Staff of the Division of Clearing and Risk prepared guidance to DCOs in order to aid DCOs in revising and improving their Recovery Plans and Wind-down Plans, and in preparing proposed rule submissions to implement the...
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Summary: Staff of the Division of Clearing and Risk prepared guidance to DCOs in order to aid DCOs in revising and improving their Recovery Plans and Wind-down Plans, and in preparing proposed rule submissions to implement their Recovery Plans and Wind-down Plans.
U.S. COMMODITY FUTURES TRADING COMMISSION
Division of Clearing and Risk
Jeffrey M. Bandman
Acting Director
______________________________________________________________________________
Three Lafayette Centre
1155 21st Street, NW, Washington, DC 20581
Telephone: (202) 418-5044
Facsimile: (202) 418-5547
jbandman@cftc.gov
CFTC Letter No. 16-61
Other Written Communication
July 21, 2016
Division of Clearing and Risk
MEMORANDUM
TO:
All Registered Derivatives Clearing Organizations
FROM:
Jeffrey M. Bandman, Acting Director, Division of Clearing and
Risk (DCR)
SUBJECT:
Recovery Plans and Wind-down Plans Maintained by Derivatives
Clearing Organizations and Tools for the Recovery and Orderly
Wind-down of Derivatives Clearing Organizations
Background
Regulation 39.39(b) requires each systemically important derivatives clearing
organization (“SIDCO”)1 and Subpart C derivatives clearing organization (“Subpart C DCO”)2
(referred to collectively hereafter as “DCOs”) to maintain viable plans for: (1) recovery3 or
orderly wind-down4 necessitated by uncovered credit losses or liquidity shortfalls; and,
separately, (2) recovery or orderly wind-down necessitated by general business risk, operational
1
derivatives clearing
organization (“SIDCO”)1 and Subpart C derivatives clearing organization (“Subpart C DCO”)2
(referred to collectively hereafter as “DCOs”) to maintain viable plans for: (1) recovery3 or
orderly wind-down4 necessitated by uncovered credit losses or liquidity shortfalls; and,
separately, (2) recovery or orderly wind-down necessitated by general business risk, operational
1 A “systemically important derivatives clearing organization” is defined in Regulation 39.2 to mean a financial
market utility that is a derivatives clearing organization (“DCO”) registered under section 5b of the Commodity
Exchange Act (“CEA”), which is currently designated by the Financial Stability Oversight Council to be
systemically important and for which the Commission acts as the Supervisory Authority pursuant to 12 U.S.C. §
5462(8). 17 C.F.R. § 39.2.
2 A “subpart C derivatives clearing organization” is defined in Regulation 39.2 to mean any derivatives clearing
organization, as defined in section 1a(15) of the CEA and Regulation 1.3(d) which: (1) is registered as a DCO under
section 5b of the CEA; (2) is not a SIDCO; and (3) has elected to become subject to the provisions of Subpart C of
Part 39 of the Commission’s regulations pursuant to Regulation 39.31. 17 C.F.R. § 39.2.
3 Pursuant to Regulation 39.39(a)(3), “Recovery means the actions of a systemically important derivatives clearing
organization or subpart C derivatives clearing organization, consistent with its rules, procedures, and other ex-ante
contractual arrangements, to address any uncovered credit loss, liquidity shortfall, capital inadequacy, or business,
operational or other structural weakness, including the replenishment of any depleted prefunded financial resources
and liquidity arrangements, as necessary to maintain the systemically important derivatives clearing organization’s
or subpart C derivatives clearing organization’s viability as a going concern.” 17 C.F.R. § 39.39(a)(3)
t loss, liquidity shortfall, capital inadequacy, or business,
operational or other structural weakness, including the replenishment of any depleted prefunded financial resources
and liquidity arrangements, as necessary to maintain the systemically important derivatives clearing organization’s
or subpart C derivatives clearing organization’s viability as a going concern.” 17 C.F.R. § 39.39(a)(3).
4 Pursuant to Regulation 39.39(a)(2), “Wind-down means the actions of a systemically important derivatives clearing
organization or subpart C derivatives clearing organization to effect the permanent cessation or sale or transfer of
one or more services.” 17 C.F.R. § 39.39(a)(2).
risk, or any other risk that threatens the DCO as a going concern (each, as applicable, a
“Recovery Plan” or “Wind-down Plan”).5 The preparation of these Recovery Plans and Wind-
down Plans requires DCOs to “identify scenarios that may potentially prevent [the DCO] from
being able to meet its obligations, provide its critical operations and services as a going concern
and assess the effectiveness of a full range of options for Recovery or orderly Wind-down.”6
Regulation 39.39 became effective on December 31, 2013; the Commission was able to, upon
request, grant a DCO up to December 31, 2014 to comply with the requirements of 39.39.7
The development of a Recovery Plan and the development of a Wind-down Plan are
critical elements of risk management and contingency planning to address the extreme
circumstances that could threaten a DCO’s viability and financial stre
9 became effective on December 31, 2013; the Commission was able to, upon
request, grant a DCO up to December 31, 2014 to comply with the requirements of 39.39.7
The development of a Recovery Plan and the development of a Wind-down Plan are
critical elements of risk management and contingency planning to address the extreme
circumstances that could threaten a DCO’s viability and financial strength. The analysis set forth
in the Recovery Plan can contribute to a better ex ante understanding by the DCO of the
scenarios that would lead to uncovered credit losses or liquidity shortfalls and the management
of challenges the DCO would face. In addition, such analysis promotes the ability of the DCO to
more effectively and efficiently meet its obligations promptly, thereby reducing the possibility of
market disruptions and financial losses to clearing members and their customers and avoiding
harm and market disruption from a DCO default. Further, this analysis can provide a DCO with
a better understanding of clearing members’ obligations and the extent to which the DCO would
perform its obligations to its clearing members in times of market stress. These analyses are
particularly critical for SIDCOs, in light of their systemically important nature.
A Wind-down Plan sets forth a plan for winding-down the DCO in an orderly manner
and would be used in a situation where recovery is not possible and resolution (if potentially
available, as discussed below) has not been triggered. A Wind-down Plan is not a substitute for
a comprehensive and effective Recovery Plan. Rather, given the potential for even the best plan
to be ineffective in a particular circumstance, the Wind-down Plan is a fundamental part of the
DCO’s risk management and contingency planning process.
A DCO’s Recovery Plan and Wind-down Plan are also important to resolution planning,
another equally critical element of contingency planning for those DCOs that are SIDCOs
tive Recovery Plan. Rather, given the potential for even the best plan
to be ineffective in a particular circumstance, the Wind-down Plan is a fundamental part of the
DCO’s risk management and contingency planning process.
A DCO’s Recovery Plan and Wind-down Plan are also important to resolution planning,
another equally critical element of contingency planning for those DCOs that are SIDCOs. A
resolution plan is drafted by the Federal Deposit Insurance Corporation (“FDIC”), the resolution
authority for any SIDCO, pursuant to its authority under Title II of the Dodd-Frank Act.8 A
5 While Regulation 39.39 only applies to SIDCOs and Subpart C DCOs, the guidance set forth herein is also
intended to be a useful resource for other DCOs that voluntarily develop Recovery Plans and Wind-down Plans.
6 17 C.F.R. § 39.39(c)(1).
7 17 C.F.R. § 39.39(f).
8 Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). This
resolution plan, drafted pursuant to Title II of Dodd-Frank, is distinguishable from the plan that a Bank Holding
Company is required to produce pursuant to Title I of the Dodd-Frank Act (“a § 165(d) Plan” or a “Living Will”),
which is also referred to as a resolution plan. See 12 U.S.C. § 5365(d). See also 12 C.F.R. § 360.10. The Living
Will, which must be submitted annually for review to the Board of Governors of the Federal Reserve and the FDIC
must provide for the rapid and orderly resolution of the Bank Holding Company, under the U.S. Bankruptcy Code,
in the event of material financial distress. This process is designed to foster resolution planning and enables
agencies to assess whether a firm could be resolved under bankruptcy without severe adverse consequences for the
financial system or the U.S. economy.
