Letter concludes that the National Bank Act permits a national bank to become a clearing member of ICE Trust, a clearinghouse for over-the-counter credit default swaps. The Bank's exposure to the ICE Trust for the defaults of other members is subject to the lending limit in 12 U.S.C. § 84 or any lower limit set by the examiner-in-charge ("EIC"). Before the Bank may become an ICE Trust clearing member, the Bank must establish a comprehensive risk management framework to govern the risks associated with its membership, and receive a written supervisory no-objection from its EIC. Other national banks may rely on the letter to become clearing members of ICE Trust, but must obtain prior written EIC approval.

O

Comptroller of the Currency

Administrator of National Banks

Washington, DC 20219

Interpretive Letter #1113

March 4, 2009 March 2009

12 USC 84

12 CFR 7.1017(a)

Subject: [ ] (“Bank”) Membership in The IntercontinentalExchange

US Trust (“ICE Trust”) Credit Default Swap Clearinghouse

Dear [ ]:

This responds to your request that the Office of the Comptroller of the Currency (“OCC”)

confirm that it is permissible for the Bank to participate as a clearing member of ICE

Trust, a clearinghouse for over-the-counter (“OTC”) credit default swaps (“CDS”).1 ICE

Trust is a New York trust company, which will be a member of the Federal Reserve

System and subject to the regulatory and supervisory requirements of the Federal Reserve

Board (“FRB”) and the New York State Banking Department. ICE Trust will meet the

statutory requirements for a multilateral clearing organization (“MCO”),2 as a State

member bank. As an MCO, ICE Trust will be permitted to clear CDS, as OTC

derivatives.3

1 A CDS is a bilateral OTC contract designed to transfer the credit exposure of specified products between

parties. The buyer of a CDS receives credit protection, whereas the seller of the swap guarantees the credit

worthiness of the obligor on the product in exchange for a fixed payment or a series of fixed payments.

Effectively, the risk of default is transferred from the buyer of the CDS to the seller.

2 An MCO is a system utilized by more than two participants in which the bilateral credit exposures of

participants arising from the transactions cleared are effectively eliminated and replaced by a system of

guarantees, insurance, or mutualized risk of loss. 12 U.S.C. § 4421(1).

3 See 12 U.S.C. § 4401 et seq., and ICE Trust Rule (“Rule”) 611

rred from the buyer of the CDS to the seller.

2 An MCO is a system utilized by more than two participants in which the bilateral credit exposures of

participants arising from the transactions cleared are effectively eliminated and replaced by a system of

guarantees, insurance, or mutualized risk of loss. 12 U.S.C. § 4421(1).

3 See 12 U.S.C. § 4401 et seq., and ICE Trust Rule (“Rule”) 611. OTC derivative transactions are defined

in 12 U.S.C. § 4421 to include any agreement, contract, or transaction that is a credit spread or credit swap

or that is a swap on one or more occurrences of any event, equity security, or other equity instrument, debt

security or other debt instrument. CDS fit within this definition of OTC derivatives.

For the reasons discussed below, we conclude that the Bank may participate as a clearing

member of ICE Trust, provided the Bank, prior to becoming a member, establishes a

comprehensive risk management framework4 to govern the risks associated with its

membership, and receives a written supervisory no-objection from its examiner-in-charge

(“EIC”).

Background

ICE Trust will provide CDS clearing services to its clearing participants (“members”).

Membership is open to market participants that meet the clearinghouse’s membership

criteria.5 The Bank proposes to become an ICE Trust clearing member.

ICE Trust will novate and clear the trades executed by its members.6 Bilateral contracts

entered into by its members will be replaced by two superseding CDS contracts between

ICE Trust and each party to the bilateral transactions. Under the new contracts, ICE

Trust will assume the counterparties’ obligations under the original contracts and

effectively become the central counterparty (i.e., the buyer to every seller and the seller to

every buyer) to CDS trades

ilateral contracts

entered into by its members will be replaced by two superseding CDS contracts between

ICE Trust and each party to the bilateral transactions. Under the new contracts, ICE

Trust will assume the counterparties’ obligations under the original contracts and

effectively become the central counterparty (i.e., the buyer to every seller and the seller to

every buyer) to CDS trades.

For admission to ICE Trust, member applicants must have a minimum tangible net worth

(Tier 1 capital) of $5 billion.7 Potential members or their parents must have a minimum

long term rating of at least “A” or its equivalent from designated or equivalent rating

agencies or otherwise demonstrate to the satisfaction of the FRB that it satisfies stringent

credit criteria.8 A member (or its affiliate) must be licensed and regulated for capital

adequacy by a “competent authority.”9 Members must provide initial and mark-to-

market margin, and contribute collateral (“Required Contributions”) to ICE Trust’s

guaranty fund (“Fund”),10 which is available to cover a member’s default.11 The

4 The risk management framework should focus on the qualitative controls necessary to address the risks of

the Bank’s activities and, in addition, provide for the Bank’s compliance with quantitative restrictions

discussed below.

