-22(d)(11). Rule 17Ad-22(e)(14)....................... None. Rule 17Ad-22(e)(15)....................... None. Rule 17Ad-22(e)(16)....................... Rule 17Ad-22(d)(3). Rule 17Ad-22(e)(17)....................... Rule 17Ad-22(d)(4). Rule 17Ad-22(e)(18)....................... Rules 17Ad-22(b)(5) through (7), (d)(2). Rule 17Ad-22(e)(19)....................... None. Rule 17Ad-22(e)(20)....................... Rule 17Ad-22(d)(7). Rule 17Ad-22(e)(21)....................... Rule 17Ad-22(d)(6). Rule 17Ad-22(e)(22)....................... None. Rule 17Ad-22(e)(23)....................... Rule 17Ad-22(d)(9). ------------------------------------------------------------------------ With respect to the provisions in its proposal where no similar existing requirement has been identified, the Commission preliminarily anticipates that covered clearing agencies may need to make more extensive changes to their policies and procedures (or implement new policies and procedures), and may need to take other steps, to satisfy the proposed requirements of Rule 17Ad-22(e). --------------------------------------------------------------------------- \103\ The Commission notes that requirements under Rules 17Ad- 22(b) apply only to registered clearing agencies that provide CCP services, the ``cover two'' requirement under Rule 17Ad-22(b)(3) applies only to registered clearing agencies that provide CCP services for security-based swaps, and requirements under Rule 17Ad- 22(d)(14) apply only to registered clearing agencies that provide CSD services. See infra Part II.B.4 (discussing, among other things, the relationship between existing requirements under Rule 17Ad-22 and proposed Rule 17Ad-22(e)(4)); see also 17 CFR 240.17Ad-22; Clearing Agency Standards Release, supra note 5. \104\ The Commission notes that the relevant requirement in Rule 17Ad-22(b)(4) concerns policies and procedures regarding an annual model validation for margin models while proposed Rule 17Ad-22(e)(6) would impose, in addition to requiring policies and procedures regarding an annual model validation for margin models, additional requirements that do not appear in Rule 17Ad-22(b)(4). See infra Part II.B.4.e (discussing the requirements under proposed Rule 17Ad- 22(e)(6)). --------------------------------------------------------------------------- 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 II.B 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\ --------------------------------------------------------------------------- \106\ For a complete discussion of the anticipated economic effect of the proposed rules, see Part IV. --------------------------------------------------------------------------- Should the Commission consider an alternative approach with respect to written policies and procedures included in the proposed rules? Why or why not? If so, what alternative approaches should the Commission consider? Please explain in detail. Should the Commission's proposed rules be less or more prescriptive? Why or why not? If so, what alternative approaches should the Commission consider? Please explain in detail. Are there any other factors that the Commission should take into consideration with respect to the requirements of the proposed rules? Should there be a phase-in period with respect to any of the requirements of proposed Rule 17Ad-22(e) ? If so, what should the phase-in periods be? What facts and circumstances should the Commission consider in evaluating whether to adopt a potential phase-in period? Please explain in detail. Could the proposed rules affect the ability of covered clearing agencies to compete for certain types of business [[Page 29519]] either within the United States or internationally? If so, how? Please provide specific examples and data. Are there significant operational or legal impediments to implementing the proposed rules? Would the proposed rules impact the ability of covered clearing agencies to clear certain products? Are any additional rules or regulations needed to facilitate compliance with the proposed rules? Are there any requirements under existing Rule 17Ad-22 that could be viewed as being consistent with the PFMI standards without being supplemented or replaced by new requirements in proposed Rule 17Ad-22(e)? Please explain in detail. B. Proposed Rule 17Ad-22(e) 1. Proposed Rule 17Ad-22(e)(1): Legal Risk Proposed Rule 17Ad-22(e)(1) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for a well-founded, clear, transparent, and enforceable legal basis for each aspect of its activities in all relevant jurisdictions.\107\ Rule 17Ad-22(d)(1) currently requires a registered clearing agency's policies and procedures to meet substantially the same requirement.\108\ Because the requirements under Rule 17Ad-22(d)(1) and proposed Rule 17Ad-22(e)(1) are substantially the same, the Commission anticipates that covered clearing agencies may need to make only limited changes to update their policies and procedures to comply with the proposed rule.