See also Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions,
Appendix I-Annex 4, 1.8 (Oct. 14, 2014) (setting forth international agreement regarding the role of resolution
plans)
ng and enables
agencies to assess whether a firm could be resolved under bankruptcy without severe adverse consequences for the
financial system or the U.S. economy.
See also Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions,
Appendix I-Annex 4, 1.8 (Oct. 14, 2014) (setting forth international agreement regarding the role of resolution
plans).
2
resolution under Title II can only occur if the failure of the company, including a DCO, could not
proceed under applicable state or federal law, including the U.S. Bankruptcy Code, without
causing serious adverse effects on financial stability in the United States.9 A DCO’s Recovery
Plan and Wind-down Plan are critical information that the resolution authority uses in
developing the resolution plan.10 Regulation 39.39(c)(2) requires certain DCOs, including
SIDCOs, to have procedures for providing the Commission and the FDIC “with information
needed for purposes of resolution planning.”11
As DCOs have actively developed their Recovery Plans and Wind-down Plans, the
Division of Clearing and Risk (“DCR”) has conducted preliminary reviews of the Recovery
Plans and Wind-down Plans. DCR has also reviewed draft proposed rule changes that the DCOs
have submitted in order to implement their Recovery Plans and Wind-down Plans
information
needed for purposes of resolution planning.”11
As DCOs have actively developed their Recovery Plans and Wind-down Plans, the
Division of Clearing and Risk (“DCR”) has conducted preliminary reviews of the Recovery
Plans and Wind-down Plans. DCR has also reviewed draft proposed rule changes that the DCOs
have submitted in order to implement their Recovery Plans and Wind-down Plans.
In the course of DCR’s preliminary review of Recovery Plans, Wind-down Plans, and
proposed rule changes, staff have discussed with DCOs, clearing members, and other market
participants a number of issues pertaining to recovery tools a DCO may seek to use including:
(1) the use of gains based haircutting as a tool to allocate losses, (2) the tools available to the
DCO in order to re-establish a matched book following a participant default, (3) the governance
for the determination that wind-down, rather than recovery, is appropriate or necessary, (4) the
structure of the DCO’s waterfall, including the amount and location of the DCO’s capital
contribution within the waterfall, and (5) the governance surrounding the recovery process,
including use of emergency powers in recovery. DCR has also received requests from DCOs for
guidance regarding these issues and to clarify the types of information and analysis that should
be included in the Recovery Plans and Wind-down Plans.
In addition, in light of the public interest in these topics, DCR sponsored a public
roundtable on March 19, 2015 to discuss and explore critical issues regarding recovery and
wind-down tools.12 Following the roundtable, DCR staff have continued to consider and to
9 See 12 U.S.C. § 5363(b)(4).
10 The Living Will is an analogous input into the FDIC’s resolution planning for Bank Holding Companies. Cf.
Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy, 78 FR 76614,
76615-16 (Dec. 18, 2013).
11 17 C.F.R. § 39.39(c)(2)
and
wind-down tools.12 Following the roundtable, DCR staff have continued to consider and to
9 See 12 U.S.C. § 5363(b)(4).
10 The Living Will is an analogous input into the FDIC’s resolution planning for Bank Holding Companies. Cf.
Resolution of Systemically Important Financial Institutions: The Single Point of Entry Strategy, 78 FR 76614,
76615-16 (Dec. 18, 2013).
11 17 C.F.R. § 39.39(c)(2). Although this memorandum does not address resolution planning, DCR notes that
Commission staff has been actively engaged with FDIC staff regarding resolution planning for DCOs. In addition,
staff of both agencies are working with international regulators and authorities on resolution planning for central
counterparties, including those registered with the Commission as DCOs, in several fora. DCR also notes that while
Title II does not “specify how a resolution should be structured,” or dictate the form of the FDIC’s resolution plans,
Title II does set forth certain policy goals for resolution. 78 FR 76615. “The FDIC must resolve the covered
financial company in a manner that holds owners and management responsible for its failure accountable—in order
to minimize moral hazard and promote market discipline—while maintaining the stability of the U.S. financial
system. Creditors and shareholders must bear the losses of the financial company in accordance with statutory
priorities and without imposing a cost on U.S. taxpayers.” Id.
12 Transcript available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/transcript031915.pdf.
The goal of this roundtable was to gather different industry viewpoints, including those of the DCOs, their clearing
members (most of which are futures commission merchants (“FCMs”)), and the clients of their FCM clearing
members (including money managers and end-users). Prior to the roundtable, end-users, including those in the
agricultural, metals, and energy industries, had not been vocal participants in the discussion
was to gather different industry viewpoints, including those of the DCOs, their clearing
members (most of which are futures commission merchants (“FCMs”)), and the clients of their FCM clearing
members (including money managers and end-users). Prior to the roundtable, end-users, including those in the
agricultural, metals, and energy industries, had not been vocal participants in the discussion. The roundtable
provided a forum for all the participants to challenge one another’s views and enabled staff to consider the
viewpoints of end-users as staff continues to review DCOs’ Recovery Plans and Wind-down Plans, and the proposed
rule changes to implement such plans.
3
discuss the issues regarding recovery tools, including those issues raised at the public roundtable,
in a number of domestic and international fora, including working groups of the U.S. Financial
Stability Oversight Council and the Financial Stability Board, as well as the Policy Standing
Group on Financial Market Infrastructures of the Committee on Payments and Market
Infrastructures and the International Organization of Securities Commissions.
In order to aid DCOs in revising and improving their Recovery Plans and Wind-down
Plans, and in preparing proposed rule submissions in order to implement their Recovery Plans
and Wind-down Plans, DCR has prepared two sets of guidance. First, section I below provides
guidance regarding the subjects and analysis that should be included in a viable Recovery Plan
and Wind-down Plan
Commissions.
In order to aid DCOs in revising and improving their Recovery Plans and Wind-down
Plans, and in preparing proposed rule submissions in order to implement their Recovery Plans
and Wind-down Plans, DCR has prepared two sets of guidance. First, section I below provides
guidance regarding the subjects and analysis that should be included in a viable Recovery Plan
and Wind-down Plan. Second, section II sets forth questions that DCOs should consider (1) in
evaluating whether particular tools for recovery and orderly wind-down should be included in
the Recovery Plans and Wind-down Plans and (2) in designing proposed rule changes to support
the inclusion of particular tools in such plans.13
I.
Subjects and Analysis to Be Addressed in Recovery Plans and Wind-down Plans
DCR encourages DCOs to address fully within their Recovery Plans and Wind-down
Plans each of the subjects listed below and to perform all related analysis thoroughly. The
Recovery Plans and Wind-down Plans should include detailed descriptions of such analysis and
any relevant information, data or documentation. DCR cautions, however, that this guidance is
designed to highlight certain broad topics of general applicability that should be addressed in
each Recovery Plan and each Wind-down Plan. This guidance is not intended as an exhaustive
checklist of the information and analysis that would be necessary to form either a complete and
viable Recovery Plan or a complete and viable Wind-down Plan.14 The analysis referred to
above should consider the DCO’s individual risk profile, operations, organizational structure,
financial resources, business model and practices, interconnections and interdependencies, and
any other relevant factors.
1. Scenarios
rmation and analysis that would be necessary to form either a complete and
viable Recovery Plan or a complete and viable Wind-down Plan.14 The analysis referred to
above should consider the DCO’s individual risk profile, operations, organizational structure,
financial resources, business model and practices, interconnections and interdependencies, and
any other relevant factors.
1. Scenarios.
Regulation 39.39(c)(1) requires each DCO to “identify scenarios that may potentially
prevent [the DCO] from being able to meet its obligations, provide its critical operations and
services as a going concern and assess the effectiveness of a range of options for recovery….”
One of the primary objectives of a Recovery Plan is to provide a workable, ex ante framework
for recovery that can be implemented quickly and effectively in the event that a scenario should
occur. Two fundamental and indispensable steps toward achieving this aim are: (1) to identify
the range of specific scenarios that may adversely impact the DCO and (2) to assess fully their
respective impacts on the DCO, the DCO’s clearing members, and other relevant stakeholders.