5 Membership criteria are designed to insure that each member has sufficient operational capabilities,

financial resources, risk management experience and regulatory oversight to be permitted to become an

ICE Trust member. ICE Trust Risk Management Framework (“RMF”) § IV.

6 Rule 301.

7 Rule 201(b)(ii) and RMF § IV.

8 Rule 201(b)(iii) and RMF § IV. This criterion is not met if an applicant is rated below “A” and the

applicant will not be admitted as an ICE Trust clearing member. Id.

9 RMF § IV, A

urces, risk management experience and regulatory oversight to be permitted to become an

ICE Trust member. ICE Trust Risk Management Framework (“RMF”) § IV.

6 Rule 301.

7 Rule 201(b)(ii) and RMF § IV.

8 Rule 201(b)(iii) and RMF § IV. This criterion is not met if an applicant is rated below “A” and the

applicant will not be admitted as an ICE Trust clearing member. Id.

9 RMF § IV, A. “Competent authorities” include the OCC, the FRB, the U.K Financial Services Authority

or any other regulatory body ICE Trust designates from time to time for this purpose. Rule 201(b)(i).

10 The Fund is designed to provide adequate funds to cover simultaneous losses associated with the default

of the two clearing members with the greatest potential up-side (widening spread) losses (i.e.,

uncollateralized losses). RMF § IV.

2

Required Contribution is based on the risk profile of the member’s portfolio, subject to a

$20 million minimum.12 The Required Contribution is determined based on the nature

and scope of, and risk associated with, each member’s activities. If a clearing member’s

portfolio presents greater risk, ICE Trust may require the member to increase the amount

of its Required Contribution.13 ICE Trust calculates each member’s Required

Contribution on a daily basis.14 If a member’s calculated Required Contribution for a

particular day exceeds the prior day’s calculated contribution by 5% or exceeds the total

Fund by 5%, ICE Trust will make a demand for the member to provide cash or collateral

to the Fund, sufficient to cover the deficit, which must be met within one hour.15

The Rules define acts that constitute member defaults and describe the actions the

clearinghouse may take once it declares a member in default.16 In the event of a member

default, the Fund may be used to pay the costs of closing out a defaulting member’s

liabilities that exceed the defaulting member’s cash/collateral (margin accounts) or

guarantee

it, which must be met within one hour.15

The Rules define acts that constitute member defaults and describe the actions the

clearinghouse may take once it declares a member in default.16 In the event of a member

default, the Fund may be used to pay the costs of closing out a defaulting member’s

liabilities that exceed the defaulting member’s cash/collateral (margin accounts) or

guarantee. ICE Trust will notify members whenever it makes a charge to the Fund.17

ICE Trust may liquidate the losses resulting from a member’s default using this priority

schedule: (1) the ICE Trust Priority Contribution;18 (2) the non-defaulting members’

Required Contributions (not to exceed an average of $50 million per non-defaulting

member) and ICE Trust’s Pro Rata Contribution19 applied pro rata to the loss based on

the relative size of such contributions, and (3) the remainder of each non-defaulting

member’s Required Contribution applied pro rata to the remaining loss based on the

relative size of such contributions.20

11 Rules 401- 404 and 801 and RMF § IV. ICE Trust is also required to make capital contributions to the

Fund of up to $100 million, which includes up to $50 million representing a first loss contribution (“ICE

Trust Priority Contribution”) and the lesser of $50 million or the average Required Contribution (“ICE

Trust Pro Rata Contribution”). Rule 801.

12 RMF, Appendix 3 and ICE Trust Clearing Participant Application Documents (“PAD”).

13 PAD.

14 RMF § IV.

15 Rule 801 and RMF § IV.

16 A member is in default if, for example, the member: (1) fails to meet or is likely to fail to meet the

member’s contract obligations with the clearinghouse, (2) fails to pay margin by prescribed deadlines,

rust Pro Rata Contribution”). Rule 801.

12 RMF, Appendix 3 and ICE Trust Clearing Participant Application Documents (“PAD”).

13 PAD.

14 RMF § IV.

15 Rule 801 and RMF § IV.

16 A member is in default if, for example, the member: (1) fails to meet or is likely to fail to meet the

member’s contract obligations with the clearinghouse, (2) fails to pay margin by prescribed deadlines,

(3) is suspended or expelled or has privileges revoked by ICE Trust, or (4) has a guarantor who fails or is

likely to fail to meet any of its obligations or is in default under a guarantee to ICE Trust. Rule 20-605(a).

