Rule2024-05322
Financial Market Utilities
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
March 15, 2024
Effective
April 15, 2024
Issuing agencies
Federal Reserve System
Abstract
The Board of Governors of the Federal Reserve System (Board) is publishing a final rule amending the requirements relating to operational risk management in the Board's Regulation HH, which applies to certain financial market utilities (FMUs) that have been designated as systemically important (designated FMUs) by the Financial Stability Oversight Council (FSOC) under Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act or Act). The amendments update, refine, and add specificity to the operational risk management requirements in Regulation HH to reflect changes in the operational risk, technology, and regulatory landscape in which designated FMUs operate. The final rule also adopts specific incident- notification requirements.
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[Federal Register Volume 89, Number 52 (Friday, March 15, 2024)]
[Rules and Regulations]
[Pages 18749-18767]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-05322]
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Rules and Regulations
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
to and codified in the Code of Federal Regulations, which is published
under 50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by the Superintendent of Documents.
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Federal Register / Vol. 89, No. 52 / Friday, March 15, 2024 / Rules
and Regulations
[[Page 18749]]
FEDERAL RESERVE SYSTEM
12 CFR Part 234
[Regulation HH; Docket No. R-1782]
RIN 7100-AG40
Financial Market Utilities
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board)
is publishing a final rule amending the requirements relating to
operational risk management in the Board's Regulation HH, which applies
to certain financial market utilities (FMUs) that have been designated
as systemically important (designated FMUs) by the Financial Stability
Oversight Council (FSOC) under Title VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (the Dodd-Frank Act or Act). The
amendments update, refine, and add specificity to the operational risk
management requirements in Regulation HH to reflect changes in the
operational risk, technology, and regulatory landscape in which
designated FMUs operate. The final rule also adopts specific incident-
notification requirements.
DATES:
Effective date: The final rule is effective April 15, 2024.
Compliance dates: Designated FMUs must be in compliance with the
rule by September 11, 2024, except for the incident management and
notification requirement in Sec. 234.3(a)(17)(vi), under Amendatory
Instruction 3, with which designated FMUs must be in compliance by June
13, 2024.
FOR FURTHER INFORMATION CONTACT: Emily Caron, Assistant Director (202-
452-5261) or Katherine Standbridge, Senior Financial Institution and
Policy Analyst (202-452-3873), Division of Reserve Bank Operations and
Payment Systems; or Corinne Milliken Van Ness, Senior Counsel (202-452-
2421) or M. Benjamin Snodgrass, Senior Counsel (202-263-4877), Legal
Division. For users of TTY-TRS, please call 711 from any telephone,
anywhere in the United States.
SUPPLEMENTARY INFORMATION:
I. Overview
Title VIII of the Dodd-Frank Act, titled the ``Payment, Clearing,
and Settlement Supervision Act of 2010,'' was enacted to mitigate
systemic risk in the financial system and to promote financial
stability, in part, through an enhanced supervisory framework for
designated FMUs. Section 803(6) of the Act defines an FMU as a ``person
that manages or operates 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 person.'' \1\ Pursuant to section
805(a)(1)(A) of the Act, and as described below, the Board is required
to prescribe risk-management standards governing the operations related
to the payment, clearing, and settlement activities of certain
designated FMUs.
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\1\ 12 U.S.C. 5462(6).
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The Board adopted Regulation HH, Designated Financial Market
Utilities, in July 2012 to implement, among other things, the statutory
provisions under section 805(a)(1)(A) of the Act.\2\ In November 2014,
the Board published amendments to the risk-management standards in
Regulation HH, 12 CFR part 234, based on the Principles for Financial
Market Infrastructures (PFMI).\3\
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\2\ 77 FR 45907 (Aug. 2, 2012).
\3\ 79 FR 65543 (Nov. 5, 2014). The PFMI, published by the
Committee on Payment and Settlement Systems (now the Committee on
Payments and Market Infrastructures) and the Technical Committee of
the International Organization of Securities Commissions in April
2012, is widely recognized as the most relevant set of international
risk-management standards for payment, clearing, and settlement
systems.
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In October 2022, the Board published for comment a notice of
proposed rulemaking (NPRM) to amend the requirements relating to
operational risk management in Regulation HH. The Board proposed to
update, refine, and add specificity to the operational risk management
requirements in Regulation HH. The proposed amendments reflected
changes in the operational risk, technology, and regulatory landscape
in which designated FMUs operate since the Board last amended
Regulation HH in 2014. The Board also proposed to adopt specific
incident-notification requirements.\4\ The public comment period for
the proposed amendments closed on December 5, 2022. The Board is now
adopting final amendments to Regulation HH, with modifications to
certain sections of the proposal as discussed below.
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\4\ 87 FR 60314 (Oct. 5, 2022).
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II. Background
A. Financial Market Utilities
FMUs provide essential infrastructure to clear and settle payments
and other financial transactions. Financial institutions, including
banking organizations, participate in FMU arrangements pursuant to a
common set of rules and procedures, technical infrastructure, and risk-
management framework.
If a systemically important FMU fails to perform as expected or
fails to effectively measure, monitor, and manage its risks, it could
pose significant risk to its participants and the financial system more
broadly. For example, the inability of an FMU to complete settlement on
time could create credit or liquidity problems for its participants or
other FMUs. An FMU, therefore, should have a robust risk-management
framework, including appropriate policies and procedures to measure,
monitor, and manage the range of risks that arise in or are borne by
the FMU.