As noted above, Regulation 39.39(b) requires DCOs to maintain viable plans for: (1)
recovery necessitated by uncovered credit losses or liquidity shortfalls and “separately” (2)
recovery necessitated by general business risk, operational risk, or any other risk that threatens
13 DCR notes that proposed rule changes submitted to the Commission, including those of the type that are discussed
in this memorandum, are required to be published concurrently on the DCO’s website. See 17 C.F.R. §§ 40.5(a)(6),
40.6(a)(2), 40.10(a).
14 Accordingly, this memorandum should not be construed in any way as limiting the Commission’s ability to
pursue actions for violations of Regulation 39.39.
4
at proposed rule changes submitted to the Commission, including those of the type that are discussed
in this memorandum, are required to be published concurrently on the DCO’s website. See 17 C.F.R. §§ 40.5(a)(6),
40.6(a)(2), 40.10(a).
14 Accordingly, this memorandum should not be construed in any way as limiting the Commission’s ability to
pursue actions for violations of Regulation 39.39.
4
the DCO as a going concern. While the recovery frameworks applicable to (1) and (2) may be
discussed within a single document, each recovery framework should be analyzed independently.
For each type of risk set forth in (1) and (2), a DCO should identify and evaluate the full range of
distinct, relevant scenarios that would prevent the DCO from being able to meet its obligations
and to provide its critical operations and services.15
DCR notes that, for this purpose, a DCO need only identify and address the types of
scenarios referenced in Regulation 39.39(c)(1), not each market scenario that would result in
losses. Thus, a DCO is not expected to analyze the number of specific scenarios or events that
may be necessary for stress testing, such as the testing required by Regulations 39.13(h)(3) and
39.36(a).
In addition to uncovered credit loss and liquidity shortfall scenarios, a Recovery Plan
should include separate analyses of multiple scenarios resulting in or from each of the following:
a.
specifically identified “general business risks,” as defined in Regulation
39.39(a)(1);16
b.
specifically identified “operational risks,” as defined in Regulation 39.39(a)(4);17
and
c
and
39.36(a).
In addition to uncovered credit loss and liquidity shortfall scenarios, a Recovery Plan
should include separate analyses of multiple scenarios resulting in or from each of the following:
a.
specifically identified “general business risks,” as defined in Regulation
39.39(a)(1);16
b.
specifically identified “operational risks,” as defined in Regulation 39.39(a)(4);17
and
c.
any other risks that might threaten the DCO’s viability as a going concern.18
While the exact combination of relevant recovery scenarios may be exclusive to a
particular DCO, DCR has identified certain commonly applicable scenarios that should be
included in all Recovery Plans. These include, but are not limited to, general business risk
scenarios and operational risk scenarios such as:
a.
a settlement bank failure;
b.
a custodian bank failure;
c.
scenarios resulting from investment risk;
d.
poor business results;
e.
the financial effects19 of cybersecurity events;
15 Cf. 17 C.F.R. § 39.13(b).
16 “General business risk,” is defined in Regulation 39.39(a)(1) to mean “any potential impairment of a [SIDCO’s]
or [Subpart C DCO’s] financial position, as a business concern, as a consequence of a decline in its revenues or an
increase in its expenses, such that expenses exceed revenues and result in a loss that the [DCO] must charge against
capital.”
17 “Operational risk” is defined in Regulation 39.39(a)(4) to mean “the risk that deficiencies in information systems
or internal processes, human errors, management failures or disruptions from external events will result in the
reduction, deterioration, or breakdown of services provided by a [SIDCO] or [Subpart C DCO].”
18 All risks should be specifically identified and separately addressed. A Recovery Plan that is limited to broadly
characterized scenarios such as “business and operational risks,” for example, would be insufficiently detailed.
5
agement failures or disruptions from external events will result in the
reduction, deterioration, or breakdown of services provided by a [SIDCO] or [Subpart C DCO].”
18 All risks should be specifically identified and separately addressed. A Recovery Plan that is limited to broadly
characterized scenarios such as “business and operational risks,” for example, would be insufficiently detailed.
5
f.
internal fraud, external fraud, and/or other actions of criminals or public enemies;
g.
legal liability not specific to the DCO’s business as a DCO (e.g., tort liability,
liability related to intellectual property); and
h.
losses resulting from interconnections and interdependencies among the DCO and
its parent, affiliates, and/or internal or external service providers (e.g., the
financial effects of the inability of an internal or external service provider to
supply key systems or services to the DCO).
The DCO also should describe the actions that it has taken to determine its general
business and operational risks and to ascertain any other risks that might threaten its viability.
Certain scenarios that pose a threat to DCOs (e.g., cybersecurity issues) may be systemic
in nature. Accordingly, the suite of scenarios included in a Recovery Plan should not be limited
to idiosyncratic events. Certain scenarios also may have contagious effects. Thus, a DCO’s
Recovery Plan should not assume that the adverse effects of all of its scenarios can be contained
to the DCO
lity.
Certain scenarios that pose a threat to DCOs (e.g., cybersecurity issues) may be systemic
in nature. Accordingly, the suite of scenarios included in a Recovery Plan should not be limited
to idiosyncratic events. Certain scenarios also may have contagious effects. Thus, a DCO’s
Recovery Plan should not assume that the adverse effects of all of its scenarios can be contained
to the DCO. An event may, for example, adversely affect the DCO’s affiliates or service
providers.20 It is also possible that an event that is idiosyncratic to the DCO performing the
analysis or a systemic event could have an effect on other DCOs, including unaffiliated DCOs.
Accordingly, the Recovery Plan should include and address scenarios that affect a DCO and
other entities, if the effect on the other entities ultimately impacts the DCO.
Each scenario and its resulting circumstances should be analyzed individually and in
detail in the DCO’s Recovery Plan. Such analyses should include, at a minimum:
a.
a description of the scenario;
b.
the events that are likely to trigger the scenario;
c.
the DCO’s process for monitoring for such events;
d.
the market conditions, operational and financial difficulties and other relevant
circumstances that are likely to result from the scenario;
e.
the potential financial and operational impact of the scenario on the DCO and on
its clearing members, internal and external service providers and relevant
affiliated companies, both in an orderly market and a disorderly market (e.g.,
where markets are unavailable or there are few solvent counterparties); and
f.
the specific steps that the DCO would expect to take when the scenario occurs or
appears likely to occur including, without limitation, any governance or other
procedures that may be necessary to implement the relevant recovery tools and to
19 The business effects of cybersecurity events would be in addressed the DCO’s business continuity plan, which is
outside the scope of this memorandum
.
the specific steps that the DCO would expect to take when the scenario occurs or
appears likely to occur including, without limitation, any governance or other
procedures that may be necessary to implement the relevant recovery tools and to
19 The business effects of cybersecurity events would be in addressed the DCO’s business continuity plan, which is
outside the scope of this memorandum.
20 If a clearing member fails in its obligations to a DCO, it may fail in its obligations to other DCOs as well. See the
discussion of a DCO’s interconnections and interdependencies, in section I.4 infra.
6
ensure that such implementation occurs in sufficient time for the recovery tools to
achieve their intended effect.
While there may be commonalities between the actions the DCO expects it would take in
each scenario, DCR expects that the DCO will analyze each scenario individually and that the
Recovery Plan will describe the differences between the approaches and the rationale for such
differences.
2.
Recovery Tools.