17 Rule 802(d).

18 The “ICE Trust Priority Contribution” is a contribution provided by ICE Trust to the Fund of up to $50

million representing a first loss contribution. Rule 801.

19 The “ICE Trust Pro Rata Contribution” is a contribution provided by ICE Trust to the Fund that is the

lesser of $50 million or the average Required Contribution.

20 Rules 801 and 802.

3

If ICE Trust draws on the Fund to cover a member default, resulting in a member having

an amount of collateral in the Fund less than the member’s Required Contribution, the

member must pay to the Fund an amount sufficient to restore the member’s Required

Contribution (“Additional Assessment”) prior to the opening of business on the next

business day.21 This amount is dynamic and can change from one day to the next based

on changes in the member’s transaction volume

ber having

an amount of collateral in the Fund less than the member’s Required Contribution, the

member must pay to the Fund an amount sufficient to restore the member’s Required

Contribution (“Additional Assessment”) prior to the opening of business on the next

business day.21 This amount is dynamic and can change from one day to the next based

on changes in the member’s transaction volume. Before the Additional Assessment is

due, a non-defaulting member may provide ICE Trust with a notice of intent to withdraw

from membership, thus becoming a “Retiring Participant.”22 As a Retiring Participant,

the amount of the Additional Assessment going forward may meet, but will not exceed,

in total, a member’s Required Contribution prior to the default.23 Thus, a Retiring

Participant has the ability to limit its contingent liability for the default of other members

to twice the member’s Required Contribution as of the day of default, subject to Monthly

Adjustments.24 25 Following the first day on which the Retiring Participant no longer has

any open positions, ICE Trust is not entitled to increase a Retiring Participant’s Required

Contribution.26

If the Fund is insufficient to discharge the obligations of the defaulting member, taking

into account the Additional Assessments, or ICE Trust determines that a winding up of

outstanding CDS is prudent or ICE Trust defaults, ICE Trust will determine close-out

values for all open positions (Wound-up Contracts) and determine a single net amount

21 Rule 802(b)(iv). If the entirety of the ICE Trust Pro Rata Contribution was not paid out under Rules

801(c)(i) and 802(b)(ii), the excess of the contribution will be available up to the ICE Trust Default

Maximum, along with any Additional Assessments, to cover a default

ll open positions (Wound-up Contracts) and determine a single net amount

21 Rule 802(b)(iv). If the entirety of the ICE Trust Pro Rata Contribution was not paid out under Rules

801(c)(i) and 802(b)(ii), the excess of the contribution will be available up to the ICE Trust Default

Maximum, along with any Additional Assessments, to cover a default.

22 A “Retiring Participant” is a clearing member who has notified ICE Trust of its intention to terminate its

status as a clearing member or who has been notified by ICE Trust of its intention to terminate the

member’s status as a member. Rule 102.

23 RMF § I.

24 While ICE Trust calculates each member’s Required Contribution daily, ICE Trust does not adjust a

member’s Required Contribution until month’s end, to reflect the average daily Required Contribution for

the month (the “Monthly Adjustment”), which may result in a positive or negative change in a Retiring

Participant’s Additional Assessment. Rules 101 and 801, and RMF § IV. Moreover, a Retiring Participant

continues to be responsible for any deficit where the member’s Required Contribution for a particular day

exceeds the prior day’s calculated contribution by 5% or exceeds the total Fund by 5%. Rule 801 and RMF

§ IV. A Retiring Participant is responsible for the Monthly Adjustment and deficit amounts if the member

has open positions at any time during the month with respect to which ICE Trust calculates and demands

these amounts. Rule 801. A Retiring Participant’s obligations remain outstanding until ICE Trust’s return

of a Retiring Participant’s Fund contribution, which is subject to the timing and formula provisions of Rule

803

responsible for the Monthly Adjustment and deficit amounts if the member

has open positions at any time during the month with respect to which ICE Trust calculates and demands

these amounts. Rule 801. A Retiring Participant’s obligations remain outstanding until ICE Trust’s return

of a Retiring Participant’s Fund contribution, which is subject to the timing and formula provisions of Rule

803.

25 The Bank, as a Retiring Participant, would continue to monitor its activities pursuant to its risk

management framework (see text below under Safety and Soundness) in order, among other things, to

ensure that the Required Contribution and Additional Assessment did not exceed the Bank’s lending limit

at the time advances of funds are made to ICE Trust. 12 U.S.C. § 84 and 12 C.F.R. Part 32.