B. Title VIII of the Dodd-Frank Act
In recognition of the criticality of FMUs to the stability of the
financial system, Title VIII of the Dodd-Frank Act established a
framework for enhanced supervision of certain FMUs. Section 804 of the
Act states that the FSOC shall designate those FMUs that it determines
are, or are likely to become, systemically important. Such a
designation by the FSOC makes an FMU subject to the supervisory
framework set out in Title VIII of the Act.
Section 805(a)(1)(A) of the Act requires the Board to prescribe
risk-management standards governing the operations related to payment,
clearing, and settlement activities of designated
[[Page 18750]]
FMUs.\5\ As set out in section 805(b) of the Act, the applicable risk-
management standards must (1) promote robust risk management, (2)
promote safety and soundness, (3) reduce systemic risks, and (4)
support the stability of the broader financial system.\6\
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\5\ 12 U.S.C. 5464(a)(1). The Act directs the Board to ``tak[e]
into consideration relevant international standards and existing
prudential requirements'' when it promulgates these risk-management
standards. Id. In addition, section 805(a)(2) of the Act grants the
U.S. Commodity Futures Trading Commission (CFTC) and the U.S.
Securities and Exchange Commission (SEC) the authority to prescribe
such risk-management standards for a designated FMU that is,
respectively, a derivatives clearing organization (DCO) registered
under section 5b of the Commodity Exchange Act or a clearing agency
registered under section 17A of the Securities Exchange Act of 1934.
12 U.S.C. 5464(a)(2).
\6\ Further, under section 805(c), the risk-management standards
may address areas such as (1) risk-management policies and
procedures, (2) margin and collateral requirements, (3) participant
or counterparty default policies and procedures, (4) the ability to
complete timely clearing and settlement of financial transactions,
(5) capital and financial resource requirements for designated FMUs,
and (6) other areas that are necessary to achieve the objectives and
principles for risk-management standards. 12 U.S.C. 5464(c).
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A designated FMU is subject to examination by the federal agency
that has primary jurisdiction over the FMU under federal banking,
securities, or commodity futures laws (the ``Supervisory Agency'').\7\
At present, the FSOC has designated eight FMUs as systemically
important, and the Board is the Supervisory Agency for two of these
designated FMUs--The Clearing House Payments Company, L.L.C. (on the
basis of its role as operator of the Clearing House Interbank Payments
System (CHIPS)) and CLS Bank International.\8\ The risk-management
standards in the Board's Regulation HH apply to Board-supervised
designated FMUs.\9\
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\7\ The Act's definition of ``Supervisory Agency'' is codified
at 12 U.S.C. 5462(8). Section 807 of the Act authorizes the
Supervisory Agencies to examine and take enforcement actions against
the Supervisory Agencies' respective designated FMUs. The Act also
describes certain authorities that the Board has with respect to
designated FMUs for which it is not the Supervisory Agency, such as
participation in examinations and recommendations on enforcement
actions. 12 U.S.C. 5466.
\8\ The SEC is the Supervisory Agency for The Depository Trust
Company (DTC); Fixed Income Clearing Corporation (FICC); National
Securities Clearing Corporation (NSCC); and The Options Clearing
Corporation (OCC). The CFTC is the Supervisory Agency for the
Chicago Mercantile Exchange, Inc. (CME); and ICE Clear Credit LLC
(ICC). See U.S. Department of the Treasury, Financial Market Utility
Designations, <a href="https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/fsoc/designations">https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/fsoc/designations</a>.
\9\ The risk-management standards in Regulation HH would also
apply to any designated FMU for which another Federal banking agency
is the Supervisory Agency. At this time, there are no such
designated FMUs.
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C. Regulation HH Risk-Management Standards for Designated FMUs
Section 234.3 of Regulation HH includes a set of 23 risk-management
standards addressing governance, transparency, and the various risks
that can arise in connection with a designated FMU's payment, clearing,
and settlement activities, including legal, financial, and operational
risks. These standards are based on and generally consistent with the
PFMI. The Regulation HH standards generally employ a flexible,
principles-based approach. In several cases, however, the Board adopted
specific minimum requirements that a designated FMU must meet in order
to achieve the overall objective of a particular standard.
1. Operational Risk Management
Section 234.3(a)(17) of Regulation HH, as amended in 2014, requires
that a designated FMU manage its operational risks by establishing a
robust operational risk-management framework that is approved by its
board of directors.\10\ Specifically, a designated FMU must (1)
identify and mitigate its plausible sources of operational risk; (2)
identify, monitor, and manage the operational risks it may pose to
other FMUs and trade repositories; (3) ensure a high degree of security
and operational reliability; (4) have adequate, scalable capacity to
handle increasing stress volumes; (5) address potential and evolving
vulnerabilities and threats; and (6) provide for rapid recovery and
timely resumption of critical operations and fulfillment of
obligations, including in the event of a wide-scale or major
disruption. Section 234.3(a)(17) also contains several specific minimum
requirements for business continuity planning, including a requirement
for the designated FMU to have a business continuity plan that (1)
incorporates the use of a secondary site at a location with a distinct
risk profile from the primary site; (2) is designed to enable critical
systems to recover and resume operations no later than two hours
following disruptive events; (3) is designed to enable it to complete
settlement by the end of the day of the disruption, even in case of
extreme circumstances; and (4) is tested at least annually.\11\
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\10\ In this SUPPLEMENTARY INFORMATION, Sec. 234.4(a)(17) will
be informally referred to as the ``operational risk management
standard.''
\11\ 12 CFR 234.3(a)(17)(vii).
