Proposed Rule2022-17316
Clearing Agency Governance and Conflicts of Interest
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Published
August 23, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is proposing rules under the Securities Exchange Act of 1934 ("Exchange Act") to help improve the governance of clearing agencies registered with the Commission ("registered clearing agencies") by reducing the likelihood that conflicts of interest may influence the board of directors or equivalent governing body ("board") of a registered clearing agency. The proposed rules would identify certain responsibilities of the board, increase transparency into board governance, and, more generally, improve the alignment of incentives among owners and participants of a registered clearing agency. In support of these objectives, the proposed rules would establish new requirements for board and committee composition, independent directors, management of conflicts of interest, and board oversight.
Full Text
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<title>Federal Register, Volume 87 Issue 162 (Tuesday, August 23, 2022)</title>
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[Federal Register Volume 87, Number 162 (Tuesday, August 23, 2022)]
[Proposed Rules]
[Pages 51812-51857]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-17316]
[[Page 51811]]
Vol. 87
Tuesday,
No. 162
August 23, 2022
Part III
Securities and Exchange Commission
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17 CFR Part 240
Clearing Agency Governance and Conflicts of Interest; Proposed Rule
Federal Register / Vol. 87, No. 162 / Tuesday, August 23, 2022 /
Proposed Rules
[[Page 51812]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 242
[Release No. 34-95431; File No. S7-21-22]
RIN 3235-0695
Clearing Agency Governance and Conflicts of Interest
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule; partial withdrawal of proposed rule; withdrawal
of applicability of proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing rules under the Securities Exchange Act of 1934 (``Exchange
Act'') to help improve the governance of clearing agencies registered
with the Commission (``registered clearing agencies'') by reducing the
likelihood that conflicts of interest may influence the board of
directors or equivalent governing body (``board'') of a registered
clearing agency. The proposed rules would identify certain
responsibilities of the board, increase transparency into board
governance, and, more generally, improve the alignment of incentives
among owners and participants of a registered clearing agency. In
support of these objectives, the proposed rules would establish new
requirements for board and committee composition, independent
directors, management of conflicts of interest, and board oversight.
DATES: As of August 23, 2022, SEC withdraws amendatory instructions # 7
and 8 (Sec. Sec. 240.17Ad-25 and 240.17Ad-26 in Release No. 34-64017),
published at 76 FR 14472 on March 16, 2011. Also as of August 23, 2022,
SEC withdraws the applicability of the proposed rule published at 75 FR
65881 on October 26, 2010 (Release No. 34-63107) as it pertained to
clearing agencies.
Comments on this proposal should be received on or before October
7, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#9ae8eff6ffb7f9f5f7f7fff4eee9dae9fff9b4fdf5ec"><span class="__cf_email__" data-cfemail="4a383f262f67292527272f243e390a392f29642d253c">[email protected]</span></a>. Please include
File Number S7-21-22 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-21-22. This file
number should be included on the subject line if email is used. To help
us process and review your comments more efficiently, please use only
one method. The Commission will post all comments on the Commission's
website (<a href="https://www.sec.gov/rules/proposed.shtml">https://www.sec.gov/rules/proposed.shtml</a>). Comments are also
available for website viewing and printing in the Commission's Public
Reference Room, 100 F Street NE, Washington, DC 20549, on official
business days between the hours of 10 a.m. and 3 p.m. Operating
conditions may limit access to the Commission's public reference room.
All comments received will be posted without change. Persons submitting
comments are cautioned that we do not redact or edit personal
identifying information from comment submissions. You should submit
only information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Matthew Lee, Assistant Director,
Stephanie Park, Senior Special Counsel, Claire Noakes, Special Counsel,
or Tanin Kazemi, Attorney-Adviser, Office of Clearance and Settlement
at (202) 551-5710, Division of Trading and Markets, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is withdrawing the following
proposed rules under the Exchange Act: Regulation MC as proposed for
security-based swap clearing agencies,\1\ and rules proposed for
clearing agencies at 17 CFR 240.17Ad-25 (``Rule 17Ad-25'') and
240.17Ad-26 (``Rule 17Ad-26'').\2\ In their place, the Commission is
proposing a new Rule 17Ad-25 to mitigate conflicts of interest, promote
the fair representation of owners and participants in the governance of
a clearing agency, identify responsibilities of the board, and increase
transparency into clearing agency governance.
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\1\ Exchange Act Release No. 63107 (Oct. 14, 2010), 75 FR 65882
(Oct. 26, 2010) (``Regulation MC Proposing Release'').
\2\ Exchange Act Release No. 64017 (Mar. 3, 2011), 76 FR 14471
(Mar. 16, 2011) (``Clearing Agency Standards Proposing Release'')
(proposing Rules 17Ad-25 and 17Ad-26).
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The Commission is also mindful of the differing perspectives that
exist at registered clearing agencies among stakeholders, including
owners and participants (some of whom also are clearing agency owners),
small and large participants, and direct participants (who are clearing
members) and indirect participants.\3\ Proposed Rule 17Ad-25 would
establish new requirements for clearing agency boards to address and
mitigate conflicts of interest and to help ensure more effective
oversight of the clearing agency by the board. The Commission believes
these requirements would help ensure that a clearing agency's
governance arrangements can more effectively manage these different
perspectives so that the clearing agency can, among other things, help
ensure that the design and implementation of risk management decisions
are effective. Specifically, the proposed rule would: (i) define
independence in the context of a director serving on the board of a
registered clearing agency and require that a majority of directors on
the board be independent, unless a majority of the voting rights
distributed to shareholders of record are directly or indirectly held
by participants of the registered clearing agency, in which case at
least 34 percent of the board must be independent directors; (ii)
establish requirements for a nominating committee, including with
respect to the composition of the nominating committee, fitness
standards for serving on the board, and documenting the process for
evaluating board nominees; (iii) establish requirements for the
function, composition, and reconstitution of the risk management
committee; (iv) require policies and procedures that identify, mitigate
or eliminate, and document the identification and mitigation or
elimination of conflicts of interest; (v) require policies and
procedures that obligate directors to report potential conflicts
promptly; (vi) require policies and procedures for the board to oversee
relationships with service providers for critical services; and (vii)
require policies and procedures to solicit, consider, and document the
registered clearing agency's consideration of the views of its
participants and other
[[Page 51813]]
relevant stakeholders regarding its governance and operations.
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\3\ Examples of indirect participants might be entities such as
customers or clients of direct participants or clearing members
since they rely on services provided by a direct participant to
access the services of the clearing agency.
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Table of Contents
I. Introduction
II. Background
A. Differing Perspectives at Registered Clearing Agencies
B. Regulatory Framework for Registered Clearing Agencies
C. Risks Associated with Clearance and Settlement
III. Proposed Rules
A. Board Composition and Requirements for Independent Directors
B. Nominating Committee
C. Risk Management Committee
D. Conflicts of Interest
E. Board Obligation to Oversee Service Providers for Critical
Services
F. Obligation to Formally Consider Stakeholder Viewpoints
G. Considerations Related to Implementation and Compliance
H. General Request for Comment
IV. Economic Analysis
A. Introduction
B. Economic Baseline
C. Consideration of Benefits and Costs
D. Reasonable Alternatives to the Proposed Rule
E. Request for Comment
V. Paperwork Reduction Act
A. Rule 17Ad-25(b)
B. Rule 17Ad-25(c)
C. Rule 17Ad-25(d)
D. Rule 17Ad-25(g)
E. Rule 17Ad-25(h)
F. Rule 17Ad-25(i)
G. Rule 17Ad-25(j)
H. Chart of Total PRA Burdens
I. Request for Comment
VI. Small Business Regulatory Enforcement Fairness Act
VII. Regulatory Flexibility Act Certification
A. Registered Clearing Agencies
B. Certification
VIII. Statutory Authority and Text of Proposed Rule
I. Introduction
Clearing agencies registered with the Commission play an important
role in the securities markets. They help ensure the prompt and
accurate clearance and settlement of securities transactions, including
the transfer of record ownership and the safeguarding of securities and
related funds, which has the effect of protecting investors and persons
facilitating transactions by and acting on behalf of investors.\4\ As
such, Section 17A of the Exchange Act requires that, before an entity
provides clearing agency services, it must register with the
Commission.\5\ Under the Commission's supervision, registered clearing
agencies, as self-regulatory organizations (``SROs'') under Section 19
of the Exchange Act,\6\ must submit to the Commission changes to their
rules for review and approval or to be deemed immediately effective
upon filing.\7\
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\4\ See 15 U.S.C. 78q-1(a)(1)(A); see, e.g., Committee on
Payment and Settlement Systems and Technical Committee of the
International Organization of Securities Commissions, Principles for
financial market infrastructures (Apr. 16, 2012), at 5 (``PFMI''),
<a href="http://www.bis.org/publ/cpss101a.pdf">http://www.bis.org/publ/cpss101a.pdf</a> (stating that financial market
infrastructures (``FMIs''), which include clearing agencies like
central counterparties (``CCPs'') and central securities
depositories (``CSDs''), ``[w]hile safe and efficient . . .
contribute to maintaining and promoting financial stability and
economic growth, FMIs also concentrate risk. If not property
managed, FMIs can be sources of financial shocks, such as liquidity
dislocations and credit losses, or a major channel through which
these shocks are transmitted across domestic and international
financial markets'').
\5\ See 15 U.S.C. 78q-1(a)(2); see also 17 CFR 240.17Ab2-1.
\6\ Upon registration, registered clearing agencies are SROs
under Section 3(a)(26) of the Exchange Act. See 15 U.S.C.
78c(a)(26).
\7\ Except for certain rule changes that do not need approval,
set forth in 17 CFR 240.19b-4(f), an SRO must submit proposed rule
changes to the Commission for review and approval pursuant to Rule
19b-4 under the Exchange Act. A stated policy, practice, or
interpretation of an SRO, such as its written policies and
procedures, would generally be deemed to be a proposed rule change.
See 15 U.S.C. 78s(b)(1); 17 CFR 240.19b-4.
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Given the important role of clearing agencies in the U.S. financial
system, the governance framework of each clearing agency is an integral
part in helping to ensure that the clearing agency is resilient and
strong. A transparent and reliable governance framework has a positive
and lasting cascading effect: Through the decision-making of the
clearing agency and to its effective and efficient supervision. From
the outset, an ideal governance framework that establishes a clear and
deliberative process would have the clearing agency consider a range of
stakeholder views as part of its rules and risk management practices,
resulting in more thorough and robust SRO rule proposals for the
Commission to consider in supervising the clearing agency. In essence,
improved governance would help promote optimum practices for all
registered clearing agencies to follow to help ensure that their
processes and decisions are clear, transparent, and reliable, that
risks are appropriately monitored, addressed, and managed, and that
their leadership is competent and accountable. When these fundamental
guiding principles on governance influence and permeate a clearing
agency's culture and operations, the clearing agency will instill
confidence in its participants, the markets, and the investing public,
thereby meeting and promoting the policy objectives in Section 17A of
the Exchange Act regarding the prompt and accurate clearance and
settlement of securities transactions, among other objectives.\8\
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\8\ See 15 U.S.C. 78q-1(a)(1)(A)-(D); see also Exchange Act
Release No. 68080 (Oct. 22, 2012), 77 FR 66219, 66252 (Nov. 2, 2012)
(``Clearing Agency Standards Adopting Release'') (noting that
``[g]overnance arrangements have the potential to play an important
role in making sure that clearing agencies fulfill the Exchange Act
requirements that the rules of a clearing agency be designed to
protect investors and the public interest and to support the
objectives of owners and participants. Similarly, governance
arrangements may promote the effectiveness of a clearing agency's
risk management procedures by creating an oversight framework that
fosters a focus on the critical role that risk management plays in
promoting prompt and accurate clearance and settlement'').
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The Commission has previously stated that clear and transparent
governance arrangements help promote accountability and reliability in
the decisions, rules and procedures of the clearing agency because they
provide interested parties (such as owners, direct and indirect
participants, and general members of the public) with information about
how such decisions are made and what the rules and procedures are
designed to accomplish.\9\ In turn, clear and transparent governance
arrangements help optimize the clearing agency's decisions, rules and
procedures that the Commission considers in the SRO rule filing process
because clearing agency transparency improves the quality of the
information shared with stakeholders, which in turn improves the public
comments submitted in response to rule filings. While the business
models of clearing agencies vary and include entities that are
affiliates of publicly traded companies and entities that function as
participant-owned utilities, the key components of a clearing agency's
governance arrangements include the
[[Page 51814]]
clearing agency's ownership structure, the composition and role of its
board, the structure and role of board committees, reporting lines
between management and the board, and the processes that help ensure
management is held accountable for the clearing agency's
performance.\10\ Regardless of the business model, the clearing agency
is more effective when it has governance arrangements that accomplish
the following: (1) help ensure that the clearing agency satisfies the
Exchange Act requirements and Commission rules that are designed to
protect investors and the public interest; and (2) support the
objectives of the clearing agency's owners, direct participants, and
indirect participants.\11\
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\9\ See Clearing Agency Standards Proposing Release, supra note
2, at 14488 (``Clear and transparent governance arrangements promote
accountability and reliability in the decisions, rules and
procedures of the clearing agency because they provide interested
parties (such as owners, participants, and general members of the
public) with information about how such decisions are made and what
the rules and procedures are designed to accomplish. The key
components of a clearing agency's governance arrangements include
the clearing agency's ownership structure, the composition and role
of its board, the structure and role of board committees, reporting
lines between management and the board, and the processes that
ensure management is held accountable for the clearing agency's
performance. Governance arrangements have the potential to play an
important role in making sure that clearing agencies fulfill the
Exchange Act requirements that the rules of a clearing agency be
designed to protect investors and the public interest and to support
the objectives of owners and participants. Similarly, governance
arrangements may promote the effectiveness of a clearing agency's
risk management procedures by creating an oversight framework that
fosters a focus on the critical role that risk management plays in
promoting prompt and accurate clearance and settlement.'').
\10\ See id. at 66269.
\11\ See id. at 66252.
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In recognizing the implications that a robust governance framework
has on the operations of clearing agencies, the Commission adopted a
series of clearing agency governance requirements. In 2012, the
Commission adopted a general governance rule for all registered
clearing agencies (that are not covered clearing agencies) under Rule
17Ad-22(d).\12\ In 2016, the Commission adopted a governance rule under
Rule 17Ad-22(e) as part of its heightened standards for covered
clearing agencies, defined as a registered clearing agency that
provides the services of a central counterparty or central securities
depository.\13\ The Commission took a broad, principles-based approach
in the design of both rules, and emphasized that governance remains an
area of continued consideration and interest, with the goal of
establishing an evolving regulatory framework for clearing
agencies.\14\
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\12\ See 17 CFR 240.17Ad-22(d)(8) (requiring that all registered
clearing agencies aside from covered clearing agencies establish,
implement, maintain and enforce written policies and procedures
reasonably designed to have governance arrangements that are clear
and transparent to fulfill the public interest requirements in
Section 17A of the Exchange Act, to support the objectives of owners
and participants, and to promote the effectiveness of the clearing
agency's risk management procedures).
\13\ See 17 CFR 240.17Ad-22(e)(2) (requiring a covered clearing
agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to provide for
governance arrangements that are clear and transparent, clearly
prioritize the safety and efficiency of the covered clearing agency,
support the public interest requirements in Section 17A of the
Exchange Act and the objectives of owners and participants,
establish that the board of directors and senior management have
appropriate experience and skills to discharge their duties and
responsibilities, specify clear and direct lines of responsibility,
and consider the interests of participants' customers, securities
issuers and holders, and other relevant stakeholders of the covered
clearing agency); see also Exchange Act Release No. 78961 (Sept. 28,
2016), 81 FR 70786 (Oct. 13, 2016) (``CCA Standards Adopting
Release'').
\14\ See Clearing Agency Standards Adopting Release, supra note
8, at 66252 (stating that ``[w]e continue to perform a careful
review and evaluation of the comments that the Commission received
on proposed Rules 17Ad-25, 17Ad-26 and Regulation MC, which
commenters rightly observed represent separate, and in some cases
more prescriptive, proposed requirements related to clearing agency
governance and mitigation of conflicts of interest . . . .We believe
it is more appropriate to consider those issues in connection with
the Commission's ongoing consideration of those rules'').
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During the ensuing years since the adoption of the 2016 covered
clearing agency governance rule, the Commission has observed and
learned from recurring tensions among incentive structures in the area
of clearing agency governance. The Commission understands that
differing views among clearing agency stakeholders can have a ripple
effect on the decisions that clearing agencies make, including risk
management decisions that, in turn, affect clearing members and the
larger financial community. Accordingly and for the reasons described
throughout this release, the Commission is proposing rules that would
build upon and strengthen the existing governance requirements adopted
by the Commission in the Clearing Agency Standards Adopting Release in
2012 and the CCA Standards Adopting Release in 2016.\15\ Specifically,
the Commission believes that the existing clearing agency governance
rules should be enhanced to help balance the differing incentives of
the registered clearing agencies, clearing members, and other key
stakeholders. While the governance requirements adopted by the
Commission at that time are broad and principles-based, the rules
proposed today would set more specific and defined parameters and
requirements for governance for all registered clearing agencies--both
covered clearing agencies under Rule 17Ad-22(e) under the Exchange Act
and all registered clearing agencies other than covered clearing
agencies that are subject to Rule 17Ad-22(d) under the Exchange Act.
Because all clearing agencies would face these tensions, the Commission
believes it is appropriate to have this governance proposal apply to
all registered clearing agencies. In this regard, the rules would
establish new governance requirements on board composition for
independent directors, nominating committees, risk management
committees, conflicts of interest, board obligations to oversee service
providers for critical services, and an obligation to formally consider
stakeholder viewpoints. The proposed rules are designed to address
governance issues specific to registered clearing agencies, due to
their distinct ownership structures and organizational forms. Moreover,
the rules are designed to take a multi-layered approach to governance
in that one rule alone would not necessarily capture and address an
issue relating to governance; each of the different rules proposed
today would provide one additional mitigation layer to help ensure that
registered clearing agencies are designed, managed, and operated under
a robust governance framework to protect investors and the public
interest and help promote the prompt and accurate clearance and
settlement of securities transactions. Each mitigation layer improves
the robustness of the governance framework by itself, with each
additional mitigation layer having a cumulative effect on robustness.
