SEC Proposes Rules for Systemically Important and Security-Based Swap Clearing Agencies

FOR IMMEDIATE RELEASE
2014-49

Washington D.C., March 12, 2014 — The Securities and Exchange Commission voted today to propose new rules to enhance the oversight of clearing agencies that are deemed to be systemically important or that are involved in complex transactions, such as security-based swaps.

"Clearing agencies that have been designated as systemically important or that clear security-based swaps are a backbone of the U.S. financial markets," said SEC Chair Mary Jo White.  "The enhanced regulatory regime proposed today reflects the importance of effective regulation of these entities."

A securities clearing agency generally acts as a middleman between the parties to a securities transaction, performing a range of services important for the effective operation of the securities markets.  These services include, for example, ensuring that funds and securities are correctly transferred between parties and, in some cases, assuming the risks of a party defaulting on a transaction by acting as a "central counterparty."

The Dodd-Frank Wall Street Reform and Consumer Protection Act called for an enhanced regulatory framework for certain clearing agencies.  The SEC´s proposal would apply to SEC-registered clearing agencies that have been designated as systemically important by the Financial Stability Oversight Council or that take part in more complex transactions, such as clearing security-based swaps.

Clearing agencies covered by the proposed rules would be subject to new requirements regarding their financial risk management, operations, governance, and disclosures to market participants and the public.  The proposal also would establish procedures for the Commission to apply the new requirements to additional clearing agencies.

The public will have 60 days to comment on the proposed rules after their publication in the Federal Register.

###

FACT SHEET

Enhanced Regulatory Framework for Covered Clearing Agencies

SEC Open Meeting

March 12, 2014

Background

A securities clearing agency generally acts as a middleman between the parties to a securities transaction, performing a range of services important for the effective operation of the securities markets.  These services include, for example, ensuring that funds and securities are correctly transferred between parties and, in some cases, assuming the risks of a party defaulting on a transaction by acting as a "central counterparty."

The SEC has overseen clearing agencies since 1975, when Congress provided the SEC with broad authority to write rules governing clearing agencies under Section 17A of the Securities Exchange Act of 1934.

Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act enhanced the SEC´s authority to adopt rules addressing risk management standards for clearing agencies that have been designated systemically important by the Financial Stability Oversight Council (FSOC).  When a clearing agency is so designated, the SEC may become its "supervisory agency."  In 2012, FSOC designated six registered clearing agencies as systemically important. 

The SEC serves as the supervisory agency for four of those clearing agencies, and the CFTC serves as the supervisory agency for the remaining two.

In addition, Title VII of the Dodd-Frank Act also amended the Exchange Act to grant the SEC authority to write rules for registered clearing agencies that clear security-based swaps.

In 2012, the SEC adopted Rule 17Ad-22 under the Exchange Act, which established standards for the risk management and operation of registered clearing agencies.  The SEC´s proposal would build on Rule 17Ad-22 by subjecting certain clearing agencies to enhanced policies and procedures requirements concerning risk management, operations, governance, and disclosure. 

Scope of the Proposal


The SEC´s proposal would create more robust requirements for "covered clearing agencies," which would include:

• Clearing agencies designated systemically important by FSOC, for which the SEC acts as the supervisory agency under Title VIII
• Clearing agencies that provide central counterparty services for security-based swaps or are otherwise involved in activities with a more complex risk profile, unless they have been designated systemically important by FSOC and their supervisory agency under Title VIII is the CFTC
• Clearing agencies that the Commission determine to be covered clearing agencies.  Proposed Rule 17Ab2-2 would provide a framework for making such determinations.

The SEC´s proposal would create two tiers of regulations under Rule 17Ad-22: (1) enhanced rules for covered clearing agencies under Rule 17Ad-22(e); and (2) the existing rules for all other registered clearing agencies under Rule 17Ad-22(d).  The two tiers would provide flexibility for new entrants that might seek to operate as registered clearing agencies while applying enhanced requirements to those clearing agencies that raise systemic risk concerns due to, among other things, their size, systemic importance, global reach, or the risks inherent in the products they clear.