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Although the term ``operational risk'' is not defined in current
Regulation HH, when the Board proposed amendments to Sec. 234.3(a)(17)
in 2014, it described operational risk as the risk that deficiencies in
information systems, internal processes, and personnel or disruptions
from external events will result in the deterioration or breakdown of
services provided by an FMU.\12\ Consistent with an all-hazards view of
managing operational risk, the Board believes operational risk could
arise internally and externally. Internal sources of operational risk
include the designated FMU's people, processes, and technology.\13\
External sources of operational risk are those that fall outside the
direct control of a designated FMU. For example, external sources of
operational risk can include the designated FMU's participants and
other entities, such as other FMUs, settlement banks, liquidity
providers, and service providers, which may transmit threats through
their various connections to the designated FMU. External sources of
operational risk also include physical events, such as pandemics,
natural disasters, and other destruction of property, as well as
information security threats, such as cyberattacks and technology
supply chain vulnerabilities. These internal and external sources of
operational risk can manifest in different scenarios (including wide-
scale or major disruptions) and can result in the reduction,
deterioration, or breakdown of services that a designated FMU provides.
A designated FMU must plan for these types of scenarios and test its
systems, polices, procedures, and controls against them.
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\12\ 79 FR 3666, 3683 (Jan. 22, 2014). The Board also
incorporated this definition of ``operational risk'' into part I of
the Federal Reserve Policy on Payment System Risk (PSR policy) in
2014, see 79 FR 2838, 2845 (Jan. 16, 2014), and into its supervisory
rating system for financial market infrastructure in 2016, see 81 FR
58932, 58936 (Aug. 26, 2016). The PSR policy is available at <a href="https://www.federalreserve.gov/paymentsystems/files/psr_policy.pdf">https://www.federalreserve.gov/paymentsystems/files/psr_policy.pdf</a>.
\13\ Deficiencies in assessing and managing these sources of
operational risk could cause errors or delays in processing, systems
outages, insufficient capacity, fraud, data loss, and data leakage.
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Importantly, the Board believes that effective operational risk
management, in combination with sound governance arrangements and
effective management of general business risk (including the risk of
losses from operational events), promotes operational resilience, which
refers to the ability of an FMU to: (1) maintain essential operational
capabilities under adverse conditions or stress, even if in a degraded
or debilitated state; and (2) recover to effective operational
capability in a time frame consistent with the provision of critical
services.\14\
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\14\ See Sec. 234.3(a)(2) and (15).
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[[Page 18751]]
2. Evolution in the Operational Risk, Technology, and Regulatory
Landscape
When the Board proposed amendments to Regulation HH's risk-
management standards in 2014, the Board recognized that there was
ongoing work and discussion domestically and internationally on
developing operational risk-management standards and guidance and
planning for business continuity with respect to cybersecurity and
responses to cyberattacks.\15\ For example, in 2016, the Committee on
Payments and Market Infrastructures (CPMI) and Technical Committee of
the International Organization of Securities Commissions (IOSCO)
published Guidance on cyber resilience for financial market
infrastructures (Cyber Guidance), which supplements the PFMI and
provides guidance on cyber resilience, including in the context of
governance, the comprehensive management of risks, and operational risk
management.\16\ The Cyber Guidance has informed the Federal Reserve's
supervision of designated FMUs.\17\
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\15\ 79 FR 3666, 3683 (Jan. 22, 2014).
\16\ CPMI-IOSCO, Guidance on Cyber Resilience for Financial
Market Infrastructures (June 2016), <a href="https://www.bis.org/cpmi/publ/d146.htm">https://www.bis.org/cpmi/publ/d146.htm</a>.
\17\ For example, when the Board finalized its ORSOM
(Organization; Risk Management; Settlement; Operational Risk and
Information Technology (IT); and Market Support, Access, and
Transparency) rating system for designated FMUs in 2016, it noted
that the then-forthcoming Cyber Guidance would guide the Board's
assessment of a designated FMU with respect to operational risk and
cybersecurity policies and procedures. 81 FR 58932, 58934 (Aug. 26,
2016).
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More recently, new challenges to operational risk management have
emerged, including a global pandemic and severe weather events. In
addition, certain types of cyberattacks that were once thought to be
extreme or ``tail-risk'' events, like attacks on the supply chain and
ransomware attacks, have become more prevalent. Technology solutions
for the mitigation and management of various operational risks have
also advanced since 2014, including the development of new technologies
that have the potential to improve the resilience of designated FMUs.
Finally, the legal, regulatory, and supervisory landscape in which
designated FMUs operate has evolved to reflect these changes in the
broader operational risk environment. For example, in July 2021, the
Board, the Office of the Comptroller of the Currency (OCC), and the
Federal Deposit Insurance Corporation (FDIC) proposed guidance for
banking organizations on managing risks associated with third-party
relationships.\18\ In November 2021, the Board, OCC, and FDIC adopted
requirements on computer-security incident notifications for banking
organizations and bank service providers (interagency notification
rule).\19\ The evolution in the operational risk, technology, and
regulatory landscape motivated the Board to conduct a full review of
Sec. 234.3(a)(17) to determine whether updates were necessary.
Following this review, the Board believes that the outcomes required by
the current operational risk management standard are generally still
relevant and comprehensive. However, the Board has identified several
areas where it believes updates to the rule are necessary.
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\18\ 86 FR 38182 (July 19, 2021). The Board, OCC, and FDIC
issued final third-party risk management guidance for banking
organizations in June 2023. 88 FR 37920 (June 9, 2023).
\19\ 86 FR 66424 (Nov. 23, 2021). Congress also recently enacted
the Cyber Incident Reporting for Critical Infrastructure Act of
2022, which requires covered entities to report significant cyber
incidents to the Cybersecurity and Infrastructure Agency (``CISA'').
See Public Law 117-103, Div. Y (codified at 6 U.S.C. 681-681g).