26 Rule 801.

4

owed by or to each member.27 ICE Trust will apply all amounts collected from members

who owe ICE Trust a net amount under the Wound-up Contracts, plus all available

amounts in the Fund, to pay all net amounts owed by ICE Trust to members under the

Wound-up Contracts, subject to ICE Trust’s limits on liability.28 29

ICE Trust will return a Retiring Participant’s Fund contribution minus any portion used

to cover the obligations of a defaulting member or in connection with Wound-up

Contracts.30

A defaulting member’s obligations remain a liability of the member and related

guarantor, which ICE Trust may collect from the member’s margin, collateral or other

assets of such member or guarantor or by legal process.31 If ICE Trust recovers funds

from a defaulting member, it is obligated to repay contributions paid by the clearing

members, as reflected in steps (4) through (6) below, subject to the following payment

priority: (1) to costs and expenses (including legal fees and expenses related to

collection); (2) to certain related unreimbursed costs and expenses (e.g., costs and

expenses of sale, opens positions, closing out) (Rule 802(a)); (3) to any deficiencies

owed to members under

ibutions paid by the clearing

members, as reflected in steps (4) through (6) below, subject to the following payment

priority: (1) to costs and expenses (including legal fees and expenses related to

collection); (2) to certain related unreimbursed costs and expenses (e.g., costs and

expenses of sale, opens positions, closing out) (Rule 802(a)); (3) to any deficiencies

owed to members under Wound-up Contracts (Rule 804); (4) to members and ICE Trust

for contributions to the Fund that were charged for the defaulting member’s deficiency

under Rule 802(b)(iv) (whether or not the member remains a member at the time of

collection), first to members to the extent they were charged after the ICE Trust Default

Maximum was reached and thereafter to the members and ICE Trust, in proportion and

up to the amount each was charged; (5) to the members whose contributions were

charged for the deficiency under Rule 802(b)(iii) in proportion and up to the amount of

the charge, and (6) to ICE Trust and any member whose contribution was charged for the

deficiency under Rule 802(b)(ii) (whether or not such members remain members at the

time of collection) in proportion and up to the amount each was charged, (7) to ICE Trust

for and up to the amount of the charge against the ICE Trust Priority Contribution,

provided that ICE Trust contributes any amount recovered to the Fund for credit to the

27 Rule 804(a).

28 Id. Under Rule 312, ICE Trust’s liability for member contract obligations is limited to amounts on

deposit with the Fund (subject to Additional Assessment limits), the ICE Trust Priority Contribution, the

ICE Trust Pro Rata Contribution (including such unpaid amounts up to the ICE Trust Default Maximum,

which is no more than $50 million per the calculation under Rule 802(b)(v)), and any amount ICE Trust

collects from a member or the member’s guarantor for its obligations or Wound-up contracts

eposit with the Fund (subject to Additional Assessment limits), the ICE Trust Priority Contribution, the

ICE Trust Pro Rata Contribution (including such unpaid amounts up to the ICE Trust Default Maximum,

which is no more than $50 million per the calculation under Rule 802(b)(v)), and any amount ICE Trust

collects from a member or the member’s guarantor for its obligations or Wound-up contracts. ICE Trust’s

liability to a member for contract obligations may not exceed the aggregate amount paid to ICE Trust by a

member within the twelve-month period preceding any claim therefore.

29 ICE Trust and any Retiring Participant may agree to establish a new general guarantee fund and have

ICE Trust accept for clearing, replacements for some or all of the Wound-up Contracts. Rule 804(b).

30 The timing of ICE Trust’s return of a Retiring Participant’s Fund contribution is determined under the

formula set forth in Rule 803.

31 Rule 802(c).

5

ICE Trust Priority Contribution, and (8) the payment of any of the defaulting member’s

other obligations.32

Discussion

For the reasons discussed below, we believe a national bank has authority to become an

ICE Trust clearing member under the NBA, provided the bank, prior to becoming a

member, establishes a comprehensive risk management framework to govern the risks

associated with membership as described below, and receives a written supervisory no-

objection letter from its EIC. Banks must limit their exposures to ICE Trust to amounts

equal to or below their Section 84 limits, as discussed below

CE Trust clearing member under the NBA, provided the bank, prior to becoming a

member, establishes a comprehensive risk management framework to govern the risks

associated with membership as described below, and receives a written supervisory no-

objection letter from its EIC. Banks must limit their exposures to ICE Trust to amounts

equal to or below their Section 84 limits, as discussed below.

National Bank Act

The NBA permits national banks to engage in foreign and domestic clearing activities,

subject to safety and soundness limitations, as activities that are part of the business of

banking because the activities are functionally equivalent to bank permissible credit and

financial intermediation activities.33 The NBA also permits national banks to provide

default fund contributions to clearinghouses as bank permissible guaranties and as

activities incidental to bank permissible activities.

