Daily Rules, Proposed Rules, and Notices of the Federal Government
The Commission is adopting rules for the operation of a registered clearing agency that identify minimum standards designed to enhance the regulatory framework for clearing agency supervision.
Congress directed the Commission to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of securities transactions when it added Section 17A to the Exchange Act as part of the Securities Acts Amendments of 1975.
The Commission used this experience with regulating clearing agencies to help address developments recently in the over-the-counter (“OTC”) derivatives markets. In December 2008, the Commission acted to facilitate the central clearing of credit default swaps (hereinafter referred to as “credit default swaps” or “CDS”), the largest category of OTC security-based swaps, by permitting certain entities that performed central counterparty (“CCP”) services to clear and settle credit default swaps on a temporary, conditional basis.
Section 17A of the Exchange Act
On July 21, 2010, President Barack Obama signed the Dodd-Frank Act into law.
Title VII of the Dodd-Frank Act (“Title VII”) provides the Commission and the Commodity Futures Trading Commission (“CFTC”) with enhanced authority to regulate certain OTC derivatives in response to the recent financial crisis.
Title VII was designed to provide greater certainty that, wherever possible and appropriate, swap and security-based swap contracts formerly traded exclusively in the OTC market are centrally cleared.
In addition to the provisions from Title VII that expand the Commission's authority under the Exchange Act to include activities related to security-based swaps, Title VIII of the Dodd-Frank Act, entitled the Payment, Clearing, and Settlement Supervision Act of 2010 (“Clearing Supervision Act”), establishes an enhanced supervisory and risk control system for systemically important clearing agencies and other financial market utilities (“FMUs”).
The definition of “financial institution,” which is contained in Section 803(5) of the Clearing Supervision Act, outlines numerous exclusions but defines financial institution as a branch or agency of a foreign bank, an organization operating under Section 25 or 25A of the Federal Reserve Act, a credit union, a broker or dealer, an investment company, an insurance company, an investment adviser, a futures commission merchant, commodity trading advisor or commodity pool operator and any company engaged in activities that are financial in nature or incidental to a financial activity. 12 U.S.C. 5462(5)(A).
Section 17A(i) of the Exchange Act provides that the Commission, in establishing clearing agency standards and in its oversight of clearing agencies, may conform such standards and such oversight to reflect evolving international standards.
The Board applies these standards in its supervisory process and expects systemically important systems, as determined by the Board and subject to its authority, to complete a self-assessment against the standards set forth in the policy.
On March 3, 2011, the Commission proposed for comment a series of rules related to standards for the operation and governance of clearing agencies (“Proposing Release”).
(1) Proposed Rule 17Ad-22, which would require certain minimum standards for all clearing agencies registered with the Commission;
(2) Proposed Rule 17Aj-1, which would require dissemination of pricing and valuation information by security-based swap CCPs;
(3) Proposed Rule 17Ad-23, which would require all clearing agencies to have adequate safeguards and procedures to protect the confidentiality of trading information of clearing agency participants;
(4) Proposed Rule 17Ad-24, which would exempt certain security-based swap dealers and security-based swap execution facilities from the definition of clearing agency;
(5) Proposed Rule 17Ab2-1, which would amend an existing Commission rule concerning registration of clearing agencies to account for security-based swap clearing agencies and to make other technical changes;
(6) Proposed Rule 17Ad-25, which would require all clearing agencies to have procedures that identify and address conflicts of interest;
(7) Proposed Rule 17Ad-26, which would require clearing agencies to set standards for all members of their boards of directors or committees; and
(8) Proposed Rule 3Cj-1, which is modeled on Section 3C(j) of the Exchange Act and would require all clearing agencies to designate a chief compliance officer.
The Commission also noted in the Proposing Release that the definition of clearing agency under Section 3(a)(23)(A) of Exchange Act includes any person who:
• Acts as an intermediary in making payments or deliveries or both in connection with transactions in securities;
• Provides facilities for the comparison of data regarding the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities;
• Acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry, without physical delivery of securities certificates (such as a securities depository); or
• Otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates (such as a securities depository).
Since the publication of the Proposing Release, the Commission has received 25 comment letters on the Proposing Release from a broad range of market participants, and the Commission and staff also had discussions with representatives of clearing agencies, trade associations, public interest groups and other interested parties.
After careful review and consideration of the comments, the Commission is today adopting Rule 17Ad-22, with certain modifications discussed below, to address comments received. As adopted, Rule 17Ad-22 is meant to establish minimum requirements for registered clearing agency risk management practices and operations with due consideration given to equivalent standards of other regulators in the United States
The Proposing Release was published in the
Set forth below is a description of the comments received by the Commission that express concerns about the general approach to clearing agency reform reflected in the Proposing Release. The Commission has carefully considered these general comments that were provided concerning the larger framework for our rule making efforts involving clearing agencies.
Three commenters asked for the implementation of the proposed rules to be subject to appropriate phase-in periods.