\109\ --------------------------------------------------------------------------- \107\ See proposed Rule 17Ad-22(e)(1), infra Part VII. The Commission preliminarily believes that (i) the United States is the relevant jurisdiction for covered clearing agencies that perform the functions of a clearing agency in the United States for purposes of Rule 17Ad-22(e)(1), and (ii) that covered clearing agencies operating in multiple jurisdictions would be required to address any conflicts of laws issues that they may encounter. \108\ Rule 17Ad-22(d)(1) requires a registered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for a well-founded, transparent, and enforceable legal framework for each aspect of its activities in all relevant jurisdictions. See 17 CFR 240.17Ad- 22(d)(1); see also Clearing Agency Standards Release, supra note 5, at 66245-46. \109\ See supra Part II.A.4. --------------------------------------------------------------------------- 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 I.A and B (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act). \111\ The role of governance arrangements in promoting effective risk management has also been a focus of rules proposed by the Commission to mitigate conflicts of interest at certain registered clearing agencies. See Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011) (proposing Rule 17Ad-23 to address conflicts of interest and Rule 17Ad-26 to require standards for board members or board committee directors at registered clearing agencies); Exchange Act Release No. 34-63107 (Oct. 14, 2010), 75 FR 65881, 65893 (Oct. 26, 2010) (proposing Regulation MC to mitigate conflicts of interest at security-based swap clearing agencies). \112\ See supra note 96 (describing the requirements in Section 19(b) of the Exchange Act). \113\ Netting offsets obligations between or among participants in the netting arrangement, thereby reducing the number and value of payments or deliveries needed to settle a set of transactions. Netting can reduce potential losses in the event of a participant default and may reduce the probability of a default. Netting arrangements can differ as to both timing and the parties to the arrangement: (i) Certain netting arrangements net payments or other contractual obligations resulting from market trades (or both) on a continuous basis, while others close-out payments or obligations when an event such as insolvency occurs; and (ii) netting arrangement may net obligations bilaterally among two parties or multilaterally among multiple parties. \114\ Collateral arrangements may involve either a pledge or a title transfer. Therefore, regarding pledged assets, a covered clearing agency would examine the degree of legal certainty that a pledge has been validly created in the relevant jurisdiction and, as appropriate, validly perfected. Regarding transfer of title to assets, a covered clearing agency would examine the degree of legal certainty that the transfer is validly created in the relevant jurisdiction and will be enforced. \115\ Novation enables a clearing agency to act as a CCP. In novation, the original contract between the buyer and seller is discharged and two new contracts are created, one between the CCP and the buyer and the other between the CCP and the seller. The CCP thereby assumes the original parties' contractual obligations to each other. Legal certainty regarding novation may reinforce market participants' confidence regarding CCP support for or guarantee of the transaction. --------------------------------------------------------------------------- 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 VII; see also Parts II.B.2 and 7 (discussing proposed Rules 17Ad-22(e)(2) and (10), respectively). Separately, the Commission has proposed rules to require policies and procedures to protect the confidentiality of trading information and procedures. See Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR 14472 (Mar. 16, 2011) (proposing Rule 17Ad- 23). --------------------------------------------------------------------------- As was the case when the Commission considered Rule 17Ad-22(d)(1), where a clearing agency is faced with significant uncertainty regarding legal risk, the Commission preliminary believes this uncertainty may undermine a covered clearing agency's ability to provide prompt and accurate clearance and settlement, to safeguard securities and funds and to provide fair procedures, as required under Section 17A of the Exchange Act. For example, where a covered clearing [[Page 29520]] agency's procedures addressing a participant default and establishing a security interest in collateral lack clarity or there is significant uncertainty regarding enforceability, there is a risk the clearing agency may face claims to void, stay or reverse its actions, which could be made by a bankruptcy trustee or other type of receiver in an insolvency of a participant, undermining the clearing agency's ability to safeguard securities and funds. As a similar example, if covered clearing agency netting activities are voided or reversed on legal grounds, which could involve a participant's insolvency, clearing and settlement could be disrupted as participant accounts are rebalanced. Also, for example, if a covered clearing agency's plan for recovery and wind-down is subject to legal uncertainty, the covered clearing agency or governmental authorities may be delayed in or prevented from taking appropriate actions, resulting in disorder that may undermine the provision of prompt and accurate clearance and settlement.\117\ --------------------------------------------------------------------------- \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\ --------------------------------------------------------------------------- \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 Rule 17Ad-22(e)(2)(i) through (iv) would require a covered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to provide for governance arrangements that are clear and transparent, clearly prioritize the safety and efficiency of the covered clearing agency, and support the public interest requirements in Section 17A of the Exchange Act and the objectives of owners and participants.