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\15\ See 17 CFR 240.17Ad-22; see also Clearing Agency Standards
Adopting Release, supra note 8; CCA Standards Adopting Release,
supra note 13.
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In Part II below, the Commission provides context for the rule
proposal by (i) discussing the different perspectives that exist among
various stakeholders at registered clearing agencies, (ii) briefly
summarizing changes to the regulatory framework for registered clearing
agencies following passage of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (``Dodd-Frank Act''),\16\ and (iii)
describing recent events that have increased focus among market
participants on the governance arrangements that direct risk management
policies and procedures at registered clearing agencies.
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\16\ Public Law 111-203, 124 Stat. 1376 (2010).
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II. Background
Rule 17Ad-22 under the Exchange Act provides for two categories of
registered clearing agencies and contains a set of rules that apply to
each category. The first category is covered clearing agencies, which
are registered clearing agencies that provide CCP \17\ or
[[Page 51815]]
CSD \18\ services.\19\ Rule 17Ad-22(e) applies to covered clearing
agencies and includes requirements intended to address the activity and
risks that their size, operation, and importance pose to the U.S.
securities markets, the risks inherent in the products they clear, and
the goals of both the Exchange Act and the Dodd-Frank Act.\20\ The
second category includes registered clearing agencies other than
covered clearing agencies; such clearing agencies must comply with Rule
17Ad-22(d).\21\ Rule 17Ad-22(d) establishes a regulatory regime to
govern registered clearing agencies that do not provide CCP or CSD
services.\22\ Currently, all clearing agencies registered with the
Commission that are actively providing clearance and settlement
services are covered clearing agencies.\23\ Although all currently
registered and active clearing agencies meet the definition of a
covered clearing agency, thereby making Rule 17Ad-22(d) not applicable
to any registered and active clearing agencies at present, clearing
agencies that are not covered clearing agencies may register with the
Commission in the future and would be subject to Rule 17Ad-22(d).\24\
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\17\ A CCP is a type of registered clearing agency that acts as
the buyer to every seller and the seller to every buyer, providing a
trade guaranty with respect to transactions submitted for clearing
by the CCP's participants. See 17 CFR 240.17Ad-22(a)(2); Exchange
Act Release No. 88616 (Apr. 9, 2020), 85 FR 28853, 28855 (May 14,
2020) (``CCA Definition Adopting Release''). A CCP may perform a
variety of risk management functions to manage the market, credit,
and liquidity risks associated with transactions submitted for
clearing. For example, CCPs help manage the effects of a participant
default by closing out the defaulting participant's open positions
and using financial resources available to the CCP to absorb any
losses. In this way, the CCP can prevent the onward transmission of
financial risk. See, e.g., Exchange Act Release No. 94196 (Feb. 9,
2022), 87 FR 10436, 10448 (Feb. 24, 2022) (``T+1 Proposing
Release''). If a CCP is unable to perform its risk management
functions effectively, however, it can transmit risk throughout the
financial system.
\18\ A CSD is a type of registered clearing agency that acts as
a depository for handling securities, whereby all securities of a
particular class or series of any issuer deposited within the system
are treated as fungible. Through use of a CSD, securities may be
transferred, loaned, or pledged by bookkeeping entry without the
physical delivery of certificates. A CSD also may permit or
facilitate the settlement of securities transactions more generally.
See 15 U.S.C. 78c(a)(23)(A); 17 CFR 240.17Ad-22(a)(3); CCA
Definition Adopting Release, supra note 17, at 28856. If a CSD is
unable to perform these functions, market participants may be unable
to settle their transactions, transmitting risk through the
financial system.
\19\ See 17 CFR 240.17Ad-22(a)(5).
\20\ See CCA Standards Adopting Release, supra note 13, at
70793. The Financial Stability Oversight Council (``FSOC'') has
designated certain financial market utilities (``FMUs'')--which
include clearing agencies that manage or operate a multilateral
system for the purpose of transferring, clearing, or settling
payments, securities, or other financial transactions among
financial institutions or between financial institutions and the
FMU--as systemically important or likely to become systemically
important (``SIFMUs''). See 12 U.S.C. 5463. An FMU is systemically
important if the failure of or a disruption to the functioning of
such FMU could create or increase the risk of significant liquidity
or credit problems spreading among financial institutions or markets
and thereby threaten the stability of the U.S. financial system. See
12 U.S.C. 5462(9).
\21\ See 17 CFR 240.17Ad-22(d).
\22\ See CCA Standards Adopting Release, supra note 13, at
70793.
\23\ They are The Depository Trust Company (``DTC''), FICC,
NSCC, ICE Clear Credit (``ICC''), ICE Clear Europe (``ICEEU''), The
Options Clearing Corporation (``OCC''), and LCH SA.
\24\ The Boston Stock Exchange Clearing Corporation (``BSECC'')
and Stock Clearing Corporation of Philadelphia (``SCCP'') are
currently registered with the Commission as clearing agencies but
conduct no clearance or settlement operations; both inactive
clearing agencies are subject to Rule 17Ad-22(d). See Exchange Act
Release No. 63629 (Jan. 3, 2011), 76 FR 1473, 1474 (Jan. 10, 2011)
(``BSECC Notice''); Exchange Act Release No. 63268 (Nov. 8, 2010),
75 FR 69730, 69731 (Nov. 15, 2010) (``SCCP Notice'').
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In establishing these regimes under Rule 17Ad-22 under the Exchange
Act, the Commission stated that the approach under Rules 17Ad-22(d) and
(e) takes into account clearing agency activities and the risks they
pose, while promoting robust risk management practices and the general
safety and soundness of registered clearing agencies and addressing
concerns relating to the level of concentration in the provision of
clearing agency services.\25\ The Commission recognized that Rule 17Ad-
22(d) would allow new entrants to more firmly establish themselves as
clearing agencies, which is important for the deconsolidation and
diffusion of risk across the market.\26\ Notwithstanding their
different risk profiles, all registered clearing agencies--whether
covered clearing agencies under Rule 17Ad-22(e) or registered clearing
agencies under Rule 17Ad-22(d)--are important to the U.S. financial
system, as evident in their obligations under Section 17A of the
Exchange Act. Effective governance--the primary way by which a clearing
agency develops and oversees the provision of its clearance and
settlement services--is the lynchpin to ensuring a well-functioning and
resilient clearing agency that can withstand periods of market
stress.\27\ In this regard, the Commission believes that the governance
requirements in proposed Rule 17Ad-25 should apply to all registered
clearing agencies. The Commission's intent with respect to proposed
Rule 17Ad-25 is, in part, to take another incremental step to help
ensure that risks posed by registered clearing agencies are
appropriately managed consistent with the purposes of the Exchange Act.
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\25\ See CCA Standards Adopting Release, supra note 13, at
70793.
\26\ See id.
\27\ See SEC Division of Trading and Markets and Office of
Compliance Inspections and Examinations, Staff Report on the
Regulation of Clearing Agencies (Oct. 1, 2020) (``Staff Report on
Clearing Agencies''), <a href="https://www.sec.gov/files/regulation-clearing-agencies-100120.pdf">https://www.sec.gov/files/regulation-clearing-agencies-100120.pdf</a>.
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A. Differing Perspectives at Registered Clearing Agencies
The Exchange Act requires each registered clearing agency to be so
organized and have the capacity to facilitate prompt and accurate
clearance and settlement.\28\ It also requires each registered clearing
agency to have rules that assure the fair representation of
shareholders and participants in the selection of directors and the
administration of its affairs.\29\ These requirements highlight the
importance of a clearing agency's organization in facilitating prompt
and accurate clearance and settlement, and of the need for a clearing
agency to have rules that help ensure that both owners and participants
participate in the selection of directors and the administration of its
affairs, including board governance. Moreover, the Commission's recent
experience has revealed that differing perspectives among other
categories of stakeholders may influence the ways risk management
decisions and practices develop and are implemented by the registered
clearing agency. These differing views--whether between small and large
clearing members or between direct and indirect participants of the
clearing agency--warrant attention as they may manifest themselves in a
clearing agency's decision-making to benefit one category of
stakeholders at the expense of another category of stakeholders.
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\28\ 15 U.S.C. 78q-1(b)(3)(A).
\29\ 15 U.S.C. 78q-1(b)(3)(C). The Exchange Act specifically
states the ``fair representation of . . . shareholders (or members)
and participants'' in the selection of directors and the
administration of affairs, reflecting the fact that a clearing
agency could be either a for-profit or not-for-profit entity. See
Regulation of Clearing Agencies, Exchange Act Release No. 16900, 20
SEC Docket 415, 420 n.15 (June 17, 1980) (explaining that ``[t]he
fair representation requirement was adopted verbatim from S. 249,
the Senate bill that preceded the Securities Acts Amendments of
1975. The report of the Senate Committee on Banking, Housing and
Urban Affairs to accompany S. 249 states: `The rules of the clearing
agency must assure fair representation of its shareholders (or
members) and participants in the decision making process of the
clearing agency . . . . The reference to shareholders of [sic]
members makes it clear that the bill establishes no norm as to
whether clearing agencies should or should not be operated for
profit. The bill makes no attempt to set up particular standards of
representation or participation. Rather, it provides that the
Commission must assure itself that the rules of the clearing agency
regarding the manner in which decisions are made give fair voice to
participants as well as to shareholders or members. Fair
representation of participants may be found if they are afforded an
opportunity to acquire voting stock of the clearing agency in
proportion to their use of its facilities''). ``Members,'' however,
is a term often used to describe the participants of a clearing
agency. This release refers to ``shareholders (or members)''
collectively as ``owners'' of the registered clearing agency. In
some instances, owners and shareholders may differ in certain
respects, such as the nature and extent of their voting rights on
the board. To avoid confusion, in this release the Commission uses
only ``participants'' to refer to the direct users of a clearing
agency, which have met the standards for participation and have
executed a participation agreement.
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[[Page 51816]]
First, based on its supervisory experiences, the Commission has
observed that owners and participants may have structural incentives
that differ from one another, leading to differing views as to the
efficacy of certain risk management tools and the potential for
divergent interests in the risk management of the clearing agency. For
example, owners and participants may have differing views as to the
scope of products cleared by the clearing agency, the minimum standards
required for participation in the clearing agency, and the size,
timing, and nature of financial resource requirements applied as part
of the risk management framework.
Fundamentally, an owner's interest in protecting the equity and
continued operation of the clearing agency diverges from a
participant's interest in avoiding the allocation of losses from a
defaulting participant. Diverging interests and incentives among owners
and participants with respect to loss allocation or scope of products--
such as in the event that some participants may want to limit access to
a market by limiting access to clearing, while owners would like to
expand the scope of products to collect fees-could limit the benefits
of a clearing agency, and even potentially cause harm to the market it
serves as well as the broader financial system to the extent that they
might undermine the risk mitigating purpose of the clearing agency by
failing to achieve the right balance among competing interests.\30\
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\30\ For a discussion of the importance of aligning clearing
agency governance with the interests of those who bear the financial
risk, see infra note 167 and accompanying text.
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When a clearing agency chooses to mutualize the risk it faces among
its owners and participants, it may find a closer alignment of
incentives among owners and participants because both owners and
participants would bear losses associated with a failure of the
clearing agency.\31\ In considering how to mutualize the risk it faces,
a clearing agency may choose from a number of different approaches. For
example, a clearing agency may be organized so that the participants
are owners of the clearing agency,\32\ which may eliminate diverging
incentives between owners and participants. Regardless of the approach,
as stated above, the Exchange Act requires that a clearing agency be so
organized and have the capacity to facilitate prompt and accurate
clearance and settlement. In addition, the Exchange Act requires that
the rules of the clearing agency assure a fair representation of its
shareholders (or members) and participants in the selection of its
directors and administration of its affairs.\33\
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\31\ See Jorge Cruz Lopez & Mark Manning, Who Pays? CCP Resource
Provision in the Post-Pittsburgh World (Dec. 2017), <a href="https://www.bankofcanada.ca/wp-content/uploads/2017/12/sdp2017-17.pdf">https://www.bankofcanada.ca/wp-content/uploads/2017/12/sdp2017-17.pdf</a>.
\32\ See, e.g., Exchange Act Release No. 52922 (Dec. 7, 2005),
70 FR 74070 (Dec. 14, 2005) (explaining that participants of DTC,
FICC, and NSCC that make full use of the services of one or more of
these clearing agency subsidiaries of DTCC are required to purchase
DTCC common shares).
\33\ See 15 U.S.C. 78q-1(b)(3)(C).
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Second, the Commission has observed differing views between large
and small participants in a registered clearing agency about risk
management practices. Consolidation among market participants in recent
years has resulted in the increased concentration of clearance and
settlement activity among a smaller set of firms. For example, over 90
percent of the total notional amount of the U.S. market in credit
derivatives is concentrated in four U.S. commercial banks.\34\ Large
clearing agency participants, especially participant-owners, often have
different incentives from smaller participants. When a small number of
dominant participants exercise control or influence over a registered
clearing agency with respect to the services provided by the registered
clearing agency or the rules applicable to its participants, these
participants may promote margin requirements that are not commensurate
with the risks and particular attributes of each participant's specific
products, portfolio, and market, thereby indirectly limiting
competition and increasing their ability to maintain higher profit
margins. Given such incentives, a registered clearing agency that is
dominated by a small number of large participants might make decisions
that are designed to provide them with a competitive advantage.
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\34\ See Staff Report on Clearing Agencies, supra note 27, at 21
(citing the Office of the Comptroller of the Currency, Quarterly
Report on Bank Trading and Derivatives Activities, Third Quarter
2019, graph 4 (Dec. 2019), <a href="https://www.occ.gov/publications-andresources/publications/quarterly-report-on-bank-trading-and-derivatives-activities/files/pub-derivativesquarterly-qtr3-2019.pdf">https://www.occ.gov/publications-andresources/publications/quarterly-report-on-bank-trading-and-derivatives-activities/files/pub-derivativesquarterly-qtr3-2019.pdf</a>).
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Third, the Commission's proposal is informed, in part, by its
experience overseeing registered clearing agencies with regard to the
concerns raised by certain participants that access criteria and risk
management standards may impose disproportionate costs relative to the
value of access to clearing agencies. In addition, when the Commission
proposed Regulation MC, the Commission identified a potential area
where a conflict of interest of participants that exercise undue
control or influence over a security-based swap clearing agency could
adversely affect the central clearing of security-based swaps by
limiting access to the security-based swap clearing agency, either by
restricting direct participation in the security-based swap clearing
agency or restricting indirect access by controlling the ability of
non-participants to enter into correspondent clearing arrangements.\35\
The resulting conflicts of interest could limit the benefits of a
registered security-based swap clearing agency in the securities market
to indirect participants. As a result, the Commission believes it
should continue to implement measures that help ensure the decisions of
a registered clearing agency reflect the interests and perspectives of
the broadest cross-section of stakeholders as possible.
---------------------------------------------------------------------------
\35\ See Regulation MC Proposing Release, supra note 1, at
65885.
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This proposal is intended to help ensure that a registered clearing
agency's governance arrangements can manage these differing
perspectives and interests more effectively. As discussed in detail
below, the Commission believes that the proposed rules would help
ensure that a registered clearing agency's governance arrangements can
more effectively manage the divergent interests between and among
clearing agency owners and participants, small and large participants,
and direct and indirect participants of a clearing agency, which, in
turn, would improve a clearing agency's risk management practices to be
fair and more effective. Imposing these requirements on all registered
clearing agencies would have the effect of building upon existing
governance requirements with consistent, more defined and robust
governance standards across all registered clearing agencies.
B. Regulatory Framework for Registered Clearing Agencies
The regulatory framework for registered clearing agencies has
evolved over the last decade. Existing elements of the regulatory
framework establish policies and procedures requirements for minimum
standards to help promote participation in registered clearing
agencies.\36\ Other rules require that certain clearing agencies have
policies and procedures for governance arrangements that support the
objectives of owners and participants and consider the interests of
participants' customers, securities issuers and holders, and other
relevant stakeholders.\37\
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\36\ See, e.g., 17 CFR 240.17Ad-22(b)(5)-(7).
\37\ See, e.g., 17 CFR 240.17Ad-22(e)(2)(iii), (vi).
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[[Page 51817]]
Following the enactment of the Dodd-Frank Act, the Commission has
taken multiple steps to strengthen its regulatory framework for
clearing agencies by: (i) establishing minimum requirements for
governance, operations, and risk management practices of registered
clearing agencies; \38\ (ii) enhancing the Commission's oversight and
enforcement of the technology and systems infrastructure that supports
clearing agencies; \39\ (iii) establishing an enhanced regulatory
framework for systemically important clearing agencies and clearing
agencies for security-based swaps; \40\ and (iv) expanding the enhanced
regulatory framework from systemically important clearing agencies to
all registered clearing agencies that provide CCP or CSD services so
that the set of covered clearing agencies includes the seven active
clearing agencies registered with the Commission.\41\ In addition, the
Commission has adopted rules to help promote access to registered
clearing agencies, including rules that require a registered clearing
agency that performs CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to: (i)
provide the opportunity for a person that does not perform any dealer
or security-based swap dealer services to obtain membership on fair and
reasonable terms at the clearing agency to clear securities for itself
or on behalf of other persons; (ii) have membership standards that do
not require that participants maintain a minimum portfolio size or
minimum transaction volume; and (iii) provide that a person maintaining
net capital equal to or greater than $50 million may obtain membership
at the clearing agency, provided that such person is able to comply
with other reasonable membership standards.\42\
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\38\ See 17 CFR 240.17Ad-22; see also Clearing Agency Standards
Adopting Release, supra note 8; CCA Standards Adopting Release,
supra note 13; CCA Definition Adopting Release, supra note 17.
\39\ See 17 CFR 242.1000 et seq.; see also Exchange Act Release
No. 73639 (Nov. 19, 2014), 79 FR 72251 (Dec. 5, 2014) (``Regulation
SCI Adopting Release'').
\40\ See 17 CFR 240.17Ad-22(e); CCA Standards Adopting Release,
supra note 13.