One commenter asked the Commission to publish any modifications it may make to the proposed rules for an additional comment period.
One commenter stated that clearing agency rules such as those related to governance, conflicts of interest, registration, and financial resources should be adopted early in the implementation of rules for the security-based swap market.
In light of the request by commenters for a phased approach to implementation of the clearing agency standards set forth in the Proposing Release,
• In the first stage, the Commission is adopting only Rule 17Ad-22. The compliance date for Rule 17Ad-22 will be sixty days from publication in the
• The second planned stage in the implementation of standards for clearing agencies is the consideration by the Commission of rules that correspond to proposed Rules 17Aj-1; 17Ad-23; 17Ad-24; 17Ab2-1 and 3Cj-1 as well as the clearing agency governance and conflict of interest concerns that its previous proposal addressed through its proposal of Rule 17Ad-25, Rule 17Ad-26 and Regulation MC.
• The third planned stage is for the Commission to consider rules tailored to clearing agencies that perform certain post-trade processing services. The Commission sought comment concerning these types of clearing agencies in the Proposing Release and preliminarily intends to propose rules addressed to them as described in more detail in Sections II.B.4 and III.A below. As appropriate, the Commission may
The Commission believes the phased approach to implementation provides clearing agencies with the benefit of additional time with respect to some of the requirements contemplated in the Proposing Release, while putting into place minimum standards for operational and risk management practices of registered clearing agencies. This approach will allow the Commission to consider further the comments received on the Proposing Release and evolution of clearance and settlement activity in light of the requirements of Title VII and Title VIII of the Dodd-Frank Act, including the implementation of the mandatory clearing requirements with respect to security-based swaps mandated by the Dodd-Frank Act. Because the Commission is adopting 17Ad-22 largely as proposed, the Commission is not republishing Rule 17Ad-22 for additional comments.
We believe that the implementation of these standards is an important first step in crafting regulatory changes contemplated by Title VII and Title VIII of the Dodd-Frank Act as intended by Congress. The adoption of Rule 17Ad-22 will also allow the Commission to coordinate its activities as the supervisory agency for clearing agencies designated as systemically important financial market utilities under Title VIII of the Dodd-Frank Act with the complementary responsibilities of the Federal Reserve.
Generally, commenters supported the requirements of proposed Rules 17Ad-22(b)(1)-(4) that would govern the risk management standards and practices of registered clearing agencies that perform CCP services or CCPs.
For instance, proposed Rule 17Ad-22(b)(1) would require a CCP to establish, implement, maintain and enforce written policies and procedures reasonably designed to measure credit exposures to participants at least once a day and limit exposures to potential losses from defaults by its participants in normal market conditions so that the operations of the clearing agency would not be disrupted and non-defaulting participants would not be exposed to losses that they cannot anticipate or control. Of those commenters who asked the Commission to consider modifications to the proposed rule, two suggested that public disclosure requirements should accompany any choice made by a CCP to reduce margin requirements on the basis of an inverse or offsetting correlation between participants' positions.
Proposed Rule 17Ad-22(b)(2) would require a CCP to establish, implement, maintain and enforce written policies and procedures reasonably designed to use margin requirements to limit its credit exposures to participants under normal market conditions and use risk-based models
With respect to proposed Rule 17Ad-22(b)(3), commenters asked the Commission to give further consideration to whether it is appropriate to create different financial resources standards for a security-based swap CCP. As proposed, the rule would require a CCP to establish, implement, maintain and enforce written policies and procedures reasonably designed to maintain sufficient financial resources to withstand, at a minimum, a default by the participant to which it has the largest exposure in extreme but plausible market conditions, provided that a security-based swap clearing agency would be required to maintain sufficient financial resources to withstand, at a minimum, a default by the two participants to which it has the largest exposures in extreme but plausible market conditions. One commenter argued that characteristics of the instruments traded in the security-based swap market support differentiating the requirements of the rule
Similarly, some commenters asked the Commission to reconsider how prescriptive it should be in its approach to the requirements of Rule 17Ad-22(b)(4).
A more complete discussion of these comments and others that pertain to Rules 17Ad-22(b)(1)-(4) is contained in Section III.C below.
The Commission acknowledges the many thoughtful comments we received regarding the risk management standards and practices reflected in the Proposing Release and agrees that the topic deserves particular care and attention.
• Many of the risk management standards and practices underlying proposed Rule 17Ad-22 require relatively significant judgments to be made and at times there are no established or definitive sources of guidance to aid decision-making. Therefore, for a CCP's risk management practices to be most effective, the CCP must have some degree of flexibility to tailor the practices appropriately to meet the demands of the specific financial markets it serves, and the Commission's interpretation of Rule 17Ad-22 should not be rigidly applied as uniform standards without variation.
• The specific risk management practices most appropriate for any individual CCP and for registered clearing agencies generally are unlikely to remain static.
For example, the Commission recognizes that a less prescriptive approach can help promote efficient practices and encourage regulated entities to consider how to manage their regulatory obligations and risk management practices in a wa