DCR believes that the DCO’s ability to implement its Recovery Plan promptly and
effectively will be significantly enhanced if the DCO, during a time of “business as usual” and
prior to the occurrence of a particular scenario: (a) has performed the thoughtful analysis
necessary to determine ex ante the specific recovery tools that it intends to activate in particular
scenarios and the sequencing thereof, and (b) has evaluated thoroughly any impediments or risks
to the timely or successful use of those tools
hanced if the DCO, during a time of “business as usual” and
prior to the occurrence of a particular scenario: (a) has performed the thoughtful analysis
necessary to determine ex ante the specific recovery tools that it intends to activate in particular
scenarios and the sequencing thereof, and (b) has evaluated thoroughly any impediments or risks
to the timely or successful use of those tools. While each scenario event will, almost inevitably,
involve unique and unforeseen circumstances that will require a certain degree of flexibility in
the DCO’s approach to addressing that event, DCR believes that maintaining an established and
carefully considered recovery toolkit to guide its recovery efforts will result in the ability to
react to an unexpected event more rapidly; provide transparency to clearing members and other
participants; and assist in ensuring that the Rules, policies and procedures necessary to
implement the recovery tools are in place. Accordingly, for each scenario, a Recovery Plan
should identify and analyze:
a.
the particular recovery tools that the DCO would expect to use in the event that
the scenario happens;21
b.
the specific order in which the DCO would expect to use such tools; the event that
would trigger the use of each tool in the sequence; and any discretion that the
DCO has in the use and/or sequencing of the tools, the parameters for the exercise
of such discretion, the factors that guide such discretion and the governance
processes for the exercise of such discretion;
c.
whether each tool is mandatory or voluntary;22
d.
the specific steps that would be required to implement each tool;
21 A variety of recovery tools may be available to a particular DCO (e.g., assessments, gains-based haircutting,
voluntary optional payments, partial tear-up, intercompany loan agreements, or other means of capital infusion by a
parent or an affiliate or insurance)
etion;
c.
whether each tool is mandatory or voluntary;22
d.
the specific steps that would be required to implement each tool;
21 A variety of recovery tools may be available to a particular DCO (e.g., assessments, gains-based haircutting,
voluntary optional payments, partial tear-up, intercompany loan agreements, or other means of capital infusion by a
parent or an affiliate or insurance). As noted above, the suitability and feasibility of certain recovery tools generally
or for a particular DCO is beyond the scope of this memorandum.
22 In this context, “mandatory” recovery tools are those recovery tools in which participation is required under the
DCO’s rules or procedures. For example, a DCO may have the rule-based authority to compel its clearing members
to provide additional funds up to a certain cap when assessed by the DCO or the rule-based authority to impose
gains-based haircuts. “Voluntary” recovery tools are those recovery tools for which participation by the DCO or its
members, as applicable, is discretionary. Voluntary recovery tools could include, for example, voluntary optional
payments by clearing members to reduce losses, voluntary partial tear-ups, borrowing under intercompany loan
agreements, or the reduction or elimination of dividend payments.
7
e.
the roles, obligations, and responsibilities of the parties that are involved in the
use of each tool (e.g., non-defaulting participants);
f.
the time frame within which each tool could be used (e.g., taking into account
notice and internal approval requirements or negotiation with clearing members in
connection with voluntary tools);
g
e.
the roles, obligations, and responsibilities of the parties that are involved in the
use of each tool (e.g., non-defaulting participants);
f.
the time frame within which each tool could be used (e.g., taking into account
notice and internal approval requirements or negotiation with clearing members in
connection with voluntary tools);
g.
the key risks associated with the use of each tool (e.g., that clearing members will
not satisfy their assessments or other obligations or participate in voluntary tools,
or that the use of assessments or other recovery tools will result in additional
defaults or otherwise exacerbate the adverse impacts of the scenario);
h.
the steps that the DCO would expect to take before an event occurs to mitigate
such identified risks;
i.
any constraints on the use or effectiveness of each tool (e.g., caps on the amount
or frequency of assessments and gains-based haircutting, the willingness of
counterparties to enter into repurchase agreements to satisfy liquidity
requirements, covenants within certain loan agreements that may restrict the
ability to borrow under such agreements or limits on the types of events for which
insurance would be available and the amount of insurance coverage);
j.
an evaluation of the likelihood that, given the factors identified in h. – i. above,
the recovery tool would be effective within the relevant timeframe;
k.
the expected impact on the DCO, its clearing members and their customers, its
parent, affiliates, and owners, and the financial system more broadly if a
particular tool is used; the manner in which the DCO would mitigate any adverse
impacts; and the mechanisms by which the DCO would enable its clearing
members to understand, measure, manage, and control the exposure created by the
tool;
l.
any incentives that would be created by the availability or the use of the tool; and
m
ffiliates, and owners, and the financial system more broadly if a
particular tool is used; the manner in which the DCO would mitigate any adverse
impacts; and the mechanisms by which the DCO would enable its clearing
members to understand, measure, manage, and control the exposure created by the
tool;
l.
any incentives that would be created by the availability or the use of the tool; and
m.
the relevant rules or rule amendments that support (or are needed to support) the
use of each tool.
The considerations set forth in a. – m. above apply to both voluntary and mandatory
recovery tools. In addition, for each voluntary recovery tool, the Recovery Plan should analyze:
(1) the process by which clearing members agree to become subject to the tool and (2) the basis
for the DCO’s confidence that such tools would be available including, without limitation, any
incentives that clearing members may have for volunteering to participate in such tools
(e.g., debt or equity instruments that provide an economic return or governance or other rights
that could be given as incentives).
A DCO ultimately may determine that it would be appropriate to take the same course of
action (e.g., use the same recovery tools in the same order) in a multitude of scenarios. Such
general conclusions, however, are appropriate only if the DCO has performed the analysis set
forth above. Such analysis also is necessary, in part, to fulfill a DCO’s obligation under
Regulation 39.39(c)(1) to “assess the effectiveness of a full range of options for recovery.”
8
the same course of
action (e.g., use the same recovery tools in the same order) in a multitude of scenarios. Such
general conclusions, however, are appropriate only if the DCO has performed the analysis set
forth above. Such analysis also is necessary, in part, to fulfill a DCO’s obligation under
Regulation 39.39(c)(1) to “assess the effectiveness of a full range of options for recovery.”
8
DCOs may wish to describe in their Recovery Plans any recovery tools that they have analyzed
but decided not to use. An understanding of the recovery tools that will be used in various
scenarios, the risks of their use, and the likely limits of their effectiveness is essential for an
accurate analysis of the sufficiency of a DCO’s financial resources to implement its Recovery
Plan.23
Further, a DCO should consider whether certain scenarios that it has identified are likely
to occur in tandem or successively. A DCO should consider the effect of such circumstances on
its recovery needs and the use and timing of its recovery tools.
3.
Wind-down Scenarios and Options.
With respect to Wind-down Plans, Regulation 39.39(c)(1) also requires each DCO “to
identify scenarios that may potentially prevent the DCO from being able to meet its obligations
or to provide its critical operations and services as a going concern.”24 A DCO is required to
assess the effectiveness of a “full range of options” for orderly wind-down. The scenarios and
related recovery tools described in the DCO’s Recovery Plan typically will serve as a
springboard for the DCO’s analysis of the events that would trigger the implementation of its
Wind-down Plan and the use of the DCO’s wind-down options
tions and services as a going concern.”24 A DCO is required to
assess the effectiveness of a “full range of options” for orderly wind-down. The scenarios and
related recovery tools described in the DCO’s Recovery Plan typically will serve as a
springboard for the DCO’s analysis of the events that would trigger the implementation of its
Wind-down Plan and the use of the DCO’s wind-down options. A Wind-down Plan should
describe, for each scenario: (a) the point or points in the Recovery Plan for that particular
scenario where recovery efforts would be deemed to have failed and the Wind-down Plan would
be triggered; (b) in that particular scenario, the wind-down options that would be available to the
DCO (i.e., the actions that the DCO could take to effect, in an orderly manner, the permanent
cessation, sale or transfer of the DCO’s clearing and other services); and (c) for each option, the
specific actions that the DCO plans to take.
A DCO’s analysis of its wind-down options should contain many of the elements of the
DCO’s analysis of its recovery tools. The Wind-down Plan should identify and analyze in detail,
with respect to each scenario:
a.
the particular wind-down options that the DCO would expect to use in the event
that its recovery efforts fail;
b.
the specific order in which the DCO would expect to employ such options and
any discretion that the DCO has with respect to the use and/or sequencing of such
options, the parameters for the exercise of such discretion, the factors that guide
such discretion, and the governance processes for the exercise of such discretion;
c.
the specific steps that would be required to implement each option (e.g.,
disclosure, risk reduction, trade reduction, transfer or close-out of positions, and
the liquidation of investments);
d
se and/or sequencing of such
options, the parameters for the exercise of such discretion, the factors that guide
such discretion, and the governance processes for the exercise of such discretion;
c.
the specific steps that would be required to implement each option (e.g.,
disclosure, risk reduction, trade reduction, transfer or close-out of positions, and
the liquidation of investments);
d.
the time that would be required to complete each step (e.g., in light of disclosure,
contract termination and other relevant requirements) and the time frame within
which the DCO believes that an orderly wind-down could be effectuated;
23 See 17 C.F.R. § 39.39(d)(2).
24 17 C.F.R. § 39.39(c)(1).