\41\ See CCA Definition Adopting Release, supra note 17.
\42\ 17 CFR 240.17Ad-22(b)(5)-(7).
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1. Current Requirements and Past Proposals on Clearing Agency
Governance
In the recent past, the Commission addressed clearing agency
governance with the adoption of two rules. In 2016, the Commission
adopted a rule that requires a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide for governance arrangements that are
clear and transparent, clearly prioritize the safety and efficiency of
the covered clearing agency, support the public interest requirements
in Section 17A of the Exchange Act, and the objectives of owners and
participants, establish that the board of directors and senior
management have appropriate experience and skills to discharge their
duties and responsibilities, specify clear and direct lines of
responsibility, and consider the interests of participants' customers,
securities issuers and holders, and other relevant stakeholders of the
covered clearing agency.\43\ In 2012, the Commission adopted a rule
that requires all registered clearing agencies aside from covered
clearing agencies to establish, implement, maintain and enforce written
policies and procedures reasonably designed to have governance
arrangements that are clear and transparent to fulfill the public
interest requirements in Section 17A of the Exchange Act, to support
the objectives of owners and participants, and to help promote the
effectiveness of the clearing agency's risk management procedures.\44\
The Commission took a broad, principles-based approach to these
governance rules to give a clearing agency the discretion to consider
its unique characteristics and circumstances, including ownership and
governance structures, effect on direct and indirect participants,
membership base, markets served, and the risks inherent in products
cleared, while at the same time, largely being subject to the
requirements of the SRO rule filing process, which requires public
notice and comment and consideration by the Commission.\45\
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\43\ See 17 CFR 240.17Ad-22(e)(2); see also CCA Standards
Adopting Release, supra note 13, at 70802. The Commission also
issued guidance on Rule 17Ad-22(e)(2) ``because . . . [as] there may
be a number of ways to address compliance with Rule 17Ad-22(e)(2),
the Commission . . . provid[ed] the following guidance that a
covered clearing agency generally should consider in establishing
and maintaining its policies and procedures: . . . whether the roles
and responsibilities of its board of directors are clearly
specified, and whether there are documented procedures for the
functioning of the board of directors, such as procedures for
identifying, addressing, and managing member conflicts of interest,
and for reviewing the board's overall performance and the
performance of its individual members regularly.'' CCA Standards
Adopting Release, supra note 13, at 70806-07.
\44\ See 17 CFR 240.17Ad-22(d)(8); see also Clearing Agency
Standards Adopting Release, supra note 8, at 66251-52.
\45\ See generally CCA Standards Adopting Release, supra note
13, at 70800 (``With a number of exceptions, Rule 17Ad-22(e) does
not prescribe a specific tool or arrangement to achieve its
requirements. The Commission believes that when determining the
content of its policies and procedures, each covered clearing agency
must have the ability to consider its unique characteristics and
circumstances, including ownership and governance structures, effect
on direct and indirect participants, membership base, markets
served, and the risks inherent in products cleared. This ability,
however, is subject to the requirements of the SRO rule filing and
advance notice processes, which provide some opportunities for the
public and participants to comment on the covered clearing agency's
rules, policies, and procedures. The Commission does not believe
that a granular or prescriptive approach to its regulation of
covered clearing agencies would be appropriate, nor would such an
approach ensure that a covered clearing agency does not become a
transmission mechanism for systemic risk. Moreover, the Commission
believes that the primarily principles-based approach reflected in
Rule 17Ad-22(e) will help a covered clearing agency continue to
develop policies and procedures that can effectively meet the
evolving risks and challenges in the markets that the covered
clearing agency serves.''); Clearing Agency Standards Adopting
Release, supra note 8, at 66252 (``We appreciate the perspective of
commenters who prefer the more general policies and procedures
design of Rule 17Ad-22(d)(8) to any more prescriptive rulemaking by
the Commission in the area of clearing agency governance.'').
---------------------------------------------------------------------------
The Commission also proposed, but did not adopt, other rules
directed to clearing agency governance: proposed Regulation MC, which
contemplated limitations on ownership and minimum requirements for
independent directors intended to satisfy a requirement for Commission
rulemaking set forth in Section 765 of the Dodd-Frank Act (``Section
765''); \46\ proposed Rule 17Ad-25, which included additional
requirements for a clearing agency to mitigate conflicts of interest;
\47\ and proposed Rule 17Ad-26, which included requirements for a
clearing agency to establish standards for directors on the board and
committees thereof.\48\ The Commission did not adopt those proposals,
which were issued in 2010 and 2011, and is now withdrawing them because
of the multiple changes that the Commission has made to its regulatory
framework for clearing agencies as stated above.
---------------------------------------------------------------------------
\46\ See Regulation MC Proposing Release, supra note 1, at
65893-904.
\47\ See Clearing Agency Standards Proposing Release, supra note
2, at 14497-98.
\48\ See id. at 14498-99.
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As part of the incremental evolution of the Commission's clearing
agency regulatory framework that has occurred over the past decade, the
Commission now believes that updated rules are warranted to build upon
and strengthen the existing clearing agency governance framework, given
the trends the Commission has observed in the securities markets and
during its supervisory processes.\49\ Specifically,
[[Page 51818]]
the Commission believes that addressing the composition of a board and
its committees will help ensure effective governance, help promote
transparency into decision-making processes, facilitate fair
representation of owners and participants, and mitigate the potential
effects of conflicts of interest between owners and participants, large
and small participants, and direct and indirect participants. For these
reasons, proposed Rule 17Ad-25 includes provisions directed to all
registered clearing agencies.
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\49\ As discussed further below, the Commission believes that
the targeted set of proposed rules for governance included in this
release can help ensure that the framework effectively addresses the
considerations set forth in Section 765 with respect to clearing of
security-based swaps. Although Section 765 directed the Commission
to focus on conflicts of interest specifically with respect to
security-based swap clearing agencies, the Commission believes that
conflicts of interest concerns can arise across all registered
clearing agencies regardless of the asset classes served.
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2. Commodity Futures Trading Commission's Governance Framework for
Derivatives Clearing Organizations
Three clearing agencies registered with the Commission are also
registered as derivatives clearing organizations (``DCOs'') with the
Commodity Futures Trading Commission (``CFTC''). The Commission
acknowledges that, while other agency rules and regulations on
governance may apply to a clearing agency registered with the
Commission that are similar in scope or purpose to proposed Rule 17Ad-
25, the Commission remains obligated to ensure that risk in the U.S.
securities markets is appropriately managed--including through
promulgation of its own rules and regulations--consistent with the
purposes of the Exchange Act. Additionally, because Rule 17Ad-22(e)
under the Exchange Act and other comparable regulations--including DCO
governance rules adopted by the CFTC in January 2020 \50\--are based on
the same international standards, namely the PFMI, the potential for
inconsistent regulation is low. In this regard, the Commission believes
its existing governance rules for covered clearing agencies and
registered clearing agencies other than covered clearing agencies are
consistent with the CFTC's governance rule for DCOs.\51\ Certain
proposed requirements in this rulemaking are also consistent with the
requirements in the CFTC's DCO regime, which provides conflicts of
interest and board composition rules.\52\ Further, in developing these
rules, Commission staff has consulted with the CFTC and the Board of
Governors of the Federal Reserve System (``FRB'').
---------------------------------------------------------------------------
\50\ See DCO General Provisions and Core Principles, 85 FR 4800
(Jan. 27, 2020), <a href="https://www.cftc.gov/sites/default/files/2020/01/2020-01065a.pdf">https://www.cftc.gov/sites/default/files/2020/01/2020-01065a.pdf</a>.
\51\ See 17 CFR 39.24 (requiring DCOs to, among other things,
have governance arrangements that are written, clear and
transparent, place a high priority on the safety and efficiency of
the derivatives clearing organization, and 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; the board of directors
shall 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).
\52\ See 17 CFR 39.25 (requiring DCOs to establish and enforce
rules to minimize conflicts of interest in the decision-making
process of the derivatives clearing organization, establish a
process for resolving such conflicts of interest, and describe
procedures for identifying, addressing, and managing conflicts of
interest involving members of the board of directors); 17 CFR 39.26
(requiring DCOs to ensure that the composition of the governing
board or board-level committee of the DCO includes market
participants and individuals who are not executives, officers, or
employees of the derivatives clearing organization or an affiliate
thereof). We note that the CFTC recently proposed amendments to its
DCO governance framework relating to risk management committee
requirements. See Governance Requirements for Derivatives Clearing
Organizations, Release Number 8565-22 (July 27, 2022), <a href="https://www.cftc.gov/PressRoom/PressReleases/8565-22">https://www.cftc.gov/PressRoom/PressReleases/8565-22</a>.
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C. Risks Associated With Clearance and Settlement
The Commission also believes that the proposed governance rules
would help ensure that registered clearing agencies make more effective
risk management decisions that take into account relevant stakeholder
perspectives and concerns. Recent episodes of increased market
volatility--in March 2020 following the outbreak of the COVID-19
pandemic, and in January 2021 following heightened interest in certain
``meme'' stocks--have revealed potential vulnerabilities in the U.S.
securities market and highlight the essential role of registered
clearing agencies in managing the risk that securities transactions may
fail to clear or settle.\53\ These events underscore the importance of
a strong regulatory framework to oversee registered clearing agencies
that clear or settle securities transactions and provide transparency
to the markets.
---------------------------------------------------------------------------
\53\ See, e.g., SEC, Staff Report on Equity and Options Market
Structure Conditions in Early 2021 (Oct. 14, 2021) (``2021 Staff
Report''), <a href="https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf">https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf</a>. Staff reports, Investor
Bulletins, and other staff documents (including those cited herein)
represent the views of Commission staff and are not a rule,
regulation, or statement of the Commission. The Commission has
neither approved nor disapproved the content of these staff
documents and, like all staff statements, they have no legal force
or effect, do not alter or amend applicable law, and create no new
or additional obligations for any person.
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Among other things, the rules of a registered clearing agency
generally require its participants to transfer collateral to the
clearing agency, which may include different types of collateral, such
as margin payments, funds, or other assets, and the requirements
associated with these rules may change in response to changes in market
volatility. The terms of these rules, and the related policies and
procedures of the registered clearing agency that implement them, are
generally approved by the board as part of the clearing agency's
governance arrangements. These rules, policies, and procedures are also
subject to Commission review as proposed rule changes under Section 19
of the Exchange Act and Rule 19b-4 thereunder.\54\ The potential for
sudden and large increases in the margin required by a registered
clearing agency of its participants, as evidenced in the March 2020 and
January 2021 events stated above, have increased scrutiny by a wide
variety of market participants into the way a registered clearing
agency establishes, implements, maintains, and enforces its rules that
impose margin requirements.\55\ Some market participants have suggested
that such margin requirements are too conservative; \56\ others have
suggested that margin requirements do not sufficiently consider the
range of participants in a clearing agency and the downstream effect
such requirements may have on other types of investors.\57\ In response
to this increased attention, the Basel Committee on Banking Supervision
(``BCBS''), the Committee on Payments and Market Infrastructure
(``CPMI''), and the International Organization of Securities
Commissions (``IOSCO'') jointly released a consultative paper on CCP
margin practices, focused on, among other things, recent market
volatility and the apparent drivers of the size and composition of
margin calls.\58\
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\54\ 15 U.S.C. 78s; 17 CFR 240.19b-4.
\55\ See, e.g., Fitch Ratings, Margin Call Disparity, Breaches
Could Drive Clearinghouse Scrutiny (July 20, 2020), <a href="https://www.fitchratings.com/research/non-bank-financial-institutions/margin-call-disparity-breaches-could-drive-clearinghouse-scrutiny-20-07-2020">https://www.fitchratings.com/research/non-bank-financial-institutions/margin-call-disparity-breaches-could-drive-clearinghouse-scrutiny-20-07-2020</a>.
\56\ See Alexander Campbell, CCP Margin Buffers Too Big,
Research Suggests (July 9, 2019), <a href="https://www.risk.net/risk-management/6783941/ccp-margin-buffers-too-big-research-suggests">https://www.risk.net/risk-management/6783941/ccp-margin-buffers-too-big-research-suggests</a>.
\57\ See Glenn Hubbard et al., Report of the Task Force on
Financial Stability, Brookings Institution (June 2021), <a href="https://www.brookings.edu/wp-content/uploads/2021/06/financial-stability_report.pdf">https://www.brookings.edu/wp-content/uploads/2021/06/financial-stability_report.pdf</a>.
\58\ See BCBS-CPMI-IOSCO, Consultative Report, Review of
Margining Practices (Oct. 2021), <a href="https://www.bis.org/bcbs/publ/d526.pdf">https://www.bis.org/bcbs/publ/d526.pdf</a>.
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Concerns about the size and timing of margin requirements are only
one example of an area in which direct and indirect participants that
rely on the clearance and settlement process have expressed concerns
about clearing
[[Page 51819]]
agency governance and, in particular, the way that such governance
would oversee or employ risk management tools under stressed market
conditions. Two other areas of heightened attention concern a clearing
agency's process for loss allocation in the event of a participant
default and an event other than a participant default (hereinafter a
``non-default loss''), such as an operational failure, cyber-attack, or
theft. For example, participants and others have expressed concerns
about the extent to which existing governance structures at registered
clearing agencies would function during a potential recovery or
resolution scenario, which would occur in the event that a clearing
agency's prefunded financial resources available to absorb any loss--
sometimes referred to as the ``clearing fund'' or ``guaranty fund''--
are insufficient to close out a defaulting participant's portfolio
without allocating losses among the non-defaulting participants of the
clearing agency.\59\ Based on its supervisory experience, the
Commission believes that this loss allocation process could thus have
significant implications for the risk management of its non-defaulting
participants.
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\59\ In 2018, a default at a European CCP increased scrutiny of
the auction process through which a CCP may choose to close out a
defaulted portfolio. CPMI-IOSCO issued a report on issues for
consideration in 2020. See Bank for International Settlements,
Central Counterparty Default Management Auctions--Issues for
Consideration (June 2020), <a href="https://www.bis.org/cpmi/publ/d192.pdf">https://www.bis.org/cpmi/publ/d192.pdf</a>.
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Further, although concerns about the size and timing of margin
requirements are, at one level, concerns about the risk management
practices of a clearing agency, they also implicate clearing agency
governance because the governance arrangements of a registered clearing
agency will determine the process for developing and approving policies
and procedures for imposing margin requirements, and the governance and
management of the registered clearing agency will also implement these
policies and procedures, whether during normal market conditions or
periods of increased market volatility.
In this regard, proposed Rule 17Ad-25 is intended to help ensure
that in periods of market stress or stress on the registered clearing
agency, the governance process of all registered clearing agencies is
transparent, objective, and addresses conflicts of interest. Trust
among market participants in the national system for clearance and
settlement, particularly in times of market stress, necessarily depends
on trust in the ability of registered clearing agencies to more
effectively manage the risk flowing from that market stress and, when
necessary, transparently and objectively impose increased margin
requirements or employ loss allocation mechanisms.
III. Proposed Rules
The Commission is proposing rules under the Exchange Act and to
address the considerations set forth in Section 765 of the Dodd-Frank
Act. Section 17(a) of the Exchange Act directs registered clearing
agencies to make and keep for prescribed periods such records, furnish
such copies, and make and disseminate such reports as the Commission,
by rule, prescribes as necessary or appropriate in the public interest,
for the protection of investors, or in furtherance of the Exchange
Act.\60\ Section 17A of the Exchange Act directs the Commission to
facilitate the establishment of a national system for the prompt and
accurate clearance and settlement of securities transactions and
provides the Commission with the authority to regulate those entities
critical to the clearance and settlement process.\61\ Section 23(a) of
the Exchange Act authorizes the Commission to make rules and
regulations as necessary or appropriate to implement the provisions of
the Exchange Act.\62\ The enactment of the Payment, Clearing, and
Settlement Supervision Act (``Clearing Supervision Act'') in 2010
(Title VIII of the Dodd-Frank Act) reaffirmed the importance of the
national system for clearance and settlement.\63\ Specifically,
Congress found that the ``proper functioning of the financial markets
is dependent upon safe and efficient arrangements for the clearing and
settlement of payments, securities, and other financial transactions.''
\64\ In addition, Section 765 of the Dodd-Frank Act specifically
directs the Commission to adopt rules to mitigate conflicts of interest
for security-based swap clearing agencies.\65\ Accordingly, the
Commission is proposing these rules pursuant to overlapping statutory
authorities, because although the Commission is able to propose these
rules pursuant to Section 17A of the Exchange Act, the Commission is
also meeting the mandatory rulemaking requirements of Section 765. The
Commission preliminarily has determined that these proposed rules are
necessary and appropriate to improve the governance of a clearing
agency that clears security-based swaps and in which a major security-
based swap participant has a material debt or equity investment.
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\60\ See 15 U.S.C. 78q(a).
\61\ See 15 U.S.C. 78q-1(a)(2)(A).
\62\ See 15 U.S.C. 78w(a).
\63\ See 12 U.S.C. 5461-5472.
\64\ 12 U.S.C. 5461(a)(1).
\65\ See 15 U.S.C. 8343.
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The Commission had previously reviewed the potential for conflicts
of interest at security-based swap clearing agencies in accordance with
Section 765 of the Dodd-Frank Act when it proposed Regulation MC, and
had identified those conflicts that could affect access to clearing
agency services, products eligible for clearing, and risk management
practices of the clearing agencies.\66\ The Commission had identified
three key areas where it believed a conflict of interest of
participants who exercise undue control or influence over a security-
based swap clearing agency could adversely affect the central clearing
of security-based swaps.\67\ First, participants could limit access to
the security-based swap clearing agency, either by restricting direct
participation in the security-based swap clearing agency or restricting
indirect access by controlling the ability of non-participants to enter
into correspondent clearing arrangements. Second, participants could
limit the scope of products eligible for clearing at the security-based
swap clearing agency, particularly if there is a strong economic
incentive to keep a product traded in the over-the-counter (``OTC'')
market for security-based swaps. Third, participants could use their
influence to reduce the amount of collateral they would be required to
contribute and liquidity resources they would have to expend as margin
or guaranty fund to the security-based swap clearing agency. Although
the Commission does not believe that the participants of security-based
swap clearing agencies are engaged in these types of activities, the
Commission recognizes that these three potential conflicts of interest
could limit the benefits of a security-based swap clearing agency in
the security-based swaps market, and even potentially cause substantial
harm to that market and the broader financial markets.