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D. Overview of the Proposal
The Board proposed to amend the operational risk management
standard to reflect changes in the operational risk and threat
landscape, as well as to reflect developments in designated FMUs'
operations and technology usage since the Board last amended Regulation
HH in 2014. The proposed amendments focused on four areas: (1) review
and testing, (2) incident management and notification, (3) business
continuity management and planning, and (4) third-party risk
management. The Board also proposed several technical or clarifying
revisions throughout Sec. Sec. 234.2 and 234.3(a).\20\
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\20\ In addition to the technical changes described below in
section III.G, the Board proposed a technical change to the title of
Sec. 234.3. Currently, the section is erroneously titled
``Standards for payment systems,'' which is the legacy title from
the initial Regulation HH risk-management standards published in
2012. The Board proposed to replace ``payment systems'' with
``designated financial market utilities.''
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III. Summary of Public Comments and Analysis
The Board received six public comment letters. Two letters were
from entities that operate designated FMUs, one letter was from a non-
profit organization, and three letters were from individuals. The Board
considered each of these comments as well as subsequent staff analysis
in developing the final rule. The Board is adopting the proposed rule
text with modifications to certain sections, as discussed below.
A. Overall Response and Approach
Commenters were generally supportive of the proposed amendments. Of
the three substantive comments received, one commenter expressed
support for the amendments as proposed. Two commenters, while
expressing support for the overall proposal, raised concerns that
aspects of the proposal were broader than necessary. These commenters
suggested additional clarifications to and refinements in the scope of
the proposed amendments. Both of these commenters raised concerns that
amendments to Regulation HH should permit a designated FMU to apply a
risk-based and proportionate approach to operational risk management.
This comment was made both generally and with respect to specific
aspects of the review and testing, business continuity management and
planning, and third-party risk management sections of the proposed
amendments. The Board generally understands a ``risk-based and
proportionate approach'' as an approach whereby entities identify,
assess, and understand the risks to which they are exposed and take
measures commensurate with those risks.\21\
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\21\ See Cyber Guidance, supra note 16, at 26.
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The final rule does not expressly specify that designated FMUs may
use a risk-based and proportionate approach to comply with the amended
operational risk management standard. The Board believes that it is
unnecessary to do so. Designated FMUs currently use risk-based and
proportionate approaches to manage operational risk, as the Board
generally has implemented principles-based requirements in Regulation
HH. The proposed amendments were not intended to affect designated
FMUs' ability to continue to use risk-based and proportionate
approaches where appropriate. Furthermore, other parts of Regulation
HH's risk-management standards, such as the framework for the
comprehensive management of risks found in Sec. 234.3(a)(3), do not
expressly specify a risk-based and proportionate approach. Thus, adding
such language to the operational risk management standard could result
in a difference in drafting not driven by a difference in intended
meaning.
The Board has, however, amended certain aspects of the proposal to
incorporate several specific concerns raised by the commenters. These
concerns and the Board's response are described in the sections that
follow.
[[Page 18752]]
B. Compliance Date
In the NPRM, the Board proposed an effective and compliance date of
60 days from the date the final rule was published in the Federal
Register. Two commenters expressed the need for additional time to
comply with the final rule and requested 180 days after publication to
comply. Specifically, these commenters requested more time to enable
designated FMUs to assess their current procedures and practices
against the amendments and to implement any necessary changes. They
also noted that the proposed third-party risk management requirements
might necessitate changes to designated FMUs' contracts with third
parties, which might take longer than 60 days. One commenter explained
that it would take longer than 60 days to implement the incident
notification requirement of the Board's proposed incident management
framework. A third commenter considered the Board's amendment of the
operational risk management standard overdue and viewed incident
management and notification as the most important part of the proposal.
The Board is adopting the final rule with an effective date of
April 15, 2024. Designated FMUs are expected to comply with the
requirements of the final rule no later than September 11, 2024, with
the exception of the requirement to establish a documented framework
for incident management, set forth in in Sec. 234.3(a)(17)(vi).
Designated FMUs are expected to comply with Sec. 234.3(a)(17)(vi) no
later than June 13, 2024. Designated FMUs are encouraged, however, to
comply with the provisions as soon as possible.
After consideration of the public comments as well as internal
analysis, the Board is providing additional time to allow sufficient
time for designated FMUs to review their existing policies, procedures,
practices, and contracts against the requirements of the final rule and
to minimize burden on designated FMUs and the markets they serve.
However, the Board adopted an earlier compliance date for the
requirement to establish a documented framework for incident
management, set forth in Sec. 234.3(a)(17)(vi). The Board believes
that designated FMUs can leverage existing practices for incident
management and notification and that an earlier compliance date
balances the need for prompt conformance with Sec. 234.3(a)(17)(vi),
which the Board considers of critical importance to both the Board and
designated FMUs' participants and other stakeholders, with the overall
burden on designated FMUs.
C. Review and Testing
Section 234.3(a)(17)(i) of Regulation HH requires designated FMUs
to identify the plausible sources of operational risk, both internal
and external, and mitigate their impact through the use of appropriate
systems, policies, procedures, and controls that are reviewed, audited,
and tested periodically and after major changes. This general review
and testing requirement applies broadly to the systems, policies,
procedures, and controls that the designated FMU develops to mitigate
sources of operational risk. The Board proposed to amend Sec.
234.3(a)(17)(i) to provide more specificity regarding its expectations
around testing, review, and remediation. Just as the current general
review and testing requirement in Sec. 234.3(a)(17)(i) applies broadly
to a designated FMU's systems, policies, procedures, and controls, the
proposed amendments would also apply broadly to the systems, policies,
procedures, and controls developed to mitigate the impact of the
designated FMU's sources of operational risk.