Clearing is a form of extending credit, one of the main functions of banking

institutions.34 A clearing agent substitutes its credit for that of its customers. A clearing

agent is liable to a clearinghouse for performance on all submitted contracts, and

assumes, with respect to the clearinghouse, the risk of other member defaults. The

clearing function also is akin to two other traditional bank credit functions: providing

bankers’ acceptances and letters of credit.35 The credit function provided by the Bank in

its clearing capacity is part of the business of banking because a principal busine

36

ss of a

ank is to extend credit.

ole of

,

b

National bank clearing activities also are functionally consistent with the primary r

banks as financial intermediaries. The role of a bank is to act as an intermediary,

facilitating the flow of money and credit among different parts of the economy.37 The

role of a bank intermediary takes many forms: providing payments transmission services

32 Id.

33 See, e.g. OCC Interpretive Letter No

National bank clearing activities also are functionally consistent with the primary r

banks as financial intermediaries. The role of a bank is to act as an intermediary,

facilitating the flow of money and credit among different parts of the economy.37 The

role of a bank intermediary takes many forms: providing payments transmission services

32 Id.

33 See, e.g. OCC Interpretive Letter No. 1014 (Jan. 10, 2005) (“IL No. 1014”); IL No. 929 (Feb. 11, 2002)

(“IL No. 929”); and OCC Interpretive Letter No. 494 (Dec. 29, 1989) (“IL No. 494”).

34 Id.

35 Id.

36 Id.

37 See, e.g., OCC No-Objection Letter No. 90-1 (Feb. 16, 1990) and OCC No-Objection Letter No. 87-5

(July 20, 1977).

6

borrowing from savers and lending to users, and participating in the capital markets,

here. As the recognized intermediaries between other, non-bank participants in th

financial markets and the payment systems, banks possess the expertise to make

exchanges of payments and securities betwee

as

e

n, and settle transactions for, parties and to

anage their own intermediation position.38

ng

and

e

or

ank has a substantial interest in the

erformance of the transaction involved.”41

of

de

antee as a condition to ICE Trust membership, subject to the limits described

elow.

m

A long line of OCC precedents support the conclusion that the Bank’s proposed cleari

services are within the legally authorized powers of national banks.39 Moreover, the

OCC has permitted national banks and their foreign branches to join clearinghouses

other entities that require members to cover a portion of the losses arising from th

default of other members, as bank permissible guaranties, where the bank had a

substantial interest in being a member and its liability was de minimis or limited, and did

not exceed Section 84 or lower EIC-established limits.40 Under 12 C.F.R

tted national banks and their foreign branches to join clearinghouses

other entities that require members to cover a portion of the losses arising from th

default of other members, as bank permissible guaranties, where the bank had a

substantial interest in being a member and its liability was de minimis or limited, and did

not exceed Section 84 or lower EIC-established limits.40 Under 12 C.F.R. § 7.1017(a), a

national bank is permitted to guarantee the obligations of another party if the bank has a

substantial interest of its own in the transaction. This regulation provides, in part, that

“[a] national bank may lend its credit, bind itself as a surety to indemnify another,

otherwise become a guarantor . . . if: (a) The b

p

Here, the Bank has a substantial interest in agreeing to cover a portion of the losses

defaulting ICE Trust clearing members where this obligation is an integral part of

permissible clearing activities. The Bank seeks to become an ICE Trust clearing member

as an effective and efficient means of clearing CDS trades. The Bank must agree to

cover a portion of the losses of defaulting clearing members as a condition of ICE Trust

clearing membership. Thus, the Bank has a substantial interest in committing to provi

the guar

b

38 See OCC Interpretive Letter 892 (Sept. 8, 2000).

39 See, e.g., Unpublished Letter (Dec. 13, 1995) (national bank membership in Exchange Clearing House

Limited (ECHO)); OCC Operating Subsidiary Notice Application Control No. 94-ML-08-00002 (Sept. 21,

1994) (national bank clearing membership in SIMEX); IL No. 494, supra (national bank and operating

subsidiary as exchange clearing member); OCC Interpretive Letter No. 422 (Apr. 11, 1988 (national bank

and operating subsidiary clearing and exchange memberships); OCC Interpretive Letter No. 384 (May 18,

1987) (same); OCC Interpretive Letter No. 380 (Dec. 29, 1986); (execution, clearance, and exchange

membership); and OCC Interpretive Letter No. 372 (Nov. 7, 1986) (same).

40 See, e.g

ating

subsidiary as exchange clearing member); OCC Interpretive Letter No. 422 (Apr. 11, 1988 (national bank

and operating subsidiary clearing and exchange memberships); OCC Interpretive Letter No. 384 (May 18,

1987) (same); OCC Interpretive Letter No. 380 (Dec. 29, 1986); (execution, clearance, and exchange

membership); and OCC Interpretive Letter No. 372 (Nov. 7, 1986) (same).