---------------------------------------------------------------------------
\66\ See Regulation MC Proposing Release, supra note 1, at
65885.
\67\ See id.
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Nevertheless, there are benefits to having participant incentives
known and reflected in the decision making activity of a board of
directors. Employees of participants--in particular, chief risk
officers or their equivalent--are likely to bring technical expertise
to a board of directors. Participants are often exposed to enormous
financial liability in the event of a default, and so they have strong
[[Page 51820]]
incentives to have sound risk management at the clearing agencies. In
order to promote the utility of having directors who are familiar with
participant operations, the proposed rule does not prohibit directors
who, among other things, receive compensation from participants from
meeting the definition of independent director (provided all other
requirements of the proposed rules are met).\68\
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\68\ Other jurisdictions have chosen a different approach, as
discussed below. See infra Part IV.B.2.
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For the reasons discussed throughout this release, the Commission
is proposing rules for all registered clearing agencies to establish
requirements for governance, including requirements for the composition
of the board of directors, to mitigate conflicts of interest, to
establish certain obligations of the board to oversee service provider
relationships, and to establish an obligation of the board to consider
the views of participants and other relevant stakeholders. Each of
these proposed rules are discussed further below.
A. Board Composition and Requirements for Independent Directors
1. Proposed Rules 17Ad-25(b), (e) and (f)
Proposed Rules 17Ad-25(b), (e), and (f) would establish
requirements related to independent directors. First, proposed Rule
17Ad-25(b)(1) would require that a majority of the directors of a
registered clearing agency must be independent directors, as defined in
proposed Rule 17Ad-25(a). The proposed rule would also provide that, if
a majority of the voting interests issued as of the immediately prior
record date are directly or indirectly held by participants, then at
least 34 percent of the members of the board of directors must be
independent directors. Proposed Rule 17Ad-25(a) would define an
``independent director'' to mean a director that has no material
relationship with the registered clearing agency, or any affiliate
thereof. Proposed Rule 17Ad-25(a) also would define ``material
relationship'' to mean a relationship, whether compensatory or
otherwise, that reasonably could affect the independent judgment or
decision-making of the director, and includes relationships during a
lookback period of one year counting back from making the initial
determination in proposed Rule 17Ad-25(b)(2). In addition, proposed
Rule 17Ad-25(a) would define ``affiliate'' to mean a person that
directly or indirectly controls, is controlled by, or is under common
control with the registered clearing agency. Proposed Rule 17Ad-
25(b)(2) would require each registered clearing agency to broadly
consider all the relevant facts and circumstances, including under
proposed Rule 17Ad-25(g), on an ongoing basis, to affirmatively
determine that a director does not have a material relationship with
the registered clearing agency or an affiliate of the registered
clearing agency to qualify as an independent director. In making such
determination, a registered clearing agency must (i) identify the
relationships between a director, the registered clearing agency, any
affiliate thereof, along with the circumstances set forth in proposed
Rule 17Ad-25(f); (ii) evaluate whether any relationship is likely to
impair the independence of the director in performing the duties of
director; and (iii) document this determination in writing. Such
documentation requirements would be subject to the recordkeeping and
retention requirements that apply to all SROs under Section 17(a)(2) of
the Exchange Act.\69\
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\69\ See 15 U.S.C. 78q(a)(2).
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The Commission believes that proposed Rules 17Ad-25(a) and 17Ad-
25(b)(2) could provide registered clearing agencies with a broad pool
of potential candidates to serve as independent directors. For example,
an employee of a participant of the registered clearing agency, a
professional in the securities or financial services industries, an
academic, and other such qualified persons would be eligible for
consideration as an independent director as long as the candidate meets
the other criteria under the definition of material relationship and
proposed Rule 17Ad-25(f).
Proposed Rule 17Ad-25(e) would require that, if any committee has
the authority to act on behalf of the board of directors, the
composition of that committee must have at least the same percentage of
independent directors as is required under these rules for the board of
directors, as set forth in proposed paragraph (b)(1).
Proposed Rule 17Ad-25(f) would describe certain circumstances that
would always exclude a director from being an independent director.
These circumstances would include: (1) the director is subject to
rules, policies, and procedures by the registered clearing agency that
may undermine the director's ability to operate unimpeded, such as
removal by less than a majority vote of shares that are entitled to
vote in such director's election; (2) the director, or a family member,
has an employment relationship with or otherwise receives compensation,
other than as a director, from the registered clearing agency or any
affiliate thereof, or the holder of a controlling voting interest of
the registered clearing agency; (3) the director, or a family member,
is receiving payments from the registered clearing agency, or any
affiliate thereof, or the holder of a controlling voting interest of
the registered clearing agency that reasonably could affect the
independent judgment or decision-making of the director, other than the
following: (i) compensation for services as a director to the board of
directors or a committee thereof; or (ii) pension and other forms of
deferred compensation for prior services not contingent on continued
service; (4) the director, or a family member, is a partner in, or
controlling shareholder of, any organization to or from which the
registered clearing agency, or any affiliate thereof, or the holder of
a controlling voting interest of the registered clearing agency, is
making or receiving payments for property or service, other than the
following: (i) payments arising solely from investments in the
securities of the registered clearing agency, or affiliate thereof; or
(ii) payments under non-discretionary charitable contribution matching
programs; (5) the director, or a family member is employed as an
executive officer of another entity where any executive officers of the
registered clearing agency serve on that entity's compensation
committee; or (6) the director, or a family member, is a partner of the
outside auditor of the registered clearing agency, or an employee of
the outside auditor who is working on the audit of the registered
clearing agency, or any affiliate thereof. Proposed Rules 17Ad-
25(f)(2)-(6) would be subject to a lookback period of one year
(counting back from making the initial determination in proposed Rule
17Ad-25(b)(2)). Family member would be defined to include any child,
stepchild, grandchild, parent, stepparent, grandparent, spouse,
sibling, niece, nephew, mother-in-law, father-in-law, son-in-law,
daughter-in-law, brother-in-law, or sister-in-law, including adoptive
relationships, any person (other than a tenant or employee) sharing a
household with the director or a nominee for director, a trust in which
these persons (or the director or a nominee for director) have more
than fifty percent of the beneficial interest, a foundation in which
these persons (or the director or a nominee for director) control the
management of assets, and
[[Page 51821]]
any other entity in which these persons (or the director or a nominee
for director) own more than fifty percent of the voting interests.
At the time of the 2016 CCA Standards Adopting Release, the
Commission declined to incorporate more prescriptive governance
elements into the rule as urged by commenters, including specific
requirements on independent representation on the board or risk
committee or governance relating to business relationships and
affiliates,\70\ based on the premise that the requirements in Section
17A of the Exchange Act relating to fair representation and the public
interest provided sufficient grounds to hold covered clearing agencies
accountable to these concerns.\71\ Similarly, with regard to the 2012
governance rule for all registered clearing agencies that are not
covered clearing agencies, the Commission declined to adopt more
prescriptive elements to its approach on governance with regard to
board composition.\72\ However, given the growing concentration of
clearing and settlement participants among a small number of firms \73\
and the concentration of differing perspectives into distinct groups of
clearing agency stakeholders, the Commission believes it is appropriate
to propose requirements on independent representation to facilitate the
consideration and management of diverse stakeholder interests in the
decision-making of the clearing agency.
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\70\ See CCA Standards Adopting Release, supra note 13, at 70804
(stating that ``[a]fter careful consideration of the comments, the
Commission has determined not to modify Rule 17Ad-22(e)(2) to
include specific requirements related to public or independent
representation on the covered clearing agency's board or risk
committee . . . . The Commission is declining to modify Rule 17Ad-
22(e)(2) to further specify that a particular director represent the
interests of buy-side or sell-side market participants . . . . In
addition, and for the same reasons, the Commission is declining to
modify Rule 17Ad-22(e)(2) to provide further specification regarding
business relationships and affiliates because these topics, like the
above, are already addressed by the fair representation requirement
in Section 17A(b)(3)(C) and the public interest requirements of
Section 17A of the Exchange Act'').
\71\ See 15 U.S.C. 78q-1(b)(3)(C).
\72\ See Clearing Agency Standards Adopting Release, supra note
8, at 66251 (adopting the rule largely as proposed and declining to
incorporate prescriptive requirements as suggested by commenters,
including ``[o]ne commenter [who] urged the Commission to ensure
that Rule 17Ad-22(d)(8) as well as any requirements adopted from the
Commission's proposed Regulation MC pertaining to the mitigation of
conflicts of interest are designed to ensure that buy-side market
participants have a meaningful voice in the operating committees of
clearing agencies because that representation is critical to
promoting robust governance arrangements at clearing agencies and
serving the best interests of the U.S. financial system. Another
commenter stated that proposed Rules 17Ad-22(d)(8), 17Ad-25, and
17Ad-26 reflect a better approach to governance, conflicts of
interest, and board and committee composition than the Commission's
proposed requirements for clearing agencies under Regulation MC. One
commenter urged the Commission to consider complementing proposed
Rule 17Ad-22(d)(8) with a minimum board independence requirement so
that at least two-thirds of all board directors would be required to
be independent'').
\73\ See Staff Report on Clearing Agencies, supra note 27, at
21.
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2. Discussion
(a) Board of Director Oversight of Management
Several current requirements under the Exchange Act and regulations
are applicable to a clearing agency's board of directors. Section 17A
of the Exchange Act requires that the rules of a clearing agency assure
the fair representation of owners and participants in the selection of
directors and the administration of the clearing agency's affairs.\74\
Rule 17Ad-22(e)(2) \75\ under the Exchange Act requires a covered
clearing agency to establish, implement, maintain, and enforce written
policies and procedures reasonably designed to provide for governance
arrangements that, in relevant part, (i) support the public interest
requirements in Section 17A of the Exchange Act applicable to clearing
agencies, and the objectives of owners and participants; (ii) establish
that the board of directors and senior management have appropriate
experience and skills to discharge their duties and responsibilities;
and (iii) consider the interests of participants' customers, securities
issuers and holders, and other relevant stakeholders of the covered
clearing agency.
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\74\ See 15 U.S.C. 78q-1(b)(3)(C).
\75\ See 17 CFR 240.17Ad-22(e)(2)(iii)-(iv), (vi).
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Given the importance of the board oversight function,\76\ CPMI-
IOSCO has issued guidance regarding the board's obligations with
respect to oversight of management.\77\ This guidance provides several
examples of effective oversight of management by clearing agency
boards. For example, the guidance highlights the board's responsibility
for: (i) carefully overseeing, monitoring and evaluating management's
implementation of the risk-management framework; (ii) taking
appropriate steps to help ensure that management is performing risk-
management tasks properly and effectively; (iii) ensuring that
processes are in place for effective and timely communication,
reporting and information flow between management and the board; (iv)
communicating with management about risk management processes; and (v)
when assessing the risk-management framework, appropriately challenging
management to demonstrate the effectiveness of risk-management
processes.\78\ Likewise, the report stated that while a board may not
delegate its ultimate responsibilities regarding risk management, it
may assign certain tasks, so long as the board clearly defines the
assigned tasks and retains ultimate responsibility over such tasks.\79\
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\76\ As a foundational principle of U.S. state corporate law, a
board of directors of a corporation has ultimate responsibility for
the oversight of management, consistent with a director's fiduciary
duties of loyalty and care to a company. See, e.g., Del. Code tit.
8, sec. 141 (2022) (establishing that the board is ultimately
responsible for the corporation's management). In the context of a
registered clearing agency incorporated under such principles, this
means that the board has ultimate responsibility for ensuring an
effective framework for the management of risk by the registered
clearing agency, so that the clearing agency can facilitate the
prompt and accurate clearance and settlement of securities
transactions. To discharge this duty effectively, the board must
necessarily work closely with management, but also effectively
oversee it.
\77\ See CPMI-IOSCO, Final Report, Resilience of central
counterparties (CCPs): Further guidance on the PFMI (July 2017)
(``CCP Resilience Guidance''), <a href="https://www.bis.org/cpmi/publ/d163.pdf">https://www.bis.org/cpmi/publ/d163.pdf</a>.
\78\ See id. at 5.
\79\ See id.
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(b) Requirement for Independent Directors
Corporate governance tools exist to help ensure that the board
performs more effective oversight of the management of the company. One
such tool is the independent director, which could bolster the board's
ability to perform effectively by reducing the potential for financial
or other relationships between directors and those persons who are
overseen by directors, such as management.\80\ The Commission is
proposing a definition of ``independent director'' that retains
elements of the definition used in Regulation MC, but with
modifications.\81\ The Commission continues to believe that as part of
the definition, the key operating elements are the concepts of material
relationships and affiliates, so those elements would be retained.
However, at the same time, the Commission proposes using a modified
definition of
[[Page 51822]]
``independent directors'' because of changes in scope of this proposed
rulemaking. Regulation MC resulted from a public roundtable discussion
and meetings held with interested persons, in part, to gain further
insight into the sources of conflicts of interest at security-based
swap clearing agencies.\82\ Regulation MC had proposed a narrower
definition of independent director, which would have excluded directors
who had material relationships with participants and their affiliates
as well,\83\ and the proposal would have covered only one class of
registered clearing agencies: security-based swap clearing agencies.
Pursuant to Section 765, Regulation MC was designed to address
anticipated governance concerns relating to participant activity \84\
that existed in the OTC derivatives market. At the time of the
proposal, the Commission also proposed Rules 17Ad-25 and 17Ad-26 for
registered clearing agencies that took a broad, principles-based
approach to clearing agency governance. Because some registered
clearing agencies that would be subject to this proposal have
participants who are also owners, the Commission's current proposal,
under proposed Rule 17Ad-25(b)(1), creates a carve-out from the
majority independence requirement when a majority of voting interests
are owned by participant-owners, as set forth below.
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\80\ See, e.g., Bruce Dravis, Director Independence and the
Governance Process (Aug. 14, 2018), <a href="https://www.americanbar.org/groups/business_law/publications/blt/2018/08/05_dravis/">https://www.americanbar.org/groups/business_law/publications/blt/2018/08/05_dravis/</a>. In the
United States, independent directors traditionally are not selected
from among management and are not intended to serve as
representatives of management, and therefore they do not carry the
same financial or other relationships that might create a conflict
of interest between the director's interests and the director's
duties to the company.
\81\ See Regulation MC Proposing Release, supra note 1, at
65897.
\82\ See id. at 65885.
\83\ See id. at 65928 (defining independent director as ``(1) A
director who has no material relationship with: (i) The security-
based swap execution facility or national securities exchange or
facility thereof that posts or makes available for trading security-
based swaps, or security-based swap clearing agency, as applicable;
(ii) Any affiliate of the security-based swap execution facility or
national securities exchange or facility thereof that posts or makes
available for trading security-based swaps, or security-based swap
clearing agency, as applicable; (iii) A security-based swap
execution facility participant, a member of a national securities
exchange that posts or makes available for trading security-based
swaps, or a participant in the security-based swap clearing agency,
as applicable; or (iv) Any affiliate of a security-based swap
execution facility participant, a member of a national securities
exchange that posts or makes available for trading security-based
swaps, or a participant in the security-based swap clearing agency,
as applicable.'').
\84\ See id. at 65885 (``These [security-based swap] entities
are not wholly-owned by participants or exchanges and may have
different governance related issues than the securities clearing
agencies currently registered with the Commission.'').
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The Commission believes that requiring a registered clearing agency
to include independent directors on the board can improve the board's
ability to conduct more effective oversight of management, which is a
critical component of the effectiveness of a registered clearing
agency. Independent directors constitute a set of directors that do not
have potential conflicts of interest resulting from their relationships
with management. This helps the board manage conflicts of interest
among directors because independent directors do not have the existing
relationships or accompanying incentives that might, for example,
discourage or dis-incentivize the board to review management's
decisions in a thorough, transparent, and consistent way. The
appearance of conflicts of interest can reduce confidence among direct
and indirect participants, other stakeholders, and the public in the
functioning of the clearing agency, particularly during periods of
market stress when general confidence in market resilience may be low.
The practice of employing independent directors is common across
the financial industry and across public companies more generally.\85\
Although Commission rules do not currently require the boards of
registered clearing agencies to include independent directors, each of
the registered clearing agencies already require directors with some
independence characteristics (such as ``nonexecutive,'' or ``public''
directors).\86\
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\85\ See, e.g., Quoc Trung Tran, Independent Directors and
Corporate Investment: Evidence from an Emerging Market, 21 J. Econ.
& Dev. 30 (2019), <a href="https://www.emerald.com/insight/content/doi/10.1108/JED-06-2019-0008/full/html">https://www.emerald.com/insight/content/doi/10.1108/JED-06-2019-0008/full/html</a> (noting that ``independent
directors have become a common approach of corporate governance'' in
recent years). For example, the NYSE listing standards require that
a majority of the board of directors of a listed company be
independent, and they preclude managers or employees of the company
from meeting the independence standard, among other criteria. See,
e.g., Weil, Gotshal & Manges LLP, Requirements for Public Company
Boards (Jan. 3, 2022), <a href="https://www.weil.com/-/media/files/pdfs/2022/january/requirements_for_public_company_boards_including_ipo_transition_rules.pdf">https://www.weil.com/-/media/files/pdfs/2022/january/requirements_for_public_company_boards_including_ipo_transition_rules.pdf</a>.
\86\ See DTCC, Board Mission Statement and Charter (Oct. 2021),
at 5, <a href="https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/DTCC-BOD-Mission-and-Charter.pdf">https://www.dtcc.com/-/media/Files/Downloads/legal/policy-and-compliance/DTCC-BOD-Mission-and-Charter.pdf</a>; ICC, Regulation and
Governance Fact Sheet (Sept. 2021), at 2, <a href="https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf">https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf</a>; ICEEU, Disclosure
Framework (Jan. 31, 2021), at 20, <a href="https://www.theice.com/publicdocs/clear_europe/ICE_Clear_Europe_Disclosure_Framework.pdf">https://www.theice.com/publicdocs/clear_europe/ICE_Clear_Europe_Disclosure_Framework.pdf</a>; OCC, Board
of Directors Charter and Corporate Governance Principles (Sept. 22,
2021), at 4-5, <a href="https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf">https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf</a>; LCH SA, Board of
Directors (2022), <a href="https://www.lch.com/about-us/structure-and-governance/board-directors-0">https://www.lch.com/about-us/structure-and-governance/board-directors-0</a>.