9
e.
the roles, obligations, and responsibilities of the various parties, including non-
defaulting participants, in the use of each option;
f.
any limits on the use of each option to effectuate an orderly wind-down;
g.
an evaluation of the likelihood that the option would result in an orderly wind-
down;
h.
the impact of each option and the steps needed to effectuate it on the DCO; the
DCO’s clearing members and their customers, parent, affiliates, and owners; and
the financial system more broadly; and
i.
the relevant DCO rules or rule amendments that support (or are needed to
support) the use of each option.
The Wind-down Plan should address the manner in which liquidity requirements would
be managed during service closure. A Wind-down Plan also should identify essential support
services (e.g., personnel, facilities, utilities, and communications technologies) and address the
manner in which the DCO would maintain such services during the wind-down period.
Regulation 39.39(b) requires that DCOs maintain Wind-down Plans that are viable
anner in which liquidity requirements would
be managed during service closure. A Wind-down Plan also should identify essential support
services (e.g., personnel, facilities, utilities, and communications technologies) and address the
manner in which the DCO would maintain such services during the wind-down period.
Regulation 39.39(b) requires that DCOs maintain Wind-down Plans that are viable.
Accordingly, Wind-down Plans should address fully any obstacles to the DCO’s Wind-down
options (e.g., the likelihood that a transfer or sale could not be effectuated in light of the financial
and operational capacity that would be required of a transferee or the status of the DCO as a
distressed seller) and explain the viability of the options in light of such obstacles.
4.
Interconnections and Interdependencies.
Both a DCO’s Recovery Plan and its Wind-down Plan should identify the financial and
operational interconnections and interdependencies among the DCO and its relevant affiliates,
internal and external service providers and other relevant stakeholders, and analyze the impact
that such relationships may have on the Recovery and/or Wind-down Plan. Without limiting the
generality of the foregoing, a Recovery Plan should, for example:
a.
identify and address the extent to which such relationships may increase the
adverse consequences of each scenario, decrease the availability or effectiveness
of particular recovery tools in certain scenarios (e.g., where multiple affiliated
entities are affected by a scenario, multiple affiliates may seek to borrow under
the same intercompany loan agreements or may rely on insurance policies with
group coverage limits) or increase the DCO’s recovery needs;
b.
specifically identify and address the multiple roles and relationships that a single
financial entity may have with respect to the DCO (e.g., a single entity may act as
a settlement bank, custodian bank, liquidity provider, and/or counterparty);
c
der
the same intercompany loan agreements or may rely on insurance policies with
group coverage limits) or increase the DCO’s recovery needs;
b.
specifically identify and address the multiple roles and relationships that a single
financial entity may have with respect to the DCO (e.g., a single entity may act as
a settlement bank, custodian bank, liquidity provider, and/or counterparty);
c.
account for the possibility that, if any relevant entity in the financial sector fails,
all of that entity’s affiliates would fail and the entity and those affiliates would
default on all obligations in all their capacities to the DCO; and
d.
identify specifically the DCO’s critical internal and external service providers, the
risks that the failure of each provider poses to the DCO, how such failures would
10
be addressed, and how the DCO would ensure that the services provided by its
internal and external service providers would continue to be provided in recovery.
In addition to the above and as discussed in section I.1, a DCO’s Recovery Plan and
Wind-down Plan should address both systemic scenarios and scenarios that are idiosyncratic to
the DCO in which other DCOs (including unaffiliated DCOs) are impacted. The Recovery Plan
and Wind-down Plan should address how the effect that the scenario has on the other DCOs
would influence the actions taken by the DCO in recovery or wind-down (e.g., the recovery tools
and wind-down options that would be available to the DCO or that the DCO would choose).
A Wind-down Plan should, without limitation:
a.
identify and address the effect that the DCO’s interconnections and
interdependencies may have on the DCO’s ability to implement its wind-down
options (e.g., the impact that such relationships may have on the value of the
DCO and its ability to be sold) and the financial resources available to the DCO to
implement its Wind-down Plan; and
b
.
A Wind-down Plan should, without limitation:
a.
identify and address the effect that the DCO’s interconnections and
interdependencies may have on the DCO’s ability to implement its wind-down
options (e.g., the impact that such relationships may have on the value of the
DCO and its ability to be sold) and the financial resources available to the DCO to
implement its Wind-down Plan; and
b.
address the impact that such relationships may have on the DCO’s ability to
maintain essential support services during the wind-down process.
5.
Agreements to Be Maintained during Recovery and Wind-down.
A DCO will have a variety of contractual arrangements that must be maintained during
ordinary operations, in times of stress and in order for the DCO to continue operations in
recovery and wind-down. Such arrangements include contractual arrangements with clearing
members (e.g., the DCO’s rules and procedures); affiliates (e.g., agreements to provide
operational, administrative and staffing services and intercompany loan agreements); linked
central counterparties (e.g., mutual offset agreements or cross-margining agreements);
counterparties; external service providers (e.g., credit agreements); and other third parties. A
DCO’s Recovery Plan and Wind-down Plan should identify and analyze the implications of such
arrangements.
The DCO should: (a) review and analyze such agreements to determine whether any of
them include covenants, material adverse change clauses or other provisions that would permit a
counterparty to alter or terminate the agreement as a result of any of the circumstances or stress
that is caused by or results from the DCO’s need to implement its Recovery Plan or its Wind-
down Plan; and, (b) if so, analyze the impact on the DCO’s ability to effectuate a successful
recovery or orderly wind-down (e.g., analyze whether the termination of such agreements render
the continuation of operations impracticable)
inate the agreement as a result of any of the circumstances or stress
that is caused by or results from the DCO’s need to implement its Recovery Plan or its Wind-
down Plan; and, (b) if so, analyze the impact on the DCO’s ability to effectuate a successful
recovery or orderly wind-down (e.g., analyze whether the termination of such agreements render
the continuation of operations impracticable). The Recovery Plan and Wind-down Plan should
include such analysis and describe the actions that the DCO has taken to ensure that its
operations can continue during recovery and wind-down despite the termination or alteration of
relevant contracts.
6.
Financial Resources.
Regulation 39.39(d)(2) requires DCOs “to maintain sufficient unencumbered liquid
financial assets, funded by the equity of its owners, to implement its recovery or wind-down
plans….” While the financial resources that a DCO is required to maintain pursuant to
Regulation 39.11(a)(2) may be sufficient, the DCO is required to “analyze its particular
11
circumstances and risks and maintain any additional resources that may be necessary to
implement the [P]lans” and to include within its Recovery Plan and its Wind-down Plan
“evidence and analysis” to support the DCO’s conclusion that the amount the DCO considers
necessary to implement both its Recovery Plan and its Wind-down Plan is, in fact, sufficient.
The above-referenced analysis should account for all extraordinary costs that may be
incurred by the DCO during recovery and wind-down
t the [P]lans” and to include within its Recovery Plan and its Wind-down Plan
“evidence and analysis” to support the DCO’s conclusion that the amount the DCO considers
necessary to implement both its Recovery Plan and its Wind-down Plan is, in fact, sufficient.
The above-referenced analysis should account for all extraordinary costs that may be
incurred by the DCO during recovery and wind-down. DCR believes that, in considering and
analyzing the magnitude of the costs associated with recovery and wind-down, it is important to
consider both the relevant increases in costs (e.g., legal fees, accounting fees, financial advisor
fees, the costs associated with employee retention programs, and other incentives to maintain
staff) as well as potential decreases in costs that might result from the contraction or (in the case
of a wind-down) the cessation of operations in a period shorter than six months.