Specifically, proposed Sec. 234.3(a)(17)(i)(A) and (B) set forth
the Board's expectations regarding review and testing. In Sec.
234.3(a)(17)(i)(A)(1), the Board proposed to require a designated FMU
to conduct tests of its systems, policies, procedures, and controls in
accordance with a documented testing framework.\22\ The Board further
proposed in Sec. 234.3(a)(17)(i)(A)(2) to require that a designated
FMU's testing assess whether its systems, policies, procedures, or
controls function as intended.\23\
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\22\ The Board explained in the NPRM that the testing framework
should account for any interdependencies between and among the
systems, policies, procedures, and controls that are being tested.
The Board further explained that a designated FMU should take a
comprehensive and risk-based approach to its operational risk
management testing program, rather than focusing only on testing
individual (or groups of) systems, policies, procedures, or controls
(or components therein). A designated FMU could describe its testing
framework in either a single document or in multiple documents, as
appropriate, and could leverage relevant industry standards as it
develops its testing framework. For example, a designated FMU could
leverage standards developed by the National Institute of Standards
and Technology (NIST), the Federal Financial Institutions
Examination Council (FFIEC), the Financial Services Sector
Coordinating Council (FSSCC), and the International Organization for
Standardization (ISO).
\23\ Such tests could include capacity stress tests, crisis
management tabletop exercises, after-action reviews of incidents,
business continuity tests both internally and with participants,
vulnerability assessments, cyber scenario-based testing, penetration
tests, and red team tests.
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In Sec. 234.3(a)(17)(i)(B), the Board proposed to require a
designated FMU to conduct a review of the design, implementation, and
testing of systems, policies, procedures, and controls after the
designated FMU experienced any material operational incidents (which
are discussed in section III.C.1 below). The Board also proposed in
Sec. 234.3(a)(17)(i)(B) to require a designated FMU to review the
design, implementation, and testing of systems, policies, procedures,
and controls after significant changes to the environment in which it
operates.\24\
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\24\ The Board also proposed a technical amendment to the
requirement for the designated FMU to review its recovery and
orderly wind-down plan under Sec. 234.3(a)(3)(iii)(G) from
``following'' to ``after'' changes to the designated FMU's systems
and environment. This conforms with the review requirement under
proposed Sec. 234.3(a)(17)(i)(B). The Board also proposed a
technical amendment to the requirement for the designated FMU to
update its public disclosure under Sec. 234.3(a)(23)(v) from
``following'' to ``to reflect'' changes to its systems and
environment. The Board did not receive any comments on these
technical amendments and is adopting them as proposed.
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Finally, the Board proposed in Sec. 234.3(a)(17)(i)(C) to require
a designated FMU to remediate, as soon as possible and following
established governance processes, any deficiencies identified during
tests and reviews.
1. Review and Testing--Section 234.3(a)(17)(i)(A) and (B)
(a) Summary of Comments
One commenter welcomed the additional clarity provided by the
proposed amendments to Sec. 234.3(a)(17)(i) generally, and another
commenter appreciated the proposal's testing and review expectations.
Two commenters suggested that all of Sec. 234.3(a)(17)(i), including
paragraphs (a)(17)(i)(A), (B), and (C), be amended to expressly
contemplate the designated FMU taking a risk-based approach to testing,
review, and remediation activities.
Commenters did not suggest other revisions to proposed Sec.
234.3(a)(17)(i)(A). With respect to the proposed review requirements
set out in Sec. 234.3(a)(17)(i)(B), two commenters raised a concern
that the proposed language could be interpreted to require a designated
FMU to review all of its systems, policies, procedures, and controls
after a material operational incident or significant change to the
environment in which the designated FMU operates. These commenters
suggested clarifying that Sec. 234.3(a)(17)(i)(B) require review of
only the relevant systems, policies, procedures, and controls affected
by material operational incidents or significant changes to the
environment.
[[Page 18753]]
One commenter further suggested that, in the case of significant
changes to the environment, Sec. 234.3(a)(17)(i)(B) require a review
only when the change is reasonably likely to create operational risk.
The commenter noted such an approach would avoid reviews when there are
changes to the environment that do not reasonably create operational
risk.
(b) Final Rule
The Board is adopting proposed Sec. 234.3(a)(17)(i)(A) and (B)
with certain revisions based on internal analysis and public comments.
Consistent with the preamble to the proposed rule, the Board has
clarified in Sec. 234.3(a)(17)(i)(A)(1) that a designated FMU's
documented testing framework must address at a minimum scope,
frequency, participation, interdependencies, and reporting. A
designated FMU may also choose to add additional pieces to their
documented testing frameworks based on their own internal analysis.
This could include documented governance processes around review and
testing. Importantly, as described further below, a designated FMU
would need to remediate deficiencies identified during testing,
following established governance processes.
The Board has adopted two amendments to proposed Sec.
234.3(a)(17)(i)(B). First, the Board has modified the rule text in
Sec. 234.3(a)(17)(i)(B) to reflect that a designated FMU's review of
design, implementation, and testing after material operational
incidents or after changes to the environment in which the designated
FMU operates applies only to affected and similar systems, policies,
procedures, and controls. The Board agrees with commenters that a
designated FMU need not review irrelevant systems, policies,
procedures, and controls.\25\ The Board would consider relevant
systems, policies, procedures, and controls to include those affected
directly by a material operational incident or significant change to
the environment. In addition, the Board would consider relevant
systems, policies, procedures, and controls to include those that have
not been directly affected but that share important features with
(i.e., are similar to) affected systems, policies, procedures, and
controls. For example, a similar system could be one that is
susceptible to the same type of vulnerability that has caused a
material operational incident in a different system, but which was not
actually affected in a particular instance.