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In that vein, in addition to the above dynamic that exists between
the board and management, registered clearing agencies must also manage
the competing and sometimes divergent interests of owners and
participants, as previously discussed in Part II.A.\87\ The structure
of a registered clearing agency, and the risk management tools that it
employs, affect how the interests of owners, participants, and other
types of stakeholders align. For example, the risk mutualizing and
trade guaranty features provided by covered clearing agencies provide
for the shift of the consequences of one party's actions to another,
binding disparate interests together in certain circumstances, such as
a participant default. These features both affect how different
stakeholders maximize their own self-interest and also distinguish the
governance of a clearing agency from other corporate structures, such
as those of other financial services companies or, more generally,
publicly traded companies, who are unable to legally bind their
customers with financial obligations that are theoretically uncapped.
In particular, the owners of a clearing agency may seek to shift risks
to the participants of the clearing agency to decrease the level of
exposure that the owners face by capitalizing the clearing agency.
Meanwhile, participants in the registered clearing agency may seek to
raise the cost of participation to exclude competitors from the
benefits of the clearing agency's risk mutualizing and mitigating
tools, or they may seek to reduce their exposure to the clearing agency
by not making certain assets available for use by the clearing agency
during loss allocation. As described below, there can be countervailing
benefits to having the interests of a director and the interests of an
owner aligned, so as to increase the likelihood that decisions made
will benefit shareholders. Likewise, there are benefits to having the
interests of a director and the interests of a participant aligned, in
order to increase the likelihood that decisions will take into account
the long-term needs of participants. The requirement in Section 17A for
fair representation recognizes that clearing agencies may serve
competing stakeholders, such as owners and participants, both in the
selection of directors and administration of their affairs.\88\
Directors may carry these perspectives when they serve on the board,
and these perspectives may influence the ultimate decision-making of
the board. For example, one set of
[[Page 51823]]
stakeholders could use the board to shift costs and risk exposure to
others (e.g., owners shifting them to participants), in ways that could
undermine the risk mutualizing and mitigating purpose of the clearing
agency.\89\ The Commission is also mindful that ultimately, owners (as
holders of voting interests) are generally in the position of electing
directors (subject to any restrictions on ownership, classes of shares,
etc.), meaning that any director who has a material relationship with a
participant and who has been nominated as a potential independent
director must nonetheless be voted onto the board of directors by the
owners; so ultimate approval of a director would remain in the hands of
owners, creating an incentive for even a director who is employed by a
participant to take into account the views of owners. Nonetheless, the
criteria for independent directors under the proposed rules would help
ensure that independent directors retain those features that
distinguish their interests from those of other directors because, for
example, an independent director cannot have an employment relationship
with or otherwise receive compensation (other than as a director) from
the registered clearing agency or any affiliate thereof, or the holder
of a controlling voting interest of the registered clearing agency. In
addition, although independent directors may be elected, in part, by
owners, the views of owners would not be the only stakeholders' views
that independent directors would consider.
---------------------------------------------------------------------------
\87\ See, e.g., Securities Industry Study, Report of the
Subcommittee on Commerce and Finance, H.R. Rep. No. 92-1519, at 84
(1972) (``1972 House Report'') (stating generally about SROs such as
clearing agencies, ``[s]elf-regulators may be parochial in
adjustment and accommodating competing aims and policies.
Furthermore, since self-regulatory bodies are composed of disparate
subsidiary groups, the legitimate interests of a particular group
may be overridden, or the tugging and pulling may result in inaction
or impasse'').
\88\ See 15 U.S.C. 78q-1(b)(3)(C).
\89\ See, e.g., PFMI, supra note 4, at 11 (``FMIs and their
participants do not necessarily bear all the risks and costs
associated with their payment, clearing, settlement, and recording
activities. Moreover, the institutional structure of an FMI may not
provide strong incentives or mechanisms for safe and efficient
design and operation, fair and open access, or the protection of
participant and customer assets. In addition, participants may not
consider the full impact of their actions on other participants,
such as the potential costs of delaying payments or settlements.'').
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Given the above dynamics between owners and participants, the
Commission believes that registered clearing agency processes involving
risk management or director nominations are also implicated in managing
the dynamics between owners and participants. Therefore, the
relationships affecting the independence of a director in the context
of a registered clearing agency also include those between the director
and the registered clearing agency itself or its affiliates.\90\ The
ability of a registered clearing agency to help ensure effective risk
management and loss allocation in the event of a default or non-default
loss is linked to the interests of the owners of the clearing agency,
who may also have financial relationships with the participants (or be
the participants) of such registered clearing agency.\91\ For example,
The Options Clearing Corporation (``OCC'') is owned by certain options
exchanges, whose customers may also be participants of OCC.\92\
Similarly, participants in the registered clearing agencies that are
subsidiaries of The Depository Trust & Clearing Corporation (``DTCC'')
are required to purchase common shares of DTCC as part of periodic
efforts to keep ownership proportionate to such owners' use of clearing
agency services.\93\ Such provisions that require common shares to be
periodically re-allocated to reflect levels of use of the clearing
agency services create financial and other relationships between a
registered clearing agency, its participants, its affiliates, and its
owners. In this sense, registered clearing agencies are not organized
in a way that reflects the corporate ownership of the typical publicly
traded company, where the shareholder base is a dispersed population
that may have coordination problems, and therefore the scope of inquiry
cannot end simply at whether a director is independent from management
alone.\94\ Rather, the owners of a registered clearing agency reflect a
few key groups, who may be owners or participants of the clearing
agency, and board composition will thus necessarily reflect these
different stakeholder groups and their views on risk management.
---------------------------------------------------------------------------
\90\ Affiliate is proposed to mean a person that directly or
indirectly controls, is controlled by, or is under common control
with the registered clearing agency. A director would, of course,
have a relationship with the clearing agency that arises from
service as a director, and the accompanying duties to the company
such as the fiduciary duties of the duty of care or the duty of
loyalty. These relationships and duties, however, do not create a
potential conflict of interest that might impair the independent
judgment of the director.
\91\ In Part III.A.2.f) below, the Commission discusses how
participant-owners may have interests that are well-aligned with the
risk management function of the clearing agency, supporting a lower
threshold of independent directors when a majority of owners are
participant-owners.
\92\ See OCC, Annual Report (2019), <a href="https://annualreport.theocc.com/About-OCC">https://annualreport.theocc.com/About-OCC</a>.
\93\ See DTCC, NSCC Important Notice No. A8986 (Apr. 5, 2021)
(regarding the period common stock reallocation process), <a href="https://www.dtcc.com/-/media/Files/pdf/2021/4/5/A8986.pdf">https://www.dtcc.com/-/media/Files/pdf/2021/4/5/A8986.pdf</a>.
\94\ See, e.g., Donald C. Clarke, Three Concepts of the
Independent Director, 32 Del. J. Corp. L. 73 (2007), <a href="https://scholarship.law.gwu.edu/cgi/viewcontent.cgi?article=1045&context=faculty_publications">https://scholarship.law.gwu.edu/cgi/viewcontent.cgi?article=1045&context=faculty_publications</a>.
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In the context of a registered clearing agency, the Commission
believes that requiring independent directors helps promote the ability
of the board to perform its oversight of management function and to
support a plurality of viewpoints voiced at the board level.
Independent directors would help ensure that, when the interests
between owners and participants diverge, the impact of such divergence
is more manageable because the board would not be composed entirely of
directors who have material relationships either to management (such as
under a situation where managers approve compensation or other payments
from the registered clearing agency to such director), owners, or
participants. Balance between stakeholders with divergent views could
help the board to adequately consider the respective needs of all
stakeholders, and help promote the integrity of the clearing agency's
risk management function. With respect to independent directors serving
on the boards of public companies, some studies have questioned whether
independent directors succeed in improving shareholder value.\95\ For
registered clearing agencies, the Commission is proposing a requirement
for independent directors for reasons unrelated to improving
shareholder value. Rather, registered clearing agencies are subject to
an expansive regulatory framework in which they operate as critical and
often systemically important financial market utilities.\96\ They are
subject to requirements under the Exchange Act to facilitate prompt and
accurate clearance and settlement, promote the public interest,\97\ and
help ensure the fair representation of owners and participants
(regardless of whether these owners and participants are the
controlling owner or the clearing agency's largest participant). As
long as a majority of directors are not solely motivated by the needs
of one category of stakeholders, this structure can help ensure that
the board addresses the full
[[Page 51824]]
set of owners and participants, even smaller participants,\98\ in
fulfilling these statutory objectives. In this way, a requirement for
independent directors is well-suited to help promote more effective
governance of a registered clearing agency and meet the purposes of the
Exchange Act.\99\
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\95\ See, e.g., id. at 75-77.
\96\ See, e.g., 12 U.S.C. 5461; see also Board of Governors of
the Federal Reserve System, Designated Financial Market Utilities,
<a href="https://www.federalreserve.gov/paymentsystems/designated_fmu_about.htm">https://www.federalreserve.gov/paymentsystems/designated_fmu_about.htm</a> (providing the list of designated financial
market utilities, including five SEC-regulated registered clearing
agencies).
\97\ See 15 U.S.C. 78q-1(b)(3)(C). See also Clarke, supra note
94, at 82-83 (noting that although there are situations where an
independent director may not make an appreciable difference in
outcomes, that provided there is a mechanism for accountability,
``[a] director serving the `public interest' should arguably be
independent of everyone [such that a director is able to] . . .
follow only the dictates of her conscience'').
\98\ See id. at 80 (stating that non-management directors are
viewed as potentially protecting small shareholders from big
shareholders).
\99\ See infra Part IV.C.1 (discussing proposed Rules 17Ad-
25(b), (e), and (f)).
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(c) Definition of ``Material Relationship''
To be an independent director consistent with the proposed rules, a
director must have no material relationships with a registered clearing
agency or its affiliate. As defined in proposed Rule 17Ad-25(a), which
was carried forward from the Commission's previous proposal in
Regulation MC,\100\ a ``material relationship'' means a relationship,
whether compensatory or otherwise, that reasonably could affect the
independent judgment or decision-making of the director. The scope
covers relationships during a lookback period of one year counting back
from making the initial determination in proposed Rule 17Ad-25(b)(2).
The proposed definition is identical to the definition proposed in
Regulation MC, except for the addition of a one-year look back period,
which is intended to address recently terminated business or personal
relationships to prevent evasion of the purposes of this provision, as
discussed further below. The Commission is retaining its prior proposed
definition of material relationship because the definition of material
relationship is not impacted by the type of security cleared (i.e.,
expanding this proposal to cover all registered clearing agencies
rather than security-based swap clearing agencies does not alter the
rationale provided under the Regulation MC). Establishing a materiality
and reasonableness threshold for such relationships provides a
registered clearing agency with discretion to apply this requirement
across a range of fact patterns while ensuring that they ultimately
facilitate the fair representation of owners and participants.
---------------------------------------------------------------------------
\100\ See Regulation MC Proposing Release, supra note 1, at
65897.
---------------------------------------------------------------------------
The proposed rule includes relationships both compensatory and
otherwise to help ensure that the evaluation of a director's
independence is thorough. Such scope of relationships would include not
only pecuniary transactions but other types of quid pro quo
arrangements, biases, or obligations between persons. Under the
Commission's proposed rule, however, such non-compensatory
relationships must reach the level of materiality to affect a
director's status as an independent director. In addition, the proposed
rule would carve out any past relationships that have terminated at
least one year prior because the Commission believes such past
relationships are unlikely to have a material effect on a director's
future decision-making. The proposed definition includes a lookback
period, which is meant to cover recently terminated relationships as a
method to avoid circumvention of the proposed independent director
requirements. As discussed below, the Commission has experience with a
one-year lookback period applied to employment relationships between
auditors and former audit clients, and the Commission believes that the
same objectives underpinning that lookback period would apply
here.\101\
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\101\ See generally Sarbanes-Oxley Act of 2002, Public Law 107-
204, sec. 206, 116 Stat. 745, 774 (2002) (``SOX'').
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Finally, the definition would require consideration of material
relationships between a director and any affiliate that directly or
indirectly controls, is controlled by, or is under common control with
the registered clearing agency. The purpose of this provision is to
address potential conflicts of interest that would arise when a
director is serving in a management or director role for an affiliate,
such as a parent company, of the registered clearing agency,\102\ or
when a director has a material level of investment in a registered
clearing agency or its affiliate. The Commission is not including a
bright-line test as to what is a material level of investment because
such an investment could be either material to the director, such as a
financial investment that is a material percentage of an individual's
wealth, or material to the registered clearing agency or its affiliate,
such as a material percentage of ownership of a company. For example,
if a director held ownership in an affiliated company of a registered
clearing agency, this investor relationship should be evaluated for
materiality and whether it could affect the independent judgment or
decision-making of the director, even if such investment did not amount
to such director being a controlling shareholder of such affiliate
(which is specifically prohibited for independent directors under
proposed rule 17Ad-25(f)(4), as discussed further below). If such
relationships were not considered, then a director who serves on the
management of the parent company and therefore indirectly manages the
registered clearing agency itself through the holding structure could
nonetheless be considered independent. The proposed definition would
help mitigate evasion of the spirit of the independent director
requirement through the use of multi-tier holding company structures
that place management responsibility at multiple levels of the
organizational structure. If the functional role of managing a clearing
agency was housed in a parent company, thereby allowing a manager to
claim to be an independent director by virtue of not being an employee
of the registered clearing agency itself but instead of the parent
company, then the Commission's intent in this proposed rule could be
easily circumvented.
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\102\ The potential implications of a director of a registered
clearing agency having a material relationship with an affiliated
company have been discussed in the context of European Union-based
CCPs under the 2012 Regulatory Technical Standards (``RTS''),
adopted by the European Commission as part of the European Market
Infrastructure Regulation (``EMIR''). Chapter III, Article 3 of the
RTS states, ``[a] CCP that is part of a group shall take into
account any implications of the group for its own governance
arrangements including whether it has the necessary level of
independence to meet its regulatory obligations as a distinct legal
person and whether its independence could be compromised by the
group structure or by any board member also being a member of the
board of other entities of the same group. In particular, such a CCP
shall consider specific procedures for preventing and managing
conflicts of interest including with respect to outsourcing
arrangements.'' See Commission Delegated Regulation (EU) No 153/2013
of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the
European Parliament and of the Council with regard to regulatory
technical standards on requirements for central counterparties, 2013
O.J. (L 52), at art. 3(4), <a href="https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0153&from=EN">https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0153&from=EN</a>.
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(d) Process for Assessing Relationships
Proposed Rule 17Ad-25(b)(2) establishes a process by which a
registered clearing agency must identify, evaluate, and document its
determinations regarding director independence. These requirements have
been included in the rule because achieving director independence
necessarily requires an assessment of a director's relationships. The
provisions of Rule 17Ad-25(b)(2) include requirements to establish a
process to identify and evaluate any such relationships and to document
that process to help ensure that a registered clearing agency has
considered a wide range of potential relationships, and applied its
analysis transparently and consistently over time.
The proposed rule also requires a registered clearing agency to
affirmatively determine that no material relationships exist, broadly
considering
[[Page 51825]]
all the relevant facts and circumstances. The Commission believes that
establishing a process helps ensure more effective identification and
evaluation of any material relationships. The Commission also believes
that affirmatively determining that a director is independent helps
promote a thorough review of the director's relationships and helps
promote confidence in the governance arrangements of the clearing
agency because each such director's independence status will have been
evaluated by the registered clearing agency. The Commission has not
specified in the rule the particular sources of information to be
reviewed or the particular approach to inquiring about relationships
because the facts and circumstances of each director or candidate's
relationships are likely to differ. The Commission is not specifying a
checklist of sources to consult and searches to perform, in order to
avoid inadvertently leaving off such checklist a source that cannot be
foreseen.
(e) Excluded Relationships
The process set forth under Rule 17Ad-25(b)(2) would also require
analysis of certain circumstances pursuant to which a director would be
precluded from being an independent director, regardless of any
determinations otherwise made pursuant to Rule 17Ad-25(b)(2). These
scenarios are intended to address cases where, in the Commission's
view, the circumstances clearly prevent a director from exercising
independent judgment or decision-making.
Currently, owners of registered clearing agencies are predominantly
non-natural persons such as participants, exchanges, or a parent
company. The Commission does not expect that a natural person serving
as a director would typically be a controlling shareholder of such
registered clearing agency, although there may be future registered
clearing agencies with this organizational structure. However, due to
the fact that directors are natural persons, but owners of registered
clearing agencies currently tend to be non-natural persons, many of the
circumstances described below seek to address the connection between
the natural person director and the non-natural person owner.
Proposed Rule 17Ad-25(f)(1) limits the ability for a registered
clearing agency to undercut the authority of independent directors,
such as through provisions established by a registered clearing agency
in the bylaws or other organizational documents. For example, if one
director who happened to be associated with management was authorized
to remove independent directors him or herself, rather than through the
normal channels of removing a director via a majority vote of the
shareholders, then any independent directors might be beholden to such
director. Likewise, if some directors--such as those with relationships
to management--could conduct closed meetings that exclude independent
directors to discuss matters before the board, the ability of
independent directors to perform their duties could be undercut. This
provision would not limit the ability of a registered clearing agency
to manage or mitigate conflicts of interests among its directors, such
as by implementing through policies and procedures a requirement that
conflicted directors recuse themselves from a matter pursuant to a
conflicts of interest policy, if such recusal would be necessary for
that director to operate more effectively. Rather, the provision
addresses whether independent directors would be limited, restricted,
or chilled in expressing their views because they were subject to
removal by a management director or denied information relevant to the
decision-making process.