40 See, e.g. OCC Interpretive Letter No. 1071 (Sept. 6, 2006) (“IL No. 1071”) and IL Nos. 1014 and 929,

supra.

41 12 C.F.R. § 7.1017(a). A nexus between a bank permissible transaction and a guaranty may provide the

“substantial interest” for the bank. See, e.g., IL No. 929, supra (bank’s provision of a default fund

contribution/guaranty was incidental to the business of bank’s clearing and execution activities and

satisfied substantial interest needed for issuance of a guarantee) and OCC Interpretive Letter No. 376 (Oct.

25, 1986) (national bank’s guarantee of third party securities borrowers’ conduct was incidental to the

bank’s securities lending program and constituted a sufficient substantial interest).

7

OCC precedent also clearly establishes that national banks may contribute to funds to

guarantee the potential losses of others, in order to engage in bank permissible activities

where the bank’s potential liability for the defaults of others is limited. For example, in

IL No. 929, the OCC found it permissible for a national bank, via its foreign bran

contribute to a foreign clearinghouse’s default fund in order to clear bank permissible

derivative contracts where the liability for other member defaults was limited.

,

ch, to

e

se

ause the bank could limit its liability and the bank had a substantial

terest in contributing to the default fund so that it could engage in bank permissible

se

ng

g

er

e losses of defaulting members was limited and that the bank had a substantial interest

s

order to clear bank permissible

derivative contracts where the liability for other member defaults was limited.

,

ch, to

e

se

ause the bank could limit its liability and the bank had a substantial

terest in contributing to the default fund so that it could engage in bank permissible

se

ng

g

er

e losses of defaulting members was limited and that the bank had a substantial interest

s.

ntial

an

integral part of ISO membership and the liability exposure was sufficiently limited where

42

Clearinghouse members were required to contribute to the default fund to cover losses

caused by any defaulting member. In the event of a member default, the clearinghouse

could seek additional contributions to the default fund by non-defaulting members. Th

non-defaulting members had the option of contributing the additional funds or resigning

their membership. Thus, the resignation option provided members the ability to limit

their liability for the default of other members to the member’s original default fund

contribution. The OCC found that the branch’s participation in the foreign clearinghou

was permissible bec

in

clearing activities.

The OCC also concluded that it was permissible for national banks to contribute to the

loss allocation system of a domestic clearinghouse as a condition to membership, where

liability for the losses of other members was limited.43 Clearinghouse members were

required to maintain clearing fund deposits in an account to be used by the clearinghou

to cover losses in the event of a member default. Any losses remaining after applying the

deposit could be allocated to non-defaulting members. In that event, a non-defaulting

member could either pay the amount of the loss or terminate its membership. If a netti

member terminated its membership, its loss allocation liability was limited to its clearin

fund deposit. As a result, a member national bank could limit its liability to its initial

required fund deposit

fter applying the

deposit could be allocated to non-defaulting members. In that event, a non-defaulting

member could either pay the amount of the loss or terminate its membership. If a netti

member terminated its membership, its loss allocation liability was limited to its clearin

fund deposit. As a result, a member national bank could limit its liability to its initial

required fund deposit. Thus, the OCC determined that a member’s obligation to cov

th

in providing the guaranty in order to engage in bank authorized clearing activitie

Similarly, the OCC permitted a national bank to become a member of domestic

independent systems operators (“ISOs”), which operate much like clearinghouses, to

execute bank permissible electricity derivative transactions.44 As a condition to

membership, the bank was to participate in a program that subjected members to pote

unlimited liability for any losses allocated to members arising from member defaults.

The ISOs had systems in place to mitigate the risk of additional assessments and the

bank’s exposure was subject to the limits of Section 84 as a legal matter.45 The OCC

determined that the bank had a substantial interest in covering such potential losses as

42 IL No. 929, supra.

43 IL No. 1014, supra.

44 IL No. 1071, supra.

45 The arrangement was also subject to any additional limits imposed by the bank’s EIC.

8

the ISO had risk of loss mitigants in place and the bank established risk management

systems and controls to estimate and maintain its potential liabilities within Section 84

mits or lower limits imposed by the EIC.

s

tion to

e

sessments, and could limit its exposure to the clearinghouse to its

ection 84 limits.

e

e size of

ce

ever,

rehensive risk

anagement framework addressing risks arising from these exposures

in place and the bank established risk management

systems and controls to estimate and maintain its potential liabilities within Section 84

mits or lower limits imposed by the EIC.