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\25\ See 87 FR 60314, 60317 (Oct. 5, 2022) (proposing that a
designated FMU conduct a review of the design, implementation, and
testing of relevant systems, policies, procedures, and controls
after the designated FMU experiences any material operational
incidents).
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Second, consistent with statements in the preamble to the NPRM and
in response to comments, the Board has clarified that Sec.
234.3(a)(17)(i)(B) requires designated FMUs to conduct reviews when a
change to the environment in which the designated FMU operates could
significantly affect the plausible sources or mitigants of operational
risk.\26\ Designated FMUs should exercise care to ensure that they
effectively identify changes to the environment that have an
operational risk component, but the review requirement would not be
triggered by a change that does not relate to operational risk.
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\26\ See id. (explaining that the operational risk environment,
including sources of risk and the nature or types of threats, can
change unexpectedly and quickly and that the proposal would ensure
that designated FMUs review and make timely changes to their
systems, policies, procedures, and controls following such changes).
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For the reasons described in section III.A, supra, the Board has
not expressly referred to a risk-based and proportionate approach in
the final rule. With respect to testing, Sec. 234.3(a)(17)(i)(A)(1)
requires a designated FMU's documented testing framework to address, at
a minimum, scope, frequency, participation, interdependencies, and
reporting--all of which could be calibrated based on a designated FMU's
identification, assessment, and prioritization of risks.\27\ With
respect to review, the Board believes the requirement to conduct
reviews after certain events is consistent with a risk-based approach.
Moreover, the two clarifications the Board has made to Sec.
234.3(a)(17)(i)(B) focus the requirements of that paragraph on the
review triggers that the Board considers most important for a
designated FMU's management of operational risk.
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\27\ The Board expects that, in developing its documented
testing framework, a designated FMU would be guided by the
documented risk-management framework established by the board of
directors, which must include, among other things, the designated
FMU's risk-tolerance policy. 12 CFR 234.3(a)(2)(iv)(F).
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2. Remediation of Identified Deficiencies--Section 234.3(a)(17)(i)(C)
(a) Summary of Comments
Similar to the comments on the testing and review requirements, two
commenters suggested that the rule text clarify that a designated FMU
may take a risk-based approach to the remediation process. One
commenter specifically recommended that the rule allow a designated FMU
to remediate or mitigate an identified deficiency in a manner that is
consistent with the designated FMU's risk appetite. As part of a risk-
based approach, one commenter suggested that a designated FMU should be
able to accept the risks associated with certain deficiencies so long
as the risks are within the designated FMU's risk appetite.
One commenter noted that, while proposed Sec. 234.3(a)(17)(i)(C)
stated that a designated FMU's remediation of deficiencies in systems,
policies, procedures, or controls should follow established governance
processes, it was unclear if the requirement to follow governance
processes referred solely to the need to validate remediation steps or
if it was intended to be broader. The commenter suggested that
governance processes for managing and overseeing remediation should
include processes for decision making on prioritization of remediation
approaches in addition to validation. One commenter noted that the
proposed rule did not address expectations regarding validation of
remediation steps. The commenter suggested that validation should be
risk-based and proportionate to the deficiency that is being
remediated.
(b) Final Rule
The Board is adopting Sec. 234.3(a)(17)(i)(C) with one
modification in response to concerns raised by commenters.\28\ In order
to address concerns that the proposal would have required a designated
FMU to approach all deficiencies in the same manner, the Board has
removed the word ``any'' from proposed Sec. 234.3(a)(17)(i)(C).\29\ In
addition, the Board expects that a designated FMU, in establishing the
governance processes contemplated by Sec. 234.3(a)(17)(i)(C), would
take into account the designated FMU's risk-tolerance policy.\30\ In
that regard, the Board notes that remediation could include both
actions to eliminate a deficiency or vulnerability or to reduce the
risk associated with a deficiency or vulnerability to an
[[Page 18754]]
acceptable level.\31\ For example, if a designated FMU were to identify
a deficiency in a system that was slated for replacement in the near
future, the designated FMU could consider steps to reduce the risk of
that deficiency pending the implementation of the new system in lieu of
working to eliminate the deficiency in the old system. When consistent
with a designated FMU's risk tolerance and otherwise consistent with a
robust operational risk framework, a designated FMU could determine and
document its decision to accept the risk of a deficiency.
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\28\ For the reasons described in section III.A, supra, the
Board has not expressly referred to a risk-based and proportionate
approach in the final rule.
\29\ As noted above, proposed Sec. 234.3(a)(17)(i)(C) would
have required a designated FMU to remediate, as soon as possible and
following established governance processes, any deficiencies
identified during tests and reviews.
\30\ A designated FMU must have governance arrangements that,
among other things, are designed to ensure that the board of
directors establishes a clear, documented risk-management framework
that includes the designated FMU's risk-tolerance policy, assigns
responsibilities and accountability for risk decisions, and
addresses decision making in crises and emergencies. 12 CFR
234.3(a)(2)(iv)(F).
\31\ The Board understands that the terms ``remediation'' and
``mitigation'' are sometimes used in different ways in the
information technology and security field. The Board's use of
``remediation'' and ``mitigation'' is consistent with NIST's
definitions of the terms. NIST defines ``remediation'' as ``the act
of mitigating a vulnerability or a threat,'' and ``mitigation'' as
``a decision, action, or practice intended to reduce the level of
risk associated with one or more threat events, threat scenarios, or
vulnerabilities.'' These definitions can be found at <a href="https://csrc.nist.gov/glossary/term/remediation">https://csrc.nist.gov/glossary/term/remediation</a> and <a href="https://csrc.nist.gov/glossary/term/mitigation">https://csrc.nist.gov/glossary/term/mitigation</a>, respectively.