Proposed Rules 17Ad-25(f)(2) through (5) identify circumstances
where a director is precluded from being an independent director
because the director has an employment relationship or has received a
payment from the clearing agency, its affiliates, or its holders of
controlling voting interests, either directly or through indirect
channels. Several of the provisions reference a family member, which
the Commission is proposing to define broadly, to include natural
persons who are related by blood, marriage, or household, including
living antecedents and descendants, as well an non-natural persons
(trusts and other legal entities) that are controlled by such natural
persons. The Commission is intending for the prohibition to be
comprehensive as to the relationship in order to cover potentially
meaningful relationships. Although the list includes non-natural
persons controlled by an extensive list of natural persons, a director
would not necessarily need to compile a list of trusts or companies
controlled by various in-laws and relatives. Instead, if the director
compiled the list of natural persons referenced in the definition, a
registered clearing agency could determine whether those persons (or
legal entities under their control) were doing business with the
registered clearing agency, any of its affiliates, the holder of a
controlling voting interest of the registered clearing agency, the
outside auditor, or an entity where an executive officer of the
registered clearing agency serves on such entity's compensation
committee, in a manner that would exclude a person from being
considered an independent director under proposed Rule 17Ad-25(f), as
described below. A registered clearing agency is likely already
determining who it is conducting business with as part of evaluating
whether to enter into contracts with those companies.
Proposed Rule 17Ad-25(f)(2) precludes a director from being an
independent director when the director is also an employee of the
registered clearing agency or its affiliates, a requirement intended to
reflect the traditional concept of director independence from
management, discussed above. Proposed Rule 17Ad-25(f)(3) and (4)
preclude a director from being an independent director when receiving
certain types of payments, such as in a scenario where the director is
a partner or a controlling shareholder of a consulting firm that
contracts with the registered clearing agency, or where the director's
spouse is a partner or controlling shareholder of a service provider
that is hired by the registered clearing agency. These proposed rules
address circumstances where payments would create a conflict of
interest and undermine the ability of the director to maintain
independent judgment. The proposed rules would carve out certain types
of payments, such as payments from pensions or deferred compensation
for prior services. The Commission believes that such payments are
generally made in response to past, rather than future, activity and
therefore do not have the potential to create conflicts of interest by
affecting future decision-making by the director.
The list of payments for property or services in proposed Rule
17Ad-25(f)(4) scopes in participant clearing fees as well. The
Commission is restricting the ability of a director to be independent
if he or she is a partner or controlling shareholder of a participant
because he or she could directly profit from reducing the size of the
clearing fees even if that impairs the quality of the risk management
of the clearing agency.
Proposed Rule 17Ad-25(f)(5) would preclude independence if a
director, or a family member, is employed the as an executive officer
of another entity where any executive officers of the registered
clearing agency serve on that entity's compensation committee. The
intent of this provision would prevent circular arrangements whereby
compensation
[[Page 51826]]
could be elevated among a chain of interested persons.
Proposed Rule 17Ad-25(f)(6) would preclude a director from being an
independent director when the director is a partner of an outside
auditor or is an employee working on an audit of the registered
clearing agency. As above, these limitations are designed to reduce the
potential for conflicts of interest that would impair an independent
director's independent judgment.
Finally, proposed Rule 17Ad-25(f) would subject paragraphs (f)(2)-
(6) to a one-year lookback period, which is intended to capture
conflicts of interest that may arise from relationships that have
recently terminated (such as departure from a job). As with the
lookback period in the ``material relationship'' definition, the
purpose of this lookback period is the same for all provisions, as well
as in the material relationship definition, which is to cover
relationships that have recently terminated, while not reaching back so
far in time as to impede the registered clearing agency's ability to
select from a large pool of skilled and experienced candidates for
independent director. The Commission believes that a one-year lookback
period is consistent with similar requirements in other statutes and
Commission rules.\103\
---------------------------------------------------------------------------
\103\ See SOX, supra note 101.
---------------------------------------------------------------------------
(f) Majority of Independent Directors
In assessing the appropriate quantum of independent directors to be
required under the proposed rule, the Commission has considered the
potential impact of divergent interests between owners and
participants, or the potential in which the interests of owners and
participants might diverge. The Commission believes that requiring a
majority of independent directors is most likely to result in the board
acting from a position where the interests of all the stakeholders of
the clearing agency are considered, rather than the interests of a
particular subset of owners or participants. Having a majority of
independent directors reduces the potential misalignment of interests
among directors and management, and among owners and participants,
helping to ensure that a majority of directors are unattached to these
dynamics. In other words, an unattached or ``disinterested'' majority
helps promote consideration of the risk management purposes of the
clearing agency, and helps decrease the likelihood that other interests
that may arise from a potential conflict of interest are the
determinative factor in board decisions. If a majority of directors are
non-independent directors, then a majority of directors influenced by
potential or perceived conflicts of interest could sway the outcome of
board decisions.
The Commission recognizes, however, that the interests of an owner
and a participant can overlap in some cases, such as when a participant
also owns a portion of its equity. For example, the Exchange Act
provides that the Commission may determine that the representation of
participants is fair if they are afforded a reasonable opportunity to
acquire voting stock of the clearing agency, directly or indirectly, in
reasonable proportion to their use of such clearing agency.\104\ The
opportunity for a participant to become such an owner of a clearing
agency is one method to mitigate the potential for conflicts of
interest among these two groups, by more closely aligning the interests
of a participant with those of a voting interest holder (i.e., owner).
---------------------------------------------------------------------------
\104\ See 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------
In this structure, owners and participants would be one and the
same, and the dynamic where diverging interests between owners and
participants undermine the risk management function of the clearing
agency is less likely because participant-owners would necessarily
internalize and synthesize the divergent interests resulting from
ownership and participation. In other words, participant-owners are
less likely to use their equity share to shift the burdens of risk
management to the participants of the clearing agency because they are
themselves participants. When a majority of voting shares are held by
participant-owners, the Commission believes that the interests of the
board will be more closely aligned with ensuring more effective risk
management. In this circumstance, the Commission believes it is
appropriate to reduce the number of independent directors required
under the rule to promote the selection of directors by participant-
owners because directors voted by a majority of persons intended to
represent the clearing agency's participant-owners would mitigate
against the possibility of a divergence of interests. Accordingly, the
Commission is proposing a lower requirement for independent directors
of at least 34 percent of directors when the registered clearing agency
has a majority of its voting interests directly or indirectly held by
participants; indirectly held by participants refers to participant
ownership of a parent company. For example, if a registered clearing
agency is wholly-owned by a holding company, and the holding company is
majority owned by the participants of the registered clearing agency,
then a 34 percent threshold would apply. Alternatively, if a registered
clearing agency was 51 percent owned by a holding company, and that
holding company was 100 percent owned by the participants of the
registered clearing agency, then that would also amount to a majority
ownerships of participants, which would cause the 34 percent
independent director provision to apply. The Commission proposes to
require 34 percent, or greater than one-third of directors, to
encourage a significant portion of directors to meet the independence
requirement but to provide a comparatively higher level of discretion
to the clearing agency to select non-independent directors. A
requirement for greater than one-third independent directors would
align with the requirement for independence in other jurisdictions for
clearing agencies.\105\ In addition, if 34 percent of directors are
independent directors, and participants and owners of the registered
clearing agency are predominantly the same entity (i.e., participant-
owners), then it remains less likely that any one of the three distinct
groups seeking to influence the registered clearing agency--owners,
management, and participants--will establish an outsized influence over
the remaining non-independent directors.
---------------------------------------------------------------------------
\105\ See EMIR at art. 27(2), <a href="https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32012R0648&from=EN">https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32012R0648&from=EN</a> (stating that ``[a]
CCP shall have a board. At least one third, but no less than two, of
the members of that board shall be independent''); see also id. at
art. 2(28) (defining independent member of the board to mean a
member of the board who has no business, family or other
relationship that raises a conflict of interests regarding the CCP
concerned or its controlling shareholders, its management or its
clearing members, and who has had no such relationship during the
five years preceding his membership of the board).
---------------------------------------------------------------------------
Finally, the proposed rule defines the 34 percent requirement using
the term ``holders of voting interests'' rather than simply ``owners''
so that the lower threshold only applies when participant-owners are
entitled to vote to elect a director, irrespective of whether someone
is otherwise entitled to the financial attributes of such ownership.
The Commission is not using the term owner as the equivalent concept of
holder of a voting interest, because the financial attributes of a
security can be separated from the voting rights of a security. The
Commission is focused on who has the ability to influence who is voted
onto the board--which accompanies voting rights, not financial
attributes--as the relevant factor in deciding whether
[[Page 51827]]
participants can enjoy that benefit of ownership as participant-owners.
(g) Other Committees of the Board Generally
Proposed Rule 17Ad-25(e) would impose the independent director
requirement as applied to the full board of directors under Rule 17Ad-
25(b)(1) to any board committee that has the authority to act on behalf
of the board. For example, if 34 percent of the board must be composed
of independent directors, any committee that is taking action based on
a board delegation also should have at least 34 percent of its members
be independent directors, unless otherwise required to meet a higher
standard under the rules.\106\ The purpose of the proposed rule is to
prevent a registered clearing agency from circumventing the proposed
requirement for independent directors by delegating key decisions of
the board to a committee with fewer independent directors than those
required of the full board under Rule 17Ad-25(b)(1).
---------------------------------------------------------------------------
\106\ For example, to help ensure that evaluations of director
nominees made by the nominating committee reflect independent
judgment, proposed Rule 17Ad-25(c)(2) would require that the
nominating committee be composed of a majority of independent
directors in all cases. See infra Part III.B.1 (discussing the
proposed rule).
---------------------------------------------------------------------------
3. Request for Comment
The Commission requests comment on all aspects of proposed Rules
17Ad-25(b), (e), and (f). In particular, the Commission requests
comment on the following specific topics:
1. Is requiring that the boards of registered clearing agencies
have a majority of independent directors an effective tool for ensuring
a transparent and objective governance process that balances the
potentially competing or divergent interests of owners and
participants? Has the Commission accurately described the benefits of
independent directors, as defined in this release, to the board of a
registered clearing agency? Why or why not?
2. Are there other ways to define ``independent director'' or
``material relationship'' that would achieve the Commission's goals? If
so, what are they? Should the Commission establish a numerical
threshold, such as $100,000 annually, for compensatory relationships in
order for them to be considered material under this rule? If so, what
should that numerical threshold be? Please be specific. Should the
Commission create a list of the types of relationships that should be
considered either material or that could affect the independent
judgment or decision-making of a director under this rule, and should
that list distinguish between compensatory and non-compensatory
relationships? Why or why not?
3. Should the Commission define the term ``control'' in the
proposed rules? If so, would it be appropriate to adopt a definition
similar to the one in 17 CFR 246.2, which states that control means the
possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of a person, whether through
the ownership of voting securities, by contract, or otherwise?
4. What is the appropriate percentage of independent directors on
the board of a registered clearing agency? Does the requirement for a
majority of directors to be independent directors support the goals
discussed in this proposal? Would another threshold be more effective
at addressing diverging views among owners, participants, and other
relevant stakeholders in the registered clearing agency? For example,
would a requirement that one-third of the directors be independent
(which has been adopted by European jurisdictions) provide the benefits
of independent directors without any of the potential drawbacks? Please
explain.
5. Is the application of director independence requirements
appropriate for all registered clearing agencies, or should there be
distinctions made among registered clearing agencies based on certain
factors, such as organizational structure or products cleared? If so,
what factors are relevant and why? Would these proposed rules apply to
all types of organizational structures in a consistent manner, or would
they impede a registered clearing agency from changing its
organizational structure into a more innovative or efficient structure?
6. Is a one-year lookback period adequate for purposes of the
``material relationship'' definition and proposed Rules 17Ad-25(f)(2)-
(6)? For example, is a one-year time period for the receipt of certain
payments by clearing agencies the appropriate length of time to
determine that a director is precluded from being considered
independent? How will this impact the ability of clearing agencies to
recruit experienced persons to serve as directors? More generally, how
large is the pool of potential directors that could serve as
independent directors, as defined in this release, on the boards of
registered clearing agencies? Are there particular elements of the
independent director definition that limit the pool of potential
independent directors? Should those elements be modified to expand the
pool?
7. Is it appropriate to include affiliates of registered clearing
agencies as relevant to the consideration of material relationships of
independent directors, as well as certain scenarios that preclude
independence?
8. Is the scope of the scenario in proposed Rule 17Ad-25(f)(4)
overly broad or overly narrow in covering all partners, regardless of
relative holdings, and controlling shareholders? Should this provision
cover all shareholders, or non-managing partners, instead? Why or why
not?
9. The Commission is proposing in Rule 17Ad-25(f)(3) to carve out
directors who are serving as directors on other boards from the list of
scenarios that explicitly preclude independence. Is this carve-out
appropriate in order to permit a director of a registered clearing
agency who also serves as a director of another legal entity to qualify
as independent (provided all other requirements are met), or should
there be some restrictions, such as restrictions on serving as a
director of an affiliate, or participant? Why or why not?
10. The Commission requests comment on whether the proposal to
require independent directors raises any potential legal issues for
those directors or clearing agency governance committee members.
Specifically, as a matter of corporate law, would independent directors
or committee members be forced to contend with competing duties or
obligations to the clearing agency such as under laws of another
jurisdiction, including any duties or obligations that would foreclose
participation in the board or the committees? If so, how may the goal
of receiving independent, diverse opinions be achieved?
11. The Commission requests comment on whether the proposed
approach to board composition and board member independence may raise
compliance issues with respect to being registered with the Commission
and the CFTC or a non-U.S. regulatory authority. If so, what steps
should the Commission take to continue to facilitate dually-registered
clearing agencies?
12. The Commission requests comment on whether the requirement to
undergo a broad consideration of facts and circumstances when
determining whether a board member is independent is sufficiently
clear. Is there additional guidance needed on what sources could be
consulted or what types of relationships could be considered?
13. The Commission is applying the lowered threshold applicable to
registered clearing agencies whose voting interests are majority-held
by participants, or whose parent company's
[[Page 51828]]
voting interests are majority-held by the registered clearing agency's
participants. Does this scope strike the right balance between
permitting flexibility in ownership structures versus providing the
lowered threshold of 34 percent independent directors only when
warranted (i.e., when the interests of participants and owners are less
likely to diverge when participant-owners are the holders of voting
interests)? Why or why not?
14. Should the Commission permit directors who have material
relationships with participants (such as being an employee of a
participant), other than those relationships that are explicitly
precluded in Rule 17Ad-25(f), to meet the definition of independent
director, or should these relationships be precluded as well? Should
the Commission be more restrictive, as is proposed in paragraph (f)(2),
with respect to compensation and payments received from the registered
clearing agency or its affiliates, rather than participants? Why or why
not?
15. The Commission is soliciting comment on how to view participant
clearing fees or other payments from participants that generate revenue
for the clearing agency as a potential scenario that precludes director
independence. Is it sufficiently clear in the text of proposed Rule
17Ad-22(f)(4) that revenues from participants are covered under the
scope of this prohibition? Should the Commission treat revenues from
participants differently from other sources of revenues or
expenditures? Should the Commission create a carve out for lower levels
of revenues in order to promote the opportunity for partners or
controlling shareholders of small participants to be able to qualify as
an independent director, such as by creating a minimum threshold of
payments covered by this provision? Why or why not?
16. The Commission is proposing an extensive list of natural
persons who fall within the definition of family member for this
rulemaking, along with legal entities under their control. Has the
Commission chosen an appropriate scope for the definition of family
member, or is the definition unworkable, either because it is
overbroad, or because it misses an important category of persons?
17. Should the Commission define ``family member'' to refer to
``spouse or spousal equivalent''? Why or why not? Is adding ``spousal
equivalent'' unnecessary because such person would be covered as ``any
person (other than a tenant or employee) sharing a household,'' which
is already part of the definition? Please explain.
18. The Commission is not specifying particular roles for several
aspects of this rulemaking, such as who makes the determination that a
director is an independent director. Should the Commission be more
prescriptive and specify whose responsibility it is to make such a
determination? Why or why not?
B. Nominating Committee
1. Proposed Rule 17Ad-25(c)
Proposed Rule 17Ad-25(c)(1) would require each registered clearing
agency to establish a nominating committee and a written evaluation
process whereby such nominating committee shall evaluate individual
nominees to serve as directors. Proposed Rule 17Ad-25(c)(2) would
require that (i) independent directors comprise a majority of the
nominating committee, and (ii) an independent director chair the
nominating committee. Proposed Rule 17Ad-25(c)(3) would require the
nominating committee to specify and document fitness standards approved
by the board. Such fitness standards for serving as a director would
need to be consistent with all the requirements of proposed Rule 17Ad-
25, and also would include that the individual nominee is not subject
to any statutory disqualification as defined under Section 3(a)(39) of
the Exchange Act.\107\ Proposed Rule 17Ad-25(c)(4) would require the
nominating committee to document the outcome of the clearing agency's
written evaluation process in a manner that is consistent with the
nominating committee's written fitness standards required under
proposed Rule 17Ad-25(c)(3). The process would require the nominating
committee to: (i) take into account each nominee's expertise,
availability, and integrity, and demonstrate that the board, taken as a
whole, has a diversity of skills, knowledge, experience, and
perspectives; (ii) demonstrate that the nominating committee has
considered whether a particular nominee would complement the other
board members, such that, if elected, the board of directors, taken as
a whole, would represent the views of the owners and participants,
including a selection of directors that reflects the range of different
business strategies, models, and sizes across participants, as well as
the range of customers and clients the participants serve; (iii)
demonstrate that the nominating committee considered the views of other
stakeholders who may be impacted by the decisions of the registered
clearing agency, including transfer agents, settlement banks, nostro
agents, liquidity providers, technology or other service providers; and
(iv) identify whether each selected nominee would meet the definition
of independent director in proposed Rules 17Ad-25(a) and (f), and
whether each selected nominee has a known material relationship with
the registered clearing agency or any affiliate thereof, an owner, a
participant, or a representative of another type of stakeholder of the
registered clearing agency described in (iii) above.
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\107\ Section 3(a)(39) of the Exchange Act lists the particular
events that would subject a person to ``statutory disqualification''
with respect to membership or participation in, or association with
a member of, a self-regulatory organization, such as a registered
clearing agency. 15 U.S.C. 78q-1(a)(3)(C).