s

tion to

e

sessments, and could limit its exposure to the clearinghouse to its

ection 84 limits.

e

e size of

ce

ever,

rehensive risk

anagement framework addressing risks arising from these exposures.

afety and Soundness

nt

amework to measure and manage the risks arising from these exposures, including:

• Effective oversight by senior management;

nterparty

credit risk, at both inception of membership and an on-going basis;

li

Recently, in OCC Interpretive Letter No. 1102 (Oct. 14, 2008), the OCC determined that

a national bank had a substantial interest in joining a foreign clearinghouse as a custodian

clearing member, where clearing members were subject to potentially unlimited liability

for the defaults of other clearinghouse members. In the event that the clearing fund wa

not sufficient to cover a member default, the clearinghouse had the right to assess the

remaining balance against all members in proportion to each member’s contribu

the fund. While the by-laws, rules and regulations of the clearinghouse did not

specifically limit the Bank’s exposure to the clearinghouse, the OCC determined that a

national bank could join the clearinghouse where it had systems in place to mitigate th

risk of additional as

S

Based on all the foregoing, we conclude that it is permissible under the NBA for th

Bank to become a clearing member of ICE Trust, provided the Bank establishes a

comprehensive risk management framework and limits its exposures to ICE Trust to its

Section 84 limits or a lower exposure limit established by the EIC, in light of th

the Bank, the nature and volume of its activities, and the characteristics of the

clearinghouse.46 The Bank’s membership in ICE Trust should enable the Bank to redu

its counterparty credit risk and operational ri

k establishes a

comprehensive risk management framework and limits its exposures to ICE Trust to its

Section 84 limits or a lower exposure limit established by the EIC, in light of th

the Bank, the nature and volume of its activities, and the characteristics of the

clearinghouse.46 The Bank’s membership in ICE Trust should enable the Bank to redu

its counterparty credit risk and operational risk from derivatives transactions since the

clearinghouse will act as a central counterparty and net members’ positions. How

because each member assumes obligations to cover losses from other defaulting

members, membership also can create a complex, contingent forward credit exposure.

Accordingly, prior to joining ICE Trust, the Bank should establish a comp

m

S

When national banks join clearinghouses or exchanges that impose liability on members

for other members’ defaults, banks should implement a comprehensive risk manageme

fr

• Policies and procedures that identify and quantify the level(s) of cou

46 Under the lending limit, 12 U.S.C. § 84 and 12 C.F.R. Part 32, a national bank’s loans and extensions of

credit to one borrower are limited to 15 percent of the bank’s capital and surplus, subject to certain

exceptions and with the application of certain loan combination rules. Additionally, a bank’s credit

exposures must be consistent with safe and sound banking practices. Accordingly, the Bank must limit its

exposure to ICE Trust so that amounts of funds advanced as margin or Fund contributions do not exceed an

amount equal to, if not below, the Section 84 limits, in light of the size of the Bank, the nature and volume

of its activities, and the characteristics of the clearinghouse.

9

dit

exposures must be consistent with safe and sound banking practices. Accordingly, the Bank must limit its

exposure to ICE Trust so that amounts of funds advanced as margin or Fund contributions do not exceed an

amount equal to, if not below, the Section 84 limits, in light of the size of the Bank, the nature and volume

of its activities, and the characteristics of the clearinghouse.

9

• Limits and other controls on the level(s) of risk with respect to counterparty

credit, concentrations, and other relevant market factors;

• A systematic approach to capture exposure in the entire clearinghouse;

risk taken, and

demonstrate compliance with approved policies and limits; and

s to ensure the integrity of measurement, control, and

reporting systems.

olicies and Procedures

licies

.

ding

redit risk management, audit, legal, and compliance. Policies should include:

d roles and responsibilities for management of risks associated with

nge and clearinghouse risks so that the bank

ior to joining an exchange or clearinghouse;

plies with all membership requirements and other applicable

ntial risk exposure and ensuring compliance with board-

Annual reviews by internal audit to assess compliance with bank policies.

ue Diligence

r to

due

nd the quality of its risk management systems. At a minimum, this should include an:

• Regular reports that accurately present the nature and level(s) of

• Auditing procedure

P

Exchange and clearinghouse memberships should be governed by appropriate po

and procedures

mpliance with board-

Annual reviews by internal audit to assess compliance with bank policies.

ue Diligence

r to

due

nd the quality of its risk management systems. At a minimum, this should include an:

• Regular reports that accurately present the nature and level(s) of

• Auditing procedure

P

Exchange and clearinghouse memberships should be governed by appropriate po

and procedures. Bank policies should establish a formal process for approving

membership in a central counterparty, as well as ongoing monitoring of risk exposure

This process should include the necessary control and oversight functions, inclu

c

•

Clearly define

membership;