Overview of Proposed Requirements

Under proposed Rule 17Ad-22(e), a covered clearing agency would be required to establish, implement, maintain and enforce policies and procedures reasonably designed to address certain aspects of its risk management and operation:

• General organization (including legal basis, governance and comprehensive risk management framework)
• Financial risk management (including credit risk, collateral, margin, and liquidity risk)
• Settlement (including settlement finality, money settlements and physical deliveries)
• Central securities depositories and settlement systems
• Default management (including default rules and procedures and segregation and portability)
• Business and operational risk management (including general business risk, custody and investment risks and operational risk)
• Access (including access and participation requirements, tiered participation arrangements and links)
• Efficiency (including efficiency and effectiveness and communication procedures and standards)
• Transparency

While many of these requirements would reflect enhancements of the SEC´s existing oversight program for registered clearing agencies, several requirements would be newly specified in light of the nature and extent of the activities of covered clearing agencies. 

The significant new requirements in proposed Rule 17Ad-22(e) would be:

Governance and Comprehensive Risk Management

• Proposed Rule 17Ad-22(e)(2) would require policies and procedures establishing qualifications of members of boards of directors and senior management of covered clearing agencies.
• Proposed Rule 17Ad-22(e)(3) would require policies and procedures designed to ensure that risk management and internal audit personnel have sufficient authority, resources, independence from management, and access to the board to fulfill their functions effectively. The proposed rule would also require policies and procedures providing for an independent audit committee.


Financial Risk Management

• Liquidity Risk – Proposed Rule 17Ad-22(e)(7) would require policies and procedures to address holding "qualifying liquid resources" sufficient to withstand the default of the participant family that would generate the largest aggregate payment obligation in extreme but plausible market conditions.  Such resources could include (1) cash, (2) assets readily available and convertible into cash through prearranged funding arrangements, and (3) other assets readily available and eligible for pledging to a central bank (when the covered clearing agency has access to routine credit at a relevant central bank). A covered clearing agency would also be required to have specified policies and procedures to test the sufficiency of its qualifying liquid resources.  
• Credit Risk – Proposed Rule 17Ad-22(e)(4) would require policies and procedures regarding daily stress testing, monthly review and annual validation of credit risk models. 
• Margin – Proposed Rule 17Ad-22(e)(6) would require policies and procedures regarding marking positions to market, collecting margin at least daily, and conducting daily backtesting, monthly sensitivity analyses, and annual model validation.
• Collateral – Proposed Rule 17Ad-22(e)(5) would require policies and procedures regarding setting and enforcing appropriately conservative haircuts and concentration limits and subjecting them to annual review. 

General Business Risk

• Proposed Rule 17Ad-22(e)(15) would require a covered clearing agency to have policies and procedures that provide for holding liquid net assets funded by equity equal to at least six months of current operating expenses so that the covered clearing agency can continue operations during a recovery or wind-down.  The proposed rule also would require policies and procedures to maintain a viable plan – approved by the board of directors and updated at least annually – for raising additional equity should its equity fall close to or below the amount required.

Commission Determinations under Proposed Rule 17Ab2-2

Proposed Rule 17Ab2-2 would provide the Commission with procedures to make three kinds of determinations regarding registered clearing agencies:

• Whether a registered clearing agency should be considered a covered clearing agency
• Whether a covered clearing agency meets the definition of "systemically important in multiple jurisdictions"
• Whether the activities of a clearing agency providing CCP services have a more complex risk profile

The SEC´s proposal contemplates allowing such determinations to occur either at the Commission´s own initiative or upon request by either a clearing agency or one of its members.

In each case, the SEC would publish notice of its intention to consider such determinations, together with a brief statement of the grounds under consideration, and provide at least a 30-day public comment period prior to any determination.  The Commission also may provide a clearing agency the opportunity for a hearing in connection with the proposed determination. 

What´s Next

The Commission will seek public comment on the proposed rules for 60 days following publication in the Federal Register.  The Commission will then review the comments and determine whether to adopt final rules.