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2. Discussion
In Part III.A.2, the Commission discussed the importance of
requiring independent directors on the board of a registered clearing
agency to help manage the dynamics that exist between owners and
participants. To help ensure that the nomination process for the
selection of independent directors is thoughtful and transparent,
promote the integrity of determinations that a nominee is independent
and is qualified to serve, and also promote more effective governance,
the Commission is proposing to require a nominating committee that is
composed of a majority of independent directors and chaired by an
independent director. The Commission is proposing to require that the
nominating committee be composed of a majority of independent directors
in all cases, even where a clearing agency is majority-owned by
participants, to help ensure that the evaluation of director nominees
by the nominating committee reflects independent judgment.\108\
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\108\ See supra note 106 and accompanying text (explaining that,
despite the composition requirements for certain board committees
under proposed Rule 17Ad-25(e), the lower independence threshold
under proposed Rule 17Ad-25(b)(1) will not apply to the nominating
committee).
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(a) Requirement for Nominating Committee
Many registered clearing agencies already have a designated
nominating committee.\109\ However, these nominating committees may not
serve as the exclusive governing body for evaluating director nominees.
To create a record that would help to ensure the integrity of the
nominating committee's consideration of each potential nominee's
qualifications, including
[[Page 51829]]
whether such nominee would qualify as an independent director under
proposed Rules 17Ad-25(b), (e), and (f), the Commission believes that
requiring the nominating committee to be the exclusive governing body
for evaluating director nominees helps ensure that director selections
are made consistent with the proposed requirements and without
influence from potential conflicts of interest. Some registered
clearing agencies currently allow other governing bodies and/or
constituents of their organizational structure to select certain
directors.\110\ While the proposed rule would not prohibit such
approaches, it would require that any such nominees be submitted first
to the nominating committee for evaluation--before being considered by
the board--pursuant to a written evaluation process established by the
registered clearing agency. This proposed requirement would help ensure
that nominees are evaluated in a manner consistent with the
requirements for independent directors and other qualifications to
serve.
---------------------------------------------------------------------------
\109\ See infra Part IV.B.4.a)(2) (discussing the current
baseline for the proposed rule).
\110\ For example, OCC currently allows certain participant
exchanges to select Exchange Director nominees for election to OCC's
board. See OCC, By-Laws (rev. Apr. 11, 2022), at 39, <a href="https://www.theocc.com/getmedia/3309eceb-56cf-48fc-b3b3-498669a24572/occ_bylaws.pdf">https://www.theocc.com/getmedia/3309eceb-56cf-48fc-b3b3-498669a24572/occ_bylaws.pdf</a> (``An individual may be nominated by, elected by, and
serve as an Exchange Director for more than one Equity Exchange.'');
see also OCC, Board of Directors Charter and Corporate Governance
Principles (rev. Sept. 22, 2021), at 4, 6, <a href="https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf">https://www.theocc.com/getmedia/99ed48a4-aa44-45ac-8dee-9399b479a1c8/board_of_directors_charter.pdf</a> (providing that Public Director and
Member Director nominees are selected by OCC's Governance and
Nominating Committee, but Exchange Director nominees are instead
selected by OCC's Equity Exchanges).
---------------------------------------------------------------------------
(b) Role of Independent Directors
Not all registered clearing agencies require that the nominating
committee be chaired by an independent director or composed of a
majority of independent directors. As discussed above, however,
independent directors are well-suited to help manage the divergent
interests that exist among management, owners, and participants,\111\
and are also best incentivized to help ensure that nominees do not have
conflicts of interest that would preclude independent decision-making
or otherwise undermine the decisions of the board.\112\ Because a
majority of independent directors can help provide perspectives broader
than owners and participants, constituting the nominating committee
with a majority of independent directors would help promote the fair
representation of owners and participants in the selection of
directors. In addition, independent directors would facilitate a fair
evaluation of a nominee's qualifications, including whether such
individual would meet the Commission's proposed criteria for being an
independent director, as such an evaluation would be conducted by a
body that is free from influence in the performance of its duties and
whose majority would itself satisfy the proposed criteria for being
independent directors. By contrast, when evaluating nominees, directors
serving on the nominating committee who are not independent directors
may be more likely to favor board candidates whose views align with
those persons with whom the director has a material relationship,
reducing the likelihood that the nominating committee will consider a
set of director nominees that represent the different stakeholders in a
clearing agency. Thus, having a nominating committee that is composed
of majority independent directors should help to address and facilitate
both the selection of independent directors, as well as the selection
of a broad range of directors that reflect the different stakeholder
groups in a fair and more representative way.
---------------------------------------------------------------------------
\111\ See supra Part III.A.2 (discussing independent directors
as a governance tool to address such divergent interests).
\112\ See supra Part III.A.2 (discussing independent directors
as a governance tool to address such conflicts).
---------------------------------------------------------------------------
(c) Fitness Standards
Fitness standards for directors help ensure that directors have the
necessary qualifications and experience to contribute more effectively
to board governance, and most clearing agencies already have documented
fitness standards for serving as director. The Commission believes that
codifying this practice by requiring documented fitness standards will
help ensure that directors are subject to consistent standards, fairly
applied over time by the nominating committee and the board. Because
the Commission is proposing rules to require independent directors, the
Commission also believes requiring documented fitness standards will
help ensure that a nominee's qualifications and relationships are
reviewed pursuant to a consistent set of standards before the
nomination is voted on by the board. In addition, the Commission is
establishing that the nominating committee is responsible for
maintaining the fitness standards because the composition of the
nominating committee, in which a majority of directors must be
independent directors, helps ensure that the standards are objective
and evenly applied across nominees and over time because they will be
maintained by a majority of directors from among the objective and
disinterested group of independent directors.
Although many registered clearing agencies already have documented
fitness standards for selecting nominees to serve as directors
generally, not all registered clearing agencies have an existing
requirement to forbid directors who have been subject to a statutory
disqualification. Because such individuals have been found in violation
of applicable laws or suspended from membership or participation in an
SRO, the Commission does not believe such an individual should serve in
the capacity of a director, where functionally the individual would be
in a position to advise and direct the decisions of a registered
clearing agency. The Commission believes that adding such a requirement
helps ensure a nominee's fitness to serve on the board.
(d) Selection Criteria for Directors
Based on its supervisory experience, the Commission believes that
enhancements to clearing agency governance practices would facilitate
the ability of clearing agencies to obtain and address input from a
broader array of market participants, especially on risk management
issues, to improve resilience. Additionally, based on its supervisory
experience, the Commission believes that clearing agencies should
consider the views of relevant stakeholders, such as clearing members
and clients, in their decision-making, as these groups will ultimately
bear the majority of any losses incurred as a result of decisions
affecting the clearing agency's risk profile. Further, based on its
supervisory experience, the Commission believes that smaller
participants and clients of participants should be represented on
clearing agency boards and board committees, including the risk
management committee, such that their views and perspectives are
formally considered in board decisions that may impact them. In the
Commission's view, the diverse perspectives and expertise that smaller
participants and clients of participants can provide will help inform a
clearing agency's operations and thereby improve the resilience of the
registered clearing agency. Therefore, the Commission believes that
board governance of the risk management function of the clearing agency
will be enhanced when it has the benefit of more diverse perspectives
on relevant risk management issues from across the range of
stakeholders--owners, direct participants, and indirect participants--
[[Page 51830]]
in a registered clearing agency. Accordingly, proposed Rules 17Ad-
25(c)(4)(i), (ii), and (iii) would require that clearing agencies take
steps to facilitate diverse perspectives and expertise on the board of
directors, as well as greater involvement by these stakeholders.
In the Commission's view, the proposed rules would complement the
Exchange Act requirements for fair representation of owners and
participants in the clearing agency's selection of directors and the
administration of the clearing agency's affairs.\113\ Proposed Rule
17Ad-25(c)(4)(ii) would help ensure that, when evaluating director
nominees, the nominating committee considers nominees that represent
the views of a broad range of participants with different business
strategies, models, and sizes--such as smaller participants and clients
of participants--for director positions. The Commission believes that
it is useful for the nominating committee to also consider nominees who
are representatives from participants and their clients for director
positions because directors representative of a diverse cross-section
of the clearing agency's participants and clients of participants are
more likely to identify and understand the disparate impacts of
different risks and risk management practices across the full set of
participants and their clients.
---------------------------------------------------------------------------
\113\ See 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------
While proposed Rule 17Ad-25(c)(4)(iii) does not require a
registered clearing agency to include other types of stakeholders in
the selection of directors, the Commission understands that other
stakeholders--including transfer agents, settlement banks, nostro
agents, liquidity providers, technology or other service providers--may
be impacted by board decisions concerning risk management and other
significant operational issues. Therefore, the Commission believes that
board governance may benefit in some instances from considering such
stakeholders' perspectives in the evaluation process for director
nominees. Accordingly, proposed Rule 17Ad-25(c)(4)(iii) would help
ensure that the nominating committee considers the views of other
stakeholders who may be impacted by the decisions of the clearing
agency into the evaluation process for director nominees. In this
regard, the Commission believes that proposed Rule 17Ad-25(c)(4)(iii)
would facilitate a process that considers the wide variety of
perspectives that may have an interest in the risk management purpose
of the clearing agency.
Proposed Rule 17Ad-25(c)(4)(iii) would give the nominating
committee discretion to determine how to consider the views of other
stakeholders, in part based on the markets served by the clearing
agency and the relevant interested stakeholders. In the Commission's
view, relevant stakeholders generally would include persons and
entities that access the national system for clearance and settlement
indirectly (e.g., institutional and retail investors), entities that
rely on the national system for clearance and settlement to more
effectively provide services to investors and market participants, and
other market infrastructures.\114\ The Commission believes that
considering the views of such persons and entities in particular would
support the Exchange Act requirements that clearing agencies be able to
facilitate prompt and accurate clearance and settlement, protect
investors and the public interest, and ensure the safeguarding of
securities and funds in the custody or control of the clearing agency
or for which the clearing agency is responsible.\115\ The Commission
understands that the scope of relevant stakeholders who may be impacted
by the decisions of the registered clearing agency will vary for each
registered clearing agency and could include direct participants,
indirect participants, and other stakeholders described in proposed
Rule 17Ad-25(c)(4)(iii).
---------------------------------------------------------------------------
\114\ See CCA Standards Adopting Release, supra note 13, at
70803 (``Other relevant stakeholders currently include, for example,
transfer agents, liquidity providers, and other linked market
infrastructures, including exchanges, matching service providers,
and payment systems.'').
\115\ See supra Part I and Part II.A; see also 15 U.S.C 78q-
1(b)(3)(A).
---------------------------------------------------------------------------
Finally, proposed Rule 17Ad-25(c)(4)(iv) would require the
nominating committee's process to identify whether each selected
nominee would meet the independent director definition in proposed
Rules 17Ad-25(a) and (f), and whether each selected nominee has a known
material relationship with the registered clearing agency or any
affiliate thereof, an owner, a participant, or a representative of
another stakeholder of the registered clearing agency described in
proposed Rule 17Ad-25(c)(4)(iii). Such record would help to ensure and
verify the integrity and consistency of the nominating committee's
process and adherence to the clearing agency's standards for
independent directors, consistent with proposed Rules 17Ad-25(b), (e),
and (f).
3. Request for Comment
The Commission requests comment on all aspects of proposed Rule
17Ad-25(c). In particular, the Commission requests comment on the
following specific topics:
19. Is it appropriate for the Commission to require that the
nominating committee be the exclusive venue for evaluating nominees for
director to the board of directors? What alternative arrangements or
processes might also be appropriate for evaluating director nominees?
Should the rules incorporate such arrangements? Why or why not? Please
explain.
20. Should the Commission be more prescriptive in requiring that
certain types of stakeholders, such as smaller participants and
customers, be afforded a right of participation in the board of a
clearing agency? Why or why not? If so, which types of stakeholders?
Please explain with specific information.
21. Do commenters agree with the Commission's assessment that
requiring a majority of independent directors on the nominating
committee will improve the quality of nominees? Please explain.
22. Do commenters believe that the proposed rule will help ensure
that the nominating committee considers nominees that represent the
views of smaller participants and clients of participants? Please
explain. Should the Commission consider additional specific composition
requirements? Why or why not? If so, what should those requirements be?
23. Has the Commission provided sufficient specificity regarding
the scope and content of the evaluation process for director nominees?
Please identify and explain other types of criteria, if any, that
should be included in the evaluation process for director nominees.
Please identify and explain any proposed criteria that should be
excluded from the evaluation process for director nominees.
C. Risk Management Committee
1. Proposed Rule 17Ad-25(d)
Proposed Rule 17Ad-25(d)(1) would require each registered clearing
agency to establish a risk management committee (or committees) to
assist the board of directors in overseeing the risk management of the
registered clearing agency. Proposed Rule 17Ad-25(d)(1) would also
require each risk management committee to reconstitute its membership
on a regular basis and at all times include representatives from the
owners and participants of the registered clearing agency. Proposed
Rule 17Ad-25(d)(2) would require that a risk management committee, in
the
[[Page 51831]]
performance of its duties, be able to provide a risk-based,
independent, and informed opinion on all matters presented to it for
consideration in a manner that supports the safety and efficiency of
the registered clearing agency.
2. Discussion
(a) Purpose and Experience of the Risk Management Committee
Covered clearing agencies are subject to the requirements of Rule
17Ad-22(e) under the Exchange Act, while all registered clearing
agencies other than covered clearing agencies are subject to the
requirements of Rule 17Ad-22(d) under the Exchange Act.\116\ Currently,
all registered clearing agencies are covered clearing agencies and, as
such, they are required to have risk management committees as a part of
their governance arrangements under Rule 17Ad-22(e)(3)(iv).\117\ While
Rule 17Ad-22(e)(3)(iv) requires covered clearing agencies to have a
risk management committee, no parallel requirement exists for
registered clearing agencies that are subject to Rule 17Ad-22(d). The
Commission recognizes that there may be future registered clearing
agencies that are not covered clearing agencies and, as a result, would
be subject to Rule 17Ad-22(d). The Commission believes that clearing
agencies subject to Rule 17Ad-22(d) will also likely face risk
management issues related to their activities and, therefore, that any
clearing agency subject to Rule 17Ad-22(d) will likely benefit from
having a risk management committee. Accordingly, the Commission is
proposing Rule 17Ad-25(d) so that clearing agencies subject to Rule
17Ad-22(d) will also be required to have risk management committees as
a part of their governance arrangements.\118\ Additionally, because the
general requirement for a risk management committee under Rule 17Ad-
22(e)(3)(iv) does not outline minimum requirements for such committee,
proposed Rule 17Ad-25(d) establishes more defined requirements related
to the purpose and function of risk management committees. The specific
requirements imposed by proposed Rule 17Ad-25(d) will help enhance risk
management governance across all registered clearing agencies.
---------------------------------------------------------------------------
\116\ See supra notes 17-23 and accompanying text (explaining
that there are two categories of clearing agencies: covered clearing
agencies and all registered clearing agencies other than covered
clearing agencies).
\117\ See 17 CFR 240.17Ad-22(e)(3)(iv); see also CCA Standards
Adopting Release, supra note 13, at 70807-09 (discussing that, under
Rule 17Ad-22(e)(3)(iv), a registered clearing agency's risk
management framework must provide risk management personnel with a
direct reporting line to, and oversight by, a risk management
committee of the board of directors).
\118\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)(1), which requires a risk management committee to assist the
board in overseeing the risk management of a registered clearing
agency); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
As discussed above, each registered clearing agency is also a
covered clearing agency and, therefore, has established some form of
risk management committee to consider risk issues generally.\119\
Critical to the effective functioning of a clearing agency is the
board's ability to understand and engage with the risks that a
registered clearing agency faces and the risk management practices it
employs to mitigate those risks. The Commission recognizes that while
the board has ultimate responsibility over risk management matters, it
may assign certain tasks to a board committee to assist the board in
discharging its ultimate responsibility.\120\ Therefore, the Commission
believes that a risk management committee of the board is a more
effective way to help ensure that the board is engaged with and
informed of the ongoing risk management of the clearing agency, and
that a dedicated committee of the board remains focused exclusively on
matters related to risk management. The Commission believes that
requiring registered clearing agencies to establish a risk management
committee of the board would help ensure that the board can more
effectively oversee management's decisions concerning matters that
implicate the clearing agency's risk management, including its
policies, procedures, and tools for mitigating risk.
---------------------------------------------------------------------------
\119\ See infra Part IV.B.4.a)(3).
\120\ See CCP Resilience Guidance, supra note 77, at 5.
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In addition, for the risk management committee itself to be
effective, it must have a clearly defined purpose and obligations to
the board. Accordingly, proposed Rule 17Ad-25(d)(2) would require that
a risk management committee, in the performance of its duties, be able
to provide a risk-based, independent, and informed opinion on all
matters presented to it for consideration in a manner that supports the
safety and efficiency of the registered clearing agency. The proposed
rule is intended to specify the role of the risk management committee
by stating the committee's purpose--namely, to provide a risk-based,
independent, and informed opinion on all matters presented to it in a
way that supports the safety and efficiency of the registered clearing
agency. The Commission believes the proposed rule helps ensure that the
committee has a clear scope and sufficient direction to more
effectively address risk management related matters, regardless of the
participants, markets, and products that a clearing agency serves.
First, with respect to its purpose, the risk management committee's
opinions must be risk-based, meaning that its opinions are focused on
both the risks that the clearing agency faces and the tools at its
disposal to mitigate and address such risks. To facilitate such an
approach, the proposed rule provides that the risk management committee
must be able to provide an opinion that supports the safety and
efficiency of the clearing agency itself. As a result, the Commission
believes that when the risk management committee makes recommendations
to the board, its opinions should reflect how the decisions support the
safety and efficiency of the clearing agency. In the Commission's view,
the stated objective of supporting the safety and efficiency of the
clearing agency helps ensure that the risk management committee's
recommendations represent the best interests of the clearing agency.
Second, the risk management committee's opinions must be independent.
That is, when making recommendations to the board, the risk management
committee's decisions or opinions must be its own, mindful of the
objective discussed above, and not merely a rubber stamp for the
recommendations presented to the committee by management. The
Commission believes that, by requiring the risk management committee to
provide an independent opinion, irrespective of its composition, the
proposed rule helps ensure that the committee is free from influence in
the performance of its duties.