•

Guidelines on the types of exchanges and clearinghouses the bank may join;

•

A well-defined risk tolerance for excha

can establish meaningful risk limits;

•

A formal process for approval of membership in exchanges or clearinghouses;

•

A comprehensive due diligence review pr

•

An initial legal review by bank counsel;

•

Ongoing reviews by bank counsel to assess any changes in membership requirements

and ensure the bank com

limits and restrictions;

•

Periodic credit reviews of current memberships on exchanges and clearinghouses,

including monitoring of pote

approved credit limits; and

•

D

Banks should conduct a thorough due diligence of exchanges or clearinghouses prio

becoming a member. Banks should evaluate the credit assessment that the central

counterparty uses for its members, both at inception and on an ongoing basis. The

diligence should be of appropriate depth to enable bank management to develop a

thorough understanding of the operational framework of the exchange or clearinghouse,

a

10

horough due diligence of exchanges or clearinghouses prio

becoming a member. Banks should evaluate the credit assessment that the central

counterparty uses for its members, both at inception and on an ongoing basis. The

diligence should be of appropriate depth to enable bank management to develop a

thorough understanding of the operational framework of the exchange or clearinghouse,

a

10

•

in-depth knowledge of the central counterparty’s role, membership criteria and

it quality of the central counterparty;

ault-

gement practices, including

understanding of the regulatory requirements of the exchange or clearinghouse; and

ls, and management's expertise. The bank’s risk

lerance for concentrations and credit exposures to central counterparties should be

ich the

y

ngent risk exposure is changing as a

art of the process. Potential exposure should be monitored individually and in aggregate

n

y

s

to the exchange or

learinghouse arising from defaults of other members if at any time the cumulative

e a membership compliance review is conducted for

ach exchange or clearinghouse. This review should be conducted at inception and

presents that it has established a comprehensive risk management framework

addressing the risks associated with its membership in ICE Trust that satisfies the above

standards.

structure, corporate governance, and management team;

•

analysis of the cred

•

understanding of membership agreement and requirements, including the def

sharing protocol;

•

analysis of central counterparty credit risk mana

collateral, margin, and netting requirements;

•

analysis of settlement and default procedures;

•

analysis by legal counsel of any default-sharing precedents and any other applicable

limits or restrictions;

•

•

assessment of key risks associated with joining the exchange or clearinghouse

uirements, including the def

sharing protocol;

•

analysis of central counterparty credit risk mana

collateral, margin, and netting requirements;

•

analysis of settlement and default procedures;

•

analysis by legal counsel of any default-sharing precedents and any other applicable

limits or restrictions;

•

•

assessment of key risks associated with joining the exchange or clearinghouse.

Bank management should establish internal risk limits that are prudent in light of the

bank's financial condition, capital leve

to

reflected in policies and procedures.

Ongoing Monitoring and Reporting

Bank policies should require a periodic review of all central counterparties for wh

bank is a member. The policies should clearly define the scope and responsibilities for

conducting these reviews. Bank management should obtain accurate and timely

information from the exchange or clearinghouse to assess and monitor potential liabilit

based upon the bank’s level of activity and applicable laws, rules, and regulations. Bank

management should also keep abreast of changes in membership rules and in member

activity, on a periodic basis, to assess how its conti

p

for all exchange and clearinghouse memberships.

Bank management should develop contingency strategies to mitigate risks associated

with exchange or clearinghouse membership, including establishing risk triggers and a

approval process for executing contingency risk mitigation strategies. The contingenc

risk mitigation strategies should include internal limits when the bank must adjust it

activities to avoid exceeding limits on potential advances of funds

c

payments under its contingent obligations approach these limits.

Senior management should ensur

e

appropriate intervals thereafter.

The Bank re

11

approval process for executing contingency risk mitigation strategies. The contingenc

risk mitigation strategies should include internal limits when the bank must adjust it

activities to avoid exceeding limits on potential advances of funds

c

payments under its contingent obligations approach these limits.

Senior management should ensur

e

appropriate intervals thereafter.

The Bank re

11

Conclusion

We conclude that the Bank may participate as a clearing member of ICE Trust, provided

the Bank, prior to becoming a member, establishes a comprehensive risk management

framework to govern the risks associated with its membership as described above, and

receives a written supervisory no-objection letter from its EIC. Our conclusions are

specifically based on the Bank’s representations, and any change in facts or

circumstances could result in a different conclusion. If you have any questions

concerning this letter, please contact Tena M. Alexander, Senior Counsel, Securities and

Corporate Practices Division, at (202) 874-4625.

Sincerely,

signed

Julie L. Williams

First Senior Deputy Comptroller

And Chief Counsel

12