A DCO should not rely on the same resources to implement both its Recovery Plan and
its Wind-down Plan. A DCO must assume that the resources that it has consumed for recovery
will not be available should recovery efforts fail and the DCO proceeds to wind-down. In
calculating the resources that would be required to implement the DCO’s Wind-down Plan,
however, a DCO need only address any added, marginal costs that may be associated with the
wind-down process that are above and beyond the costs incurred in recovery.
Having considered the financial resources available to the DCO for recovery and wind-
down purposes in light of the expected costs, the DCO’s Recovery Plan and Wind-down Plan
should include, at a minimum, the following evidence and analysis:
a
need only address any added, marginal costs that may be associated with the
wind-down process that are above and beyond the costs incurred in recovery.
Having considered the financial resources available to the DCO for recovery and wind-
down purposes in light of the expected costs, the DCO’s Recovery Plan and Wind-down Plan
should include, at a minimum, the following evidence and analysis:
a.
a demonstration of the amount of unencumbered liquid financial assets, funded by
the equity of the DCO’s owners, that would be necessary to implement the DCO’s
Recovery Plan and its Wind-down Plan (this demonstration should be based upon
a thorough and realistic analysis of the full financial impact, both in terms of
financial resources and liquidity needs, of the relevant recovery scenarios and
tools and wind-down options); and
b.
(i) a demonstration that the financial resources that the DCO is required to
maintain pursuant to Regulation 39.11(a)(2) are sufficient for this purpose and the
supporting analysis or, (ii) if such financial resources are not sufficient, a
demonstration that the DCO maintains the additional resources necessary to
maintain its Recovery Plan and Wind-down Plan.
All financial information included in a DCO’s Recovery Plan and its Wind-down Plan
should be as up-to-date as practicable to ensure the accuracy of the financial calculations and
analysis. Both a DCO’s Recovery Plan and its Wind-down Plan should include a viable plan for
raising additional financial resources including, where appropriate, capital, in a scenario in which
the DCO is unable, or virtually unable to comply with any of the Part 39 financial resource
requirements.25 This financial resource plan should be approved by the Board of Directors of the
DCO. In developing this plan, the DCO should consider a strategy for raising additional capital
from plausibly interested parties under plausible potential structures.
25 See 17 C.F.R. § 39.39(e).
12
hich
the DCO is unable, or virtually unable to comply with any of the Part 39 financial resource
requirements.25 This financial resource plan should be approved by the Board of Directors of the
DCO. In developing this plan, the DCO should consider a strategy for raising additional capital
from plausibly interested parties under plausible potential structures.
25 See 17 C.F.R. § 39.39(e).
12
7.
Governance.
DCR believes that governance is necessarily a part of a complete Recovery Plan and a
complete Wind-down Plan, and that pre-defined governance arrangements will assist DCOs in
reacting quickly to scenarios, provide transparency to the recovery and wind-down processes,
and assist in ensuring that recovery and wind-down decisions (both in the planning and
implementation stages) are vetted properly and with appropriate consideration of the interests of
affected parties. Accordingly, both a DCO’s Recovery Plan and its Wind-down Plan should set
forth all relevant governance arrangements. Both a DCO’s Recovery Plan and its Wind-down
Plan should analyze issues pertaining to the DCO’s corporate structure that may have impacts on
the use of recovery tools and wind-down options. Without limiting the generality of the
foregoing, a DCO’s Recovery Plan and Wind-down Plan, as applicable, should:
a.
identify the persons responsible for the development, review, approval, and
ongoing monitoring and updating of the DCO’s Recovery Plan and Wind-down
Plan;
b.
describe the involvement of the DCO’s clearing members in the development,
review, and updating of the Recovery Plan and the Wind-down Plan, and in
assessing the effects of the Recovery Plan and Wind-down Plan on clearing
members;
c.
describe how the costs and benefits of various recovery tools are taken into
account during the decision-making process;
d
ery Plan and Wind-down
Plan;
b.
describe the involvement of the DCO’s clearing members in the development,
review, and updating of the Recovery Plan and the Wind-down Plan, and in
assessing the effects of the Recovery Plan and Wind-down Plan on clearing
members;
c.
describe how the costs and benefits of various recovery tools are taken into
account during the decision-making process;
d.
describe the Recovery Plan and Wind-down Plan approval and amendment
processes;
e.
describe the specific roles and responsibilities of the DCO’s Board of Directors,
relevant committees (e.g., the risk committee), and other employees and clearing
members in activating the Recovery Plan and Wind-down Plan and in
implementing various aspects thereof including, without limitation, the use of
recovery tools and wind-down options; and
f.
the discretion of such persons and entities in activating the Recovery Plan and
Wind-down Plan, the parameters for exercise of such discretion, where such
discretion may be exercised, the factors that guide such discretion, and the
governance processes for the exercise of such discretion.
A DCO should consider the use of a “decision tree” as a communication tool in this context.
Such a decision tree might outline the procedures for the decisions that must be made and
the actions that must be taken in order to:
a.
activate the Recovery Plan or Wind-down Plan when a scenario is likely to be
triggered;
b.
activate the Recovery Plan or Wind-down Plan when circumstances warrant; and
c.
implement each step within the Recovery Plan or Wind-down Plan.
13
is context.
Such a decision tree might outline the procedures for the decisions that must be made and
the actions that must be taken in order to:
a.
activate the Recovery Plan or Wind-down Plan when a scenario is likely to be
triggered;
b.
activate the Recovery Plan or Wind-down Plan when circumstances warrant; and
c.
implement each step within the Recovery Plan or Wind-down Plan.
13
The decision tree also might identify the persons or entities responsible for making such
decisions or taking such actions. To the extent that the decision making process differs in
particular recovery or wind-down scenarios, such differences should be identified within the
relevant Recovery Plan or Wind-down Plan, as applicable.
8.
Notifications.
A DCO’s Recovery Plan and Wind-down Plan should include procedures for informing
the Commission when the Recovery Plan is initiated or wind-down is pending, consistent with
Regulation 39.39(c)(1), and for providing such notice to clearing members26 and other
stakeholders. The Recovery Plan and Wind-down Plan also should include procedures for
providing the Commission and the FDIC with information needed for the purposes of resolution
planning.27
9.
Assumptions.
Neither a DCO’s Recovery Plan nor its Wind-down Plan should assume action or
participation by the Commission or any other foreign or domestic regulator. To the extent that
the DCO would need regulatory approvals in order to take certain actions specified in a
Recovery Plan or Wind-down Plan, the Recovery Plan or Wind-down Plan, as applicable, should
identify what approvals would be necessary and the procedures that the DCO would follow to
obtain such approvals
ion or
participation by the Commission or any other foreign or domestic regulator. To the extent that
the DCO would need regulatory approvals in order to take certain actions specified in a
Recovery Plan or Wind-down Plan, the Recovery Plan or Wind-down Plan, as applicable, should
identify what approvals would be necessary and the procedures that the DCO would follow to
obtain such approvals. In addition, and as discussed above, neither a DCO’s Recovery Plan nor
its Wind-down Plan should assume that events are idiosyncratic; that the DCO’s relevant
affiliates or internal or external service providers would not be affected by an event; that, in a
scenario, internal and external service providers would continue to perform as expected pursuant
to existing contracts or that replacements easily could be found (particularly in the context of a
wind-down); or any other facts or circumstances that plausibly may not be present in the scenario
or that would cause the DCO to underestimate the impact of a scenario.
10.
Updates.