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The Board expects that a designated FMU will conduct an internal
risk analysis of all deficiencies identified in review and testing, as
required in Sec. 234.3(a)(17)(i)(A) and (B), and use established
governance processes to determine how to address and prioritize
identified deficiencies in order to reduce the level of risk posed by
those deficiencies.\32\ The decisions a designated FMU makes may depend
upon the facts and circumstances.\33\
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\32\ As noted above, a designated FMU's documented testing
framework could address governance processes for remediation.
\33\ A designated FMU should consult widely used and relevant
industry standards to inform its understanding of how it should
remediate deficiencies. These industry standards, such as those
published by NIST, FFIEC, FSSCC, and ISO, are updated regularly and
typically offer current and specific information on operational risk
management practices.
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Finally, commenters noted that proposed Sec. 234.3(a)(17)(i)(C)
did not specifically address validation but that the NPRM stated that
it would be imperative for a designated FMU to perform subsequent
validation to assess whether the remediation measures have addressed
deficiencies without introducing vulnerabilities. The Board continues
to believe that designated FMUs should assess the effectiveness and
broader impact of any changes they make to remediate a deficiency.\34\
The Board acknowledges that the validation performed may depend on the
nature of both the deficiency and any changes made to remediate the
deficiency. As with remediation, the Board believes that a designated
FMU, in its governance processes, could address validation in a risk-
based manner.
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\34\ In the event a designated FMU accepts the risk of a
deficiency, there may be no change to validate.
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D. Incident Management and Notification
The Board proposed in Sec. 234.3(a)(17)(vi) to require a
designated FMU to establish a documented framework for incident
management that provides for the prompt detection, analysis, and
escalation of an incident; appropriate procedures for addressing an
incident; and incorporation of lessons learned following an
incident.\35\
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\35\ These broad categories in incident management are generally
consistent with those identified in the NIST computer-security
incident handling guide. See NIST, Computer Security Incident
Handling Guide (Special Publication 800-61, rev. 2), <a href="https://nvlpubs.nist.gov/nistpubs/specialpublications/nist.sp.800-61r2.pdf">https://nvlpubs.nist.gov/nistpubs/specialpublications/nist.sp.800-61r2.pdf</a>.
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Specifically, in Sec. 234.3(a)(17)(vi) the Board proposed to
require that a designated FMU's incident management framework include a
plan for notification and communication of material operational
incidents. This plan, among other things, would need to identify the
entities that would be notified of operational incidents, including
non-participants that could be affected by material operational
incidents at the designated FMU. Relevant entities may also include
appropriate industry information-sharing fora, such as groups that are
designed to share information about cyber threats or support cyber risk
management.
In Sec. 234.3(a)(17)(vi)(A), the Board proposed to require a
designated FMU to notify the Board immediately when it activated its
business continuity plan or had a reasonable basis to conclude that (1)
there was an actual or likely disruption, or material degradation, to
any of its critical operations or services,\36\ or to its ability to
fulfill its obligations on time; or (2) there was unauthorized entry,
or the potential for unauthorized entry, into the designated FMU's
computer, network, electronic, technical, automated, or similar systems
that affects or has the potential to affect its critical operations or
services.
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\36\ Critical operations and critical services are discussed
below in section III.G.2.
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In Sec. 234.3(a)(17)(vi)(B), the Board proposed to require a
designated FMU to establish criteria and processes, including the
appropriate methods of communication, to provide for timely
communication and responsible disclosure of material operational
incidents to its participants or other relevant entities that have been
identified in its notification and communication plan. As proposed,
this incident notification requirement would arise in two
circumstances. First, under proposed Sec. 234.3(a)(17)(vi)(B)(1), a
designated FMU would need to notify affected participants immediately
in the event of actual disruptions or material degradation to its
critical operations or services or to its ability to fulfill its
obligations on time. Second, under proposed Sec.
234.3(a)(17)(vi)(B)(2), a designated FMU would need to notify all
participants and other relevant entities in a timely and responsible
manner of all other material operational incidents that require
immediate notification to the Board.\37\
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\37\ As noted in the NPRM, a designated FMU would need to
identify non-participant relevant entities in its plan for
notification and communication of material operational incidents.
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1. Documented Incident Management Framework--Section 234.3(a)(17)(vi)
(a) Summary of Comments
One commenter broadly supported the proposal and viewed incident
management and notification as the most important part of the Board's
proposed amendments to Regulation HH. Two commenters did not object in
concept to the requirement for a documented framework for incident
management but expressed concerns with specific aspects of the proposed
requirement to have a plan for notification and communication of
material operational incidents. These concerns are discussed in
sections III.D.2 and III.D.3, infra.
(b) Final Rule
The Board is adopting the introductory portion of Sec.
234.3(a)(17)(vi) as proposed and, as discussed below, has adopted Sec.
234.3(a)(17)(vi)(A) and (B) with certain modifications. In line with
the all-hazards approach to operational risk management in this
standard, the Board reiterates its belief that it is important for a
designated FMU to be prepared to detect, address, and learn from any
type of operational incident, regardless of the scenario or source of
risk and the level of severity. Different types of incidents may
require different levels of escalation internally or externally, and
may require different strategies for containment or eradication. For
example, given the increasing prevalence of cyberattacks in the
financial sector, a designated FMU should plan for an incident where a
participant (or another type of connected entity), rather than the
designated FMU itself, is experiencing a cyberattack. In this scenario,
a designated FMU should be operationally prepared to take, and should
have a legal basis to take,
[[Page 18755]]
appropriate steps to mitigate the risk of contagion to itself or other
participants, including, but not limited to, restricting or limiting a
participant's access to the designated FMU or a particular
functionality or disconnecting the participant from the FMU if
necessary. Relatedly and as further discussed in section III.E.3, a
designated FMU should also have processes and procedures to determine
whether and when it would be appropriate to reestablish availability to
such a participant.