Finally, the risk management committee's opinions must be informed.
That is, when making recommendations to the board, the risk management
committee's opinions should demonstrate that the committee was able to
engage thoughtfully and knowledgeably with the matters presented to it.
In this regard, for the risk management committee to provide an
informed opinion, its members should have a clear understanding of the
clearing agency's operations and risk management procedures, including
the risks that it faces and its methods of addressing such risks.
Accordingly, the Commission believes that, in complying with this
proposed requirement, the risk management committee generally should
include directors with specific risk management expertise and
[[Page 51832]]
experience related to the risks that the clearing agency faces.\121\
Because the risks a clearing agency faces will vary depending on the
products it clears and the markets it serves, the Commission believes
that a clearing agency should have discretion to determine the
appropriate qualifications and expertise needed for the risk management
committee to provide an informed opinion. The Commission also believes
that, by requiring the risk management committee to provide an informed
opinion, the proposed rule helps ensure that the committee's
recommendations are more reliable and effective. In the Commission's
view, the risk management committee's ability to provide risk-based,
independent, and informed opinions is critical to the proper
functioning and effectiveness of the committee.
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\121\ The Commission has previously recognized that, because
clearing and settlement is a highly specialized area, specific risk
management expertise and experience are needed to serve on the risk
management committee and make informed decisions. See Regulation MC
Proposing Release, supra note 1, at 65899, 65921 (discussing the
``highly specialized risk management expertise required of directors
serving on [the risk management] committee'').
---------------------------------------------------------------------------
(b) Representation of Owners and Participants
Commission rules do not currently require a registered clearing
agency to include representatives from the clearing agency's owners and
participants on the risk management committee. Based on its supervisory
experience, the Commission believes that clearing agencies will benefit
from the diverse perspectives and expertise that representatives from
owners and participants can provide, which enhances the effectiveness
of their risk management practices. With this in mind, the Commission
is proposing that the risk management committee at all times include
representatives from the owners and participants of the registered
clearing agency.\122\ In the Commission's view, these representatives
would be persons who have a relationship with the clearing agency's
owners and participants, such as employees of the owners and
participants or those who have an ownership interest in the owners and
participants. Based on its supervisory experience, the Commission
believes that representatives from a clearing agency's owners and
participants will likely have an understanding of the clearing agency's
operations and procedures, as well as the complex risk management
issues that the clearing agency's board must consider. In this regard,
requiring the risk management committee to include representatives from
the clearing agency's owners and participants helps ensure that the
risk management committee's recommendations to the board reflect these
stakeholders' unique perspectives and expertise on risk management
issues.
---------------------------------------------------------------------------
\122\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)(1)); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
Proposed Rule 17Ad-25(d)(1) requires that the risk management
committee at all times include multiple representatives from the owners
and participants of the registered clearing agency. By requiring the
risk management committee to include representatives from the clearing
agency's owners and participants, the Commission believes that the
committee will likely include representation from a broad range of
participants with different business strategies, models, and sizes. The
committee generally should include both small and large participants.
The Commission recognizes that, other than requiring that multiple
representatives from the clearing agency's owners and participants
serve on the committee at all times, the proposed rule does not require
that a certain percentage or number of such representatives serve on
the committee. Accordingly, the Commission believes that the proposed
rule provides a registered clearing agency with some discretion to
determine the appropriate composition for the risk management committee
with respect to representation from its owners and participants. By
requiring that the risk management committee include multiple
representatives from the owners and participants of the clearing
agency, the proposed rule helps ensure a minimum standard for the
inclusion of market participants on risk management committees while
providing sufficient flexibility to registered clearing agencies given
the range of different sizes, business models, and governance
structures across clearing agencies.
(c) Requirement To Reconstitute Membership
Many registered clearing agencies have established policies and
procedures for governance arrangements that help promote participation
from a broader array of owners and participants on the risk management
committee through the use of regular reconstitution.\123\ The
Commission believes that codifying this practice will set a minimum
standard for the reconstitution of the risk management committee's
membership. Therefore, the Commission is proposing that the risk
management committee reconstitute its membership on a regular
basis.\124\ Requiring the risk management committee to regularly
reconstitute its membership helps ensure that a broad range of owners
and participants will be able to provide their risk management
expertise and participate in the decision-making of the risk management
committee over time. In the Commission's view, the proposed
reconstitution requirement achieves the above objective of ensuring a
broad range of participation on the risk management committee without
imposing specific obligations related to owners, participants, or
independent directors that may be suitable in some, but not necessarily
all, cases.
---------------------------------------------------------------------------
\123\ See, e.g., ICC, ICE Clear Credit Regulation and Governance
Fact Sheet, at 3 (April 2022), <a href="https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf">https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Regulation_and_Governance.pdf</a>; OCC,
Risk Committee Charter, at 1 (rev. Sept. 22, 2021), <a href="https://www.theocc.com/getmedia/e71a4c1d-52dc-4c95-aeb1-98dab9159f41/risk_committee_charter.pdf">https://www.theocc.com/getmedia/e71a4c1d-52dc-4c95-aeb1-98dab9159f41/risk_committee_charter.pdf</a>.
\124\ See supra Part III.C.1 (discussing proposed Rule 17Ad-
25(d)(1)); infra Part VIII (providing the proposed rule text).
---------------------------------------------------------------------------
Because the risk management committee is broadly responsible for
providing recommendations to the board on all risk management related
matters, it is important that the committee's membership reflects a
wide range of owners and participants with relevant experience and
expertise on a variety of risk management issues. By requiring the risk
management committee to regularly reconstitute its membership, proposed
Rule 17Ad-25(d)(1) helps ensure ongoing diversity of perspectives
across owners and participants and expertise on the risk management
committee. The Commission believes the proposed reconstitution
requirement helps ensure that the risk management committee is well-
positioned to provide more effective recommendations to the board on
all risk management matters. The Commission also believes the proposed
reconstitution requirement helps ensure that the committee is able to
provide fresh perspectives on risk management matters, which, in turn,
helps promote more effective and reliable risk management practices at
a registered clearing agency.
The Commission acknowledges that proposed Rule 17Ad-25(d)(1) only
requires the risk management committee to reconstitute its membership
``on a regular basis.'' In this regard, the proposed rule provides a
registered clearing agency with discretion to
[[Page 51833]]
determine the appropriate timing for reconstitution. For example, the
charter for a registered clearing agency's risk management committee
could establish that the committee will conduct a review of its members
on an annual basis, or other specified length of time, to assess
whether the committee continues to be an accurate reflection of the
clearing agency's owners and participants. The charter could also
establish that members of the committee serve for a specified term, or
that the committee would rotate or replace directors on the committee
at certain intervals absent a specified turnover threshold among
directors. Additionally, registered clearing agencies could stagger
terms in order to have regular turnover of participants and other
members of the risk management committee.
3. Request for Comment
The Commission generally requests comments on all aspects of
proposed Rule 17Ad-25(d). In addition, the Commission requests comments
on the following specific issues:
24. The Commission is not proposing to carve out the risk
management committee from the director independence requirements under
proposed Rule 17Ad-25(e). Should the Commission include such a carve-
out for the risk management committee so that a registered clearing
agency would not be required to include independent directors on the
committee? Why or why not? If not, should there be separate director
independence requirements applicable only to the risk management
committee that reflect the highly specialized risk management expertise
needed to serve on the committee? Why or why not?
25. Is the proposed requirement that the registered clearing
agency's risk management committee be a committee of the board a more
effective way to structure the risk management committee than requiring
that the risk management committee be an external committee, such as a
management committee or an advisory committee? Why or why not? If not,
should the risk management committee be structured to represent more
participants, regardless of whether those participants are represented
on a clearing agency's board? Why or why not?
26. The Commission is not specifying whose responsibility it is to
determine the matters presented to the risk management committee for
consideration. Should the Commission be more prescriptive and specify
whose responsibility it is to make such determinations? If so, should
the Commission require the risk management committee to designate
thresholds or identify the types of risk management related matters
that warrant consideration by the committee? Why or why not? Please
explain.
27. Is the proposed requirement that the risk management committee
include at all times representatives from the registered clearing
agency's owners and participants sufficient to help ensure that the
directors serving on the committee will have the specific risk
management expertise and relevant experience needed to make effective
risk management decisions? Why or why not? In requiring that the risk
management committee include such representatives at all times, should
the Commission require that a specific percentage or number of
representatives from the clearing agency's owners and participants
serve on the risk management committee? Why or why not? If so, what
percentage or number? Please explain with specific information.
28. Should the Commission require the risk management committee to
include at all times a specific percentage or number of representatives
from small participants of the clearing agency in addition to
representatives from the owners and participants more generally, as
proposed? Why or why not? If so, what percentage or number? Please
explain with specific information.
29. The Commission is not specifying whose responsibility it is to
determine the appropriate qualifications and expertise needed for a
director to serve on the risk management committee. Should the
Commission be more prescriptive and specify whose responsibility it is
to make this determination, such as the nominating committee, or should
this determination remain up to the discretion of the registered
clearing agency? Why or why not? Please explain.
30. The Commission requests comment on whether the requirement that
a risk management committee ``reconstitute'' its membership on a
regular basis is sufficiently clear. Is there additional guidance
needed on what ``reconstitute'' means? Is it sufficiently clear that
the term ``reconstitute'' refers to the membership of the risk
management committee and not to the form of the committee? Why or why
not? Should the Commission instead require that the membership be
``rotated''? \125\ Please explain.
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\125\ The CFTC's proposal would require a risk management
committee to ``rotate'' its membership on a regular basis. See supra
note 52 and accompanying text.
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31. Has the Commission provided a sufficient explanation for what
constitutes ``on a regular basis'' with respect to how often a risk
management committee is required to reconstitute its membership? Why or
why not? Would a more specific reconstitution requirement be
appropriate? For example, should this requirement specify a frequency
for the risk management committee's reconstitution (e.g., annually)?
Why or why not? If so, please explain what the appropriate frequency
should be.
D. Conflicts of Interest
1. Proposed Rules 17Ad-25(g) and (h)
Proposed Rule 17Ad-25(g) would require each registered clearing
agency to establish, implement, maintain, and enforce written policies
and procedures reasonably designed to identify and document existing or
potential conflicts of interest in the decision-making process of the
clearing agency involving directors or senior managers of the
registered clearing agency; and mitigate or eliminate and document the
mitigation or elimination of such conflicts of interest. Additionally,
proposed Rule 17Ad-25(h) would require registered clearing agencies to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to require a director to document and
inform the registered clearing agency promptly of the existence of any
relationship or interest that reasonably could affect the independent
judgment or decision-making of the director.
2. Discussion
At the time of the 2016 CCA Standards Adopting Release, the
Commission declined to incorporate more prescriptive governance
elements into the rule as urged by commenters, including specific
requirements on conflicts of interest,\126\ based on the premise that
the requirements in Section 17A of the Exchange Act relating to fair
representation and the public interest provided sufficient
[[Page 51834]]
grounds to hold covered clearing agencies accountable to these
concerns.\127\ At the time, the Commission also observed that as a
general matter, the market for clearing agency services demonstrates
evidence of a significant volume of activity being concentrated in a
small number of large financial institutions.\128\ The concentration of
clearing and settlement services within a handful of entities
continues, suggesting that additional interventions may be
appropriate.\129\ The Commission is concerned that this characteristic
could impede the continued development of open, transparent, and
competitive markets and, therefore, believes it is appropriate to
propose requirements on registered clearing agencies on mitigating or
eliminating conflicts of interest so that such conflicts do not
undermine the integrity of decisions made in the governance of the
clearing agency. The proposed rules are intended to address concerns
that the institutions that currently dominate the securities markets
would have conflicts of interest that influence their participation in
the development of centralized trading and clearance and settlement
systems for securities. As they relate to clearing agencies that clear
security-based swaps, the proposed rules would also advance the policy
objectives set forth in Section 765 by establishing new requirements
for policies and procedures that require such clearing agencies to
identify, mitigate or eliminate, and document the identification and
mitigation or elimination of conflicts of interest.
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\126\ See CCA Standards Adopting Release, supra note 13, at
70804 (stating that ``[o]ne commenter stated that proposed Rule
17Ad-22(e)(2) does not require covered clearing agencies to resolve
conflicts of interests among board members and management and urged
the Commission explicitly to require covered clearing agencies to
document and maintain policies and procedures governing the
resolution of conflicts of interests that may impact certain
decisions by the board of directors. The Commission notes . . . that
the commenter's concern is addressed by Section 17A(b)(3)(F) of the
Exchange Act, which requires that the rules of a clearing agency be
designed, in general, to protect investors and the public
interest'').
\127\ See 15 U.S.C. 78q-1(b)(3)(C).
\128\ See CCA Standards Adopting Release, supra note 13, at
70793 (stating that ``the Commission has considered the level of
concentration in the provision of clearing agency services'' and
acknowledging concerns ``that at present the clearance and
settlement industry, like much of the financial sector, can be
described as highly concentrated, and . . . that it is paramount . .
. [to] promote the proliferation of viable new clearing agencies,
given that existing clearing agencies typically serve as
intermediaries for trillions of dollars in trading volumes'').
\129\ See Staff Report on Clearing Agencies, supra note 27, at
21.
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With the above in mind, requirements on registered clearing
agencies to address conflicts of interest would strengthen the
integrity of a registered clearing agency's governance arrangements,
including those regarding director independence, the fitness standards
applied and nominations made by the nominating committee, and the
independent opinions and recommendations made by the risk management
committee previously discussed. Proposed Rules 17Ad-25(g) and (h) help
promote the integrity of these governance arrangements by helping
ensure that a registered clearing agency is capable of both identifying
potential conflicts when they arise and subjecting conflicts to a
transparent and uniform process of review, mitigation or elimination,
and documentation. Specifically, the proposed rules would help ensure
that potential conflicts of interest are identified and documented,
that policies and procedures for their management have been established
ex ante to help ensure a consistent approach over time, and that cases
are subject to established processes for review and mitigation or
elimination. In some cases, for example, a conflicts of interest policy
may simply require that a director or senior manager recuse herself
from a particular decision to mitigate or eliminate the conflict of
interest. At the same time, the Commission believes that disclosure,
while an effective tool for the clearing agency to identify and
recognize a conflict of interest, is insufficient by itself to reduce
the potential harm a conflict of interest may have on the clearing
agency. Instead, the Commission believes that as the clearing agency is
best positioned to identify and address conflicts of interest that may
arise in its operations and risk management and decision-making, the
clearing agency is best positioned through reasonable policies and
procedures to mitigate--namely, reduce--or eliminate these conflicts of
interest so that such conflicts do not undermine the integrity of
decisions made in the governance of the clearing agency. In addition,
the policies and procedures approach helps ensure the documentation of
conflicts of interest and their mitigation or elimination, helping the
Commission to assess and compare the types of conflicts that arise
across clearing agencies to help promote more effective oversight and
regulation of clearing agencies.
In the absence of policies and procedures to address conflicts of
interest, directors and senior managers of a registered clearing agency
could undermine the purpose of requiring independent directors and
centralizing the nominating process for new directors in a nominating
committee composed of a majority of independent directors. More
broadly, the proposed rules help to ensure that when directors and
senior managers develop relationships that create potential conflicts
of interest, the clearing agency has a process to manage those
relationships to mitigate or eliminate conflicts so that they do not
undermine the integrity of decisions made in the governance of the
clearing agency.
(a) Potential Conflicts
Under proposed Rule 17Ad-25(g), the registered clearing agency must
be able to identify and document both existing and potential conflicts
of interest involving directors or senior managers of the registered
clearing agency. The rule is intended to address the conflicts of
interests of directors and senior managers that could undermine the
decision-making process within a registered clearing agency or
interfere with fair representation and equitable treatment of clearing
members or other market participants by a registered clearing agency.
Being able to identify potential conflicts of interest is critical to
ensuring the effective identification and management of actual
conflicts of interest. In other words, a clearing agency must be able
to spot close cases, where another director, manager, employee, or
observer might perceive a conflict of interest, in order to more
effectively manage actual conflicts and help ensure the integrity of
decisions made in the governance of the clearing agency.
As previously discussed in Part II.A, it is important for the
registered clearing agency to consider the differing incentives and
interests of individual directors, once they are on the board, when
they are governing the registered clearing agency. The board as a whole
is ultimately responsible for overseeing the clearing agency's
compliance with the regulatory obligations under the Dodd-Frank Act and
the Exchange Act, including the open and fair access requirements.\130\
Yet, depending on their affiliation with owners, large participants,
small participants, or indirect participants, individual directors may
be subject to different perspectives and motivations when fulfilling
these duties and roles. Like participants themselves, direct
participant directors may on balance be more likely to favor reducing
or minimizing the risk exposure of the clearing agency, potentially at
the expense of more open access; in contrast, indirect participant
directors may be inclined to favor expanded access to products and
services, which may increase the amount of risk that the clearing
agency must successfully manage.\131\
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\130\ See Regulation MC Proposing Release, supra note 1, at
65888.
\131\ See id.
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The Commission believes that because interests and incentives may
vary among directors and over time for
[[Page 51835]]
a range of reasons, it is not possible to predict how any individual
director will address particular matters. For this reason, the approach
taken in proposed Rule 17Ad-25(g)--as well as proposed Rule 17Ad-
25(h)--is intended to achieve an appropriate balance among these
various considerations by taking a principles-based approach to
addressing conflicts of interest. While the proposed rule provides the
registered clearing agency with a certain level of discretion to
address specific facts and circumstances it faces in light of its
governance structure, the product it clears, and the market it serves,
it is designed to complement other applicable, more prescriptive
requirements in this proposal, which the registered clearing agency may
also separately apply where relevant. Additionally, the proposed rule
is intended to limit the clearing agency's discretion through more
prescriptive procedural requirements the clearing agency must undertake
to establish, implement, maintain, and enforce written policies and
procedures reasonably designed to document the identification,
mitigation or elimination of conflicts of interest under proposed Rule
17Ad-25(g).
(b) Obligation of Dire
[…truncated; see source link]Indexed from Federal Register on August 23, 2022.
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