Both a DCO’s Recovery Plan and its Wind-down Plan should be based upon the rights
and obligations contained in the current rules, policies, and procedures of the DCO and, as
applicable, other pre-existing contractual arrangements. That is, neither a Recovery Plan nor a
Wind-down Plan should assume that proposed or future rules, policies, or procedures will be put
in place.28 In addition, both a DCO’s Recovery Plan and its Wind-down Plan should include
procedures for evaluating and updating the Recovery Plan or Wind-down Plan at regular
intervals and additionally, promptly when warranted by changes to the DCO’s rules, policies,
and procedures; contractual arrangements; business model and practices; financial resources; risk
profile; operations; organizational structure; interdependencies and interconnections; product
offerings; or other circumstances. Both a DCO’s Recovery Plan and its Wind-down Plan should
26 See 17 CFR § 39.21.
27 See 17 C.F.R. § 39.39(c)(2)
when warranted by changes to the DCO’s rules, policies,
and procedures; contractual arrangements; business model and practices; financial resources; risk
profile; operations; organizational structure; interdependencies and interconnections; product
offerings; or other circumstances. Both a DCO’s Recovery Plan and its Wind-down Plan should
26 See 17 CFR § 39.21.
27 See 17 C.F.R. § 39.39(c)(2).
28 However, DCR notes that when the DCO initially develops its Recovery Plan and Wind-down Plan, the DCO may
need to propose rule changes in order to implement its Recovery Plan or Wind-down Plan. Following this initial
development phase, DCR expects that, as stated above, the Recovery Plan and Wind-down Plan will be based upon
the current rules, policies, and procedures of the DCO.
14
include pinpoint citations, where applicable, to the DCO’s rules, policies, procedures, and
agreements.
11.
Testing.
The Recovery Plan and Wind-down Plan also should include procedures for regularly
testing the viability of the Recovery Plan or Wind-down Plan. Where applicable, such tests
should be conducted with the participation of clearing members. Both the Recovery Plan and
Wind-down Plan should identify the types of testing that will be performed; the frequency with
which the Recovery Plan or Wind-down Plans, as applicable will be tested; to whom the findings
are reported; and the procedures for updating the Recovery Plan or Wind-down Plan in light of
such findings.
II
s
should be conducted with the participation of clearing members. Both the Recovery Plan and
Wind-down Plan should identify the types of testing that will be performed; the frequency with
which the Recovery Plan or Wind-down Plans, as applicable will be tested; to whom the findings
are reported; and the procedures for updating the Recovery Plan or Wind-down Plan in light of
such findings.
II.
Questions DCOs Should Consider Regarding Recovery Tools
DCR recommends that each DCO consider the questions below as it analyzes and
evaluates the feasibility and suitability of tools for inclusion in its Plans, and the scope of its
analysis. This guidance is not intended to be exhaustive or to provide a checklist of factors that a
DCO must consider in the analysis of the feasibility or suitability of tools for inclusion in its
Recovery Plan or Wind-down Plan. Rather, DCR is recommending that each DCO consider the
questions set forth below in light of its risk profile, organizational structure, financial resources,
individual business model and practices, interconnections and interdependencies, and any other
relevant circumstances. These factors should be considered in light of the DCO’s obligation to
have governance arrangements that “explicitly support the stability of the broader financial
system and other relevant public interest considerations of clearing members, customers of
clearing members, and other relevant stakeholders,” and the DCO’s board of directors’
obligation to “make certain that the [DCO’s] design, rules, overall strategy, and major decisions
appropriately reflect the legitimate interests of clearing members, customers of clearing
members, and other relevant stakeholders.”29
To the extent that a DCO reaches the conclusion that rule changes are necessary, as the
DCO undertakes the analysis of the questions set forth below, the DCO should design and submit
proposed rule changes
s] design, rules, overall strategy, and major decisions
appropriately reflect the legitimate interests of clearing members, customers of clearing
members, and other relevant stakeholders.”29
To the extent that a DCO reaches the conclusion that rule changes are necessary, as the
DCO undertakes the analysis of the questions set forth below, the DCO should design and submit
proposed rule changes. When submitting such proposed rule changes to the Commission,
SIDCOs should include the analysis of the questions below in the advance notice required by
Regulation 40.10(a).30 Subpart C DCOs should also include such analysis with rule changes
submitted pursuant to Regulations 40.5 or 40.6.31 DCR notes that when such proposed rule
29 See 17 C.F.R. § 39.32(a)(1)(ii); (a)(2).
30 See 17 C.F.R. § 40.10(a). In particular, Regulation 40.10(a)(1) states that the notice of a proposed rule change
“shall specifically describe: (i) The nature of the change and the expected effects on risks to the [SIDCO], its
clearing members, or the market; and (ii) How the [SIDCO] plans to manage any identified risks.”
31 See 17 C.F.R. §§ 40.5, 40.6.
For rule changes submitted pursuant to Regulation 40.5, Regulation 40.5(a)(5) requires a DCO to “[p]rovide an
explanation and analysis of the operation, purpose, and effect of the proposed rule or rule amendment and its
compliance with applicable provisions of the Act, including core principles, and the Commission’s regulations
thereunder, including, as applicable, a description of the anticipated benefits to market participants or others, any
potential anticompetitive effects on market participants or others, and how the rule fits into the registered entity’s
framework of self-regulation.” In addition, Regulation 40.5(a)(7) requires a DCO to “[p]rovide additional
information which may be beneficial to the Commission in analyzing the new rule or rule amendment. If a proposed
15
icipated benefits to market participants or others, any
potential anticompetitive effects on market participants or others, and how the rule fits into the registered entity’s
framework of self-regulation.” In addition, Regulation 40.5(a)(7) requires a DCO to “[p]rovide additional
information which may be beneficial to the Commission in analyzing the new rule or rule amendment. If a proposed
15
changes are submitted to the Commission, the proposed changes are required to be published
concurrently on the DCO’s website.32
Questions for Consideration
1.
Transparency.
a.
Does the design of the DCO’s rule book, written procedures, and other materials
provided to clearing members and clients enable those stakeholders to measure,
manage, and control their exposures? If so, how?
b.
Are the loss allocation rules and procedures clear, transparent, and
comprehensible? If so, what is the basis for this conclusion?
c.
Do the DCO’s rules and procedures unambiguously set forth the timeframes in
which particular tools will be used?
2.
Governance.
a.
How do the governance arrangements with regards to (i) the adoption of Recovery
Plans and (ii) the use of each Recovery tool include, to the extent appropriate and
practicable, the views of all relevant constituencies? Are such governance
arrangements, in each instance, clearly and comprehensively set forth in the
DCO’s rules?
i. Do such governance arrangements include the participation, to the extent
practicable, of all relevant constituencies?
1
doption of Recovery
Plans and (ii) the use of each Recovery tool include, to the extent appropriate and
practicable, the views of all relevant constituencies? Are such governance
arrangements, in each instance, clearly and comprehensively set forth in the
DCO’s rules?
i. Do such governance arrangements include the participation, to the extent
practicable, of all relevant constituencies?
1. To the extent stakeholder participation is accomplished through
consultation, what is meant by consultation? Specifically: What
information is provided? What opportunity will the consultees have to
evaluate the information? From whom (inside or outside of the DCO)
will they be able to seek advice? What happens if some or all of the
consultees disagree with the approach presented?
rule affects, directly or indirectly, the application of any other rule of the registered entity, the pertinent text of any
such rule must be set forth and the anticipated effect described.”
For rule changes submitted pursuant to Regulation 40.6, Regulation 40.6(a)(7)(v) requires a DCO to provide “[a]
concise explanation and analysis of the operation, purpose, and effect of the proposed rule or rule amendment and its
compliance with applicable provisions of the Act, including core principles, and the Commission’s regulations
thereunder.” In addition, Regulation 40.6(a)(8) requires a DCO to “provide, if requested by Commission staff,
additional evidence, information or data that may be beneficial to the Commission in conducting a due diligence
assessment of the filing and the registered entity’s compliance with any of the requirements of the Act or the
Commission’s regulations or policies thereunder.” This memorandum constitutes such a request. If no such
analysis is provided at the time that a proposed rule change is filed with the Commission, a more formal and
individualized request may be sent.
32 See 17 C.F.R. §§ 40.5(a)(6), 40.6(a)(2), 40.10(a).
16
ng and the registered entity’s compliance with any of the requirements of the Act or the
Commission’s regulations or policies thereunder.” This memorandum constitutes such a request. If no such
analysis is provided at the time that a proposed rule change is filed with the Commission, a more formal and
individualized request may be sent.
32 See 17 C.F.R. §§ 40.5(a)(6), 40.6(a)(2), 40.10(a).
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ii. How does the DCO make certain that such governance arrangements
appropriately reflect the legitimate interests of clearing members, customers
of clearing members, and other relevant stakeholders?
b.