\119\ The proposed rule contains requirements similar to those currently applicable to registered clearing agencies under Rule 17Ad-22(d)(8), but the proposed rule also requires that a covered clearing agency's policies and procedures provide for governance arrangements that clearly prioritize the safety and efficiency of the covered clearing agency.\120\ --------------------------------------------------------------------------- \119\ See proposed Rule 17Ad-22(e)(2), infra Part VII. Proposed Rule 17Ad-22(e)(2) would complement other requirements that may apply separately, including requirements in proposed Rules 17Ad-25 and 17Ad-26, and requirements for security-based swap clearing agencies under Section 765 of the Dodd-Frank Act, 12 U.S.C. 8343. See supra note 111 (noting rules proposed by the Commission to address potential conflicts of interest). \120\ Specifically, Rule 17Ad-22(d)(8) requires a registered clearing agency to establish, implement, maintain and enforce written policies and procedures reasonably designed to have governance arrangements that are clear and transparent to fulfill the public interest requirements in Section 17A of the Exchange Act applicable to clearing agencies, to support the objectives of owners and participants, and to promote the effectiveness of the clearing agency's risk management procedures. See 17 CFR 240.17Ad-22(d)(8); see also Clearing Agency Standards Release, supra note 5, at 66251- 52. --------------------------------------------------------------------------- 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 I.A and note 96 (describing the Commission's framework for regulation of SROs and the SRO rule filing process). \122\ See 15 U.S.C. 78q-1(a)(3)(F), (H). --------------------------------------------------------------------------- Consistent with these requirements and the Exchange Act requirements discussed above,\123\ the Commission preliminarily believes that the governance requirements proposed in Rule 17Ad- 22(e)(2) are appropriate because governance arrangements are fundamental to the functioning of a covered clearing agency pursuant to Section 17A of the Exchange Act.\124\ Consistent with the Commission's statutory mandate under the Exchange Act, the proposed rule would specify that governance arrangements also be consistent with the public interest requirements in Section 17A of the Exchange Act as applicable to clearing agencies. Because a covered clearing agency's decisions can have widespread impact, affecting multiple market participants, financial institutions, markets, and jurisdictions, the Commission preliminarily believes it is important that each covered clearing agency place a high priority on the safety and efficiency of its operations and explicitly support the objectives of owners and participants. In addition, supporting the public interest is a broad [[Page 29521]] concept that includes, for example, contributing to the ongoing development of the U.S. financial system, in particular the national clearance and settlement system contemplated by Section 17A of the Exchange Act, and protecting investors and fostering fair and efficient markets. The Commission believes that, by supporting the public interest, market participants can develop common processes that help reduce uncertainty in the market, such as industry standards and market protocols related to clearance and settlement that facilitate a common understanding and interactions among clearing agencies and their members. The Commission preliminarily believes that covered clearing agencies, as SROs, are appropriately positioned to determine, based on their experience in providing clearance and settlement services and based on information obtained from their members and other stakeholders, as appropriate in the circumstances, what governance arrangements appropriately support the public interest requirements in Section 17A applicable to clearing agencies consistent with the expectations of such stakeholders,\125\ balancing the potentially competing viewpoints of the various stakeholders. The Commission also preliminarily believes that mechanisms through which a covered clearing agency could support the objectives of owners and participants could potentially include representation on the board of directors, user committees, and various public consultation processes. --------------------------------------------------------------------------- \123\ See notes 54-56 and accompanying text; see also Parts I.A and B (generally discussing the regulatory framework under Section 17A of the Exchange Act, as amended by the Dodd-Frank Act). \124\ See 15 U.S.C. 78q-1(a)(2)(A). \125\ See supra note 95 (describing requirements for SROs under the Exchange Act and Rule 19b-4). --------------------------------------------------------------------------- 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 VII. \129\ For a discussion of current practices at registered clearing agencies regarding boards of directors and senior management, and the anticipated impact of the proposed requirements for governance, see Parts IV.B.3.a.ii and IV.C.3.a.ii, respectively. --------------------------------------------------------------------------- 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 cove [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3AR1-2014-05806. Public record. Not legal advice.