Do the DCO’s rules permit the use of discretionary authority, including any
emergency rules and procedures, to deviate from the ex ante Recovery rules in
ways that increase members’ and their clients’ exposures, and thereby undermine
predictability, including clearing members’ and their clients’ ability to measure,
manage, and control those exposures?
i. If so, what are the limits on the use of such discretionary authority? Are the
limits clearly defined in the ex ante rules? Who is the decision maker and
how was that decision maker chosen? Are there checks to the decision
maker’s authority?
ii. How does the DCO balance the need for members and their clients to
measure, manage, and control exposures with the DCO’s discretionary
authority in an emergency?
iii. Do the DCO’s emergency rules and procedures provide a mechanism to
require affirmative consent from clearing members and, to the extent
practicable, other relevant stakeholders (or representatives thereof), in either
case, whose rights and obligations would be materially affected as a result of
the DCO’s exercise of its discretionary authority?
c
scretionary
authority in an emergency?
iii. Do the DCO’s emergency rules and procedures provide a mechanism to
require affirmative consent from clearing members and, to the extent
practicable, other relevant stakeholders (or representatives thereof), in either
case, whose rights and obligations would be materially affected as a result of
the DCO’s exercise of its discretionary authority?
c. To the extent that the foregoing governance arrangements rely on representatives of
stakeholders (e.g., consultation with or consent of a risk committee that includes such
representatives), please answer the following questions:
i.
How are the representatives chosen? Are the representatives’ interests
aligned with those of the relevant stakeholder constituency? What is the basis
for this conclusion?
ii.
Do the representatives’ duties run to the DCO, its board or its owners?
What is the basis for this conclusion? The DCO should provide relevant
documents (e.g., charter of a risk committee) as part of its rule submission.
d. How do the DCO’s governance arrangements address potential for the DCO’s board
of directors to have inconsistent, and possibly conflicting, duties to the shareholders
of the DCO and the clearing membership?
e. What are the potential impacts of the DCO’s corporate structure on the use of
particular recovery tools?
3.
DCO Capital Contribution.
a.
Does the DCO’s Recovery Plan include capital contributed by the DCO? What is
the position of the DCO’s capital contribution in the waterfall (i.e., is the DCO’s
capital contribution used prior to the mutualized resources contributed by the non-
defaulting clearing members)?
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pacts of the DCO’s corporate structure on the use of
particular recovery tools?
3.
DCO Capital Contribution.
a.
Does the DCO’s Recovery Plan include capital contributed by the DCO? What is
the position of the DCO’s capital contribution in the waterfall (i.e., is the DCO’s
capital contribution used prior to the mutualized resources contributed by the non-
defaulting clearing members)?
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4.
Timing and Gains Based Haircutting.
a.
Does the DCO’s Recovery Plan take into account the need and appropriate time
window for (i) developing a private sector solution or (ii) allowing the relevant
public authorities to perform the requisite analysis to determine whether
resolution is appropriate, prior to making a decision to terminate services and
Wind-down?33 At what point does this time window begin relative to the DCO’s
initiation of gains based haircutting, if applicable?
b.
Do the DCO’s Recovery and Wind-down Plans clarify when gains based
haircutting will be initiated? Is gains based haircutting initiated prior to the
projected exhaustion of pre-funded financial resources and assessments designed
to address losses from the default that the DCO is managing?
c.
What are the duration and frequency limits on the use of gains based haircuts?
Do the DCO’s rules and Recovery and Wind-down Plans provide clarity
regarding these limits that allow clearing members and their clients to measure,
manage, and control their exposures? What is the basis for this conclusion?
5.
Application of Resources.
a.
Do the DCO’s rules permit or require the DCO to use the financial resources set
forth in Regulation 39.11(b)(1), (e.g., DCO capital, pre-funded resources,
assessments, etc.) for one or more of the following purposes:
i
mits that allow clearing members and their clients to measure,
manage, and control their exposures? What is the basis for this conclusion?
5.
Application of Resources.
a.
Do the DCO’s rules permit or require the DCO to use the financial resources set
forth in Regulation 39.11(b)(1), (e.g., DCO capital, pre-funded resources,
assessments, etc.) for one or more of the following purposes:
i. Substitution for mark-to-market payments on the defaulter’s liquidated
positions;
ii. Payments to participants with winning auction bids for the defaulter’s
positions; or
iii. Compensation to participants (1) who receive positions through forced
allocations or (2) whose positions are partially torn-up?
If so, please explain.
b.
Do the DCO’s rules permit or require the DCO to use the financial resources set
forth in Regulation 39.11(b)(1), (e.g., DCO capital, pre-funded resources,
assessments, etc.) for any purpose other than those set forth in (a) above? If so,
please explain.
c.
Reversing the Waterfall:
33 DCR notes that Regulation 39.14(b) provides that a DCO “shall effect a settlement with each clearing member at
least once each business day, and shall have the authority and operational capacity to effect a settlement with each
clearing member, on an intraday basis, either routinely, when thresholds specified by the [DCO] are breached, or in
times of extreme market volatility.” DCR has interpreted Regulation 39.14(b) to prohibit the use of a suspension of
clearing, including during the time period described in section II.4.a.
18
y, and shall have the authority and operational capacity to effect a settlement with each
clearing member, on an intraday basis, either routinely, when thresholds specified by the [DCO] are breached, or in
times of extreme market volatility.” DCR has interpreted Regulation 39.14(b) to prohibit the use of a suspension of
clearing, including during the time period described in section II.4.a.
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i. Do the DCO’s rules require the DCO to take commercially reasonable steps to
prosecute claims against the defaulter, directly or as part of the defaulter’s
insolvency, resolution, or similar proceeding?
ii. To the extent that funds are collected from the defaulter or as part of the
defaulter’s insolvency, resolution, or similar proceeding, are such funds (after
reasonable expenses of collection) used to “reverse the waterfall” (e.g.,
starting with gains based haircuts)? Are such funds used for any other
purpose? Please explain.
iii. Similarly, are any default resources remaining after completion of the
liquidation of the defaulter’s positions and replenishment used to reverse the
waterfall? Are such funds used for any other purpose? Please explain.
6.
Fully Addressing Losses.
a.
Do the DCO’s Recovery and Wind-down Plans provide a means to fully address
credit losses? What is the basis for this conclusion?
i. Do the DCO’s Recovery and Wind-down Plans include voluntary tools, such
as auctions or voluntary tear-up, possibly supplemented by incentives such as
juniorization, to return to a matched book? Please explain which tools are
used, the order in which they are expected to be used, and the basis for the
DCO’s decision to use these tools in this order?
ii
t is the basis for this conclusion?
i. Do the DCO’s Recovery and Wind-down Plans include voluntary tools, such
as auctions or voluntary tear-up, possibly supplemented by incentives such as
juniorization, to return to a matched book? Please explain which tools are
used, the order in which they are expected to be used, and the basis for the
DCO’s decision to use these tools in this order?
ii. To the extent that such tools do not lead to full liquidation of the defaulter’s
positions, do the DCO’s Recovery and Wind-down Plans also use compulsory
tools, including complete tear-up, partial tear-up or forced allocation?
iii. Does the DCO’s Recovery Plan include gains based haircutting? Does the
DCO’s Wind-down Plan include gains based haircutting?? In each case, if so,
how? If not, what is the basis for the DCO’s conclusion that it fully addresses
all uncovered credit losses?
b.
Is the DCO’s Recovery Plan designed to promote the DCO’s ability to maintain
its critical services?
7.
Analysis of Tools.
a.
Has the DCO fully analyzed, individually and holistically, all tools included in its
Recovery and Wind-down Plans, to understand the legal basis, impact on
financial stability, and associated performance risk? What is the basis for this
conclusion?
*****
This memorandum represents the position of DCR only and does not
necessarily represent the views of the Commission or the views of any other division or office of
the Commission.
If you have any questions regarding any of the information contained in this document,
please contact Robert B. Wasserman, Chief Counsel, 202-418-5092 or Kirsten V.K. Robbins,
Associate Chief Counsel, 202-418-5313.
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This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.