2. Incident Notification to the Board--Section 234.3(a)(17)(vi)(A)
(a) Summary of Comments
Two commenters expressed concerns regarding the circumstances that
would trigger a notice requirement to the Board. One commenter noted
that proposed Sec. 234.3(a)(17)(vi)(A) would require a designated FMU
to notify the Board any time the designated FMU activated its business
continuity plan. This commenter highlighted that activation of the
business continuity plan may not involve an actual disruption to the
designated FMU's critical operations or services and that the proposal
could result in unnecessary notifications. Two commenters indicated
concern with the words ``likely'' in proposed Sec.
234.3(a)(17)(vi)(A)(1) and ``potential'' in proposed Sec.
234.3(a)(17)(vi)(A)(2). The concerns raised include providing
notifications where it was unnecessary, the potential for false alarms
or misimpressions regarding a designated FMU's reliability, and
desensitization of supervisors and participants due to excessive
notification regarding insignificant events, with one commenter
suggesting notices be limited to actual incidents. One commenter also
noted that the ``likely'' and ``potential'' standards were different
from other incident notification requirements such as under the Cyber
Incident Reporting for Critical Infrastructure Act (CIRCIA) and
suggested harmonizing the proposed notification requirements with other
laws and regulations.
These commenters suggested a number of specific revisions to the
proposal. One suggested limiting notification to the Board to actual
disruptions or material degradations. Another suggested limiting
notifications of an unauthorized entry, or the potential for
unauthorized entry, to situations which could result in a serious
detriment to participants or other relevant entities, and more
generally suggested granting more discretion for a designated FMU to
determine appropriate circumstances for notice based on the probability
and severity of an event.
One commenter supported the requirement to provide ``immediate''
notification to the Board and affected parties. Two commenters
requested clarification of the term ``immediately'' as used regarding
notification of material operational incidents in proposed Sec.
234.3(a)(17)(vi)(A) and (a)(17)(vi)(B)(1). These commenters requested
that the explanation provided in the NPRM, which distinguished
``immediately'' from ``instantaneous,'' be directly incorporated into
the text of Regulation HH. One commenter suggested that such a revision
would provide greater clarity to participants and other relevant
entities.
Finally, two commenters responded to a question in the NPRM
regarding the process by which a designated FMU should provide notice
to the Board. These commenters suggested that notices be provided to
the team responsible for ongoing supervision of the designated FMU. One
of the commenters noted that a designated FMU's supervisory team would
likely continue to expect notice regardless of whether a designated FMU
was required to notify a central point of contact. One of the
commenters also suggested that the Board specify contacts and provide a
method for delivering notices outside of business hours.
(b) Final Rule
The Board is adopting Sec. 234.3(a)(17)(vi)(A) as proposed, with
two revisions that respond to comments received. First, as proposed,
Sec. 234.3(a)(17)(vi)(A)(2) would have required notice to the Board of
an unauthorized entry, or a potential for unauthorized entry, into a
designated FMU's computer, network, electronic, technical, automated,
or other systems that affect or have the potential to affect its
critical operations or services. In light of concerns regarding
unnecessary notices, the Board believes it is appropriate to clarify
what constitutes the ``potential'' for unauthorized entry. The Board
has amended Sec. 234.3(a)(17)(vi)(A)(2) to refer instead to an
unauthorized entry or a vulnerability that could allow unauthorized
entry. The Board believes that it is important to receive notice from a
designated FMU if the designated FMU has a reasonable basis to conclude
that there exists a vulnerability (such as a zero-day vulnerability)
that may be, but has not yet been, exploited.\38\
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\38\ ``Zero-day'' vulnerabilities are those for which patches
are not yet available. See, e.g., Board of Governors of the Federal
Reserve System, Cybersecurity and Financial System Resilience
Report, at 23 (Aug. 2023), available at <a href="https://www.federalreserve.gov/publications/files/cybersecurity-report-202308.pdf">https://www.federalreserve.gov/publications/files/cybersecurity-report-202308.pdf</a>.
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Second, the Board has clarified that a designated FMU must notify
the Board of incidents ``in accordance with the process established by
the Board.'' The Board will provide actual notice of this process to
affected designated FMUs.
Other than with respect to these revisions, the Board has adopted
Sec. 234.3(a)(17)(vi)(A) as proposed. Given the large volume and value
of payment, clearing, and settlement activity processed by designated
FMUs and their interconnectedness with financial institutions and
markets, material operational issues occurring at designated FMUs could
have financial stability implications. Therefore, the Board continues
to believe that it is critical for the Board to be notified immediately
of these types of issues.\39\ The Board notes that ``immediately'' as
used in Sec. 234.3(a)(17)(vi)(A) is meant to convey the urgency in
notifying the Board of these material operational incidents.
``Immediate'' does not mean ``instantaneous,'' and as such the Board
does not believe clarification expressly stating this is necessary. The
Board would expect to be notified of an operational incident once the
designated FMU activates its business continuity plan or has a
reasonable basis to conclude that an incident meets any of the criteria
in Sec. 234.3(a)(17)(vi)(A), even if the designated FMU does not yet
have detailed information on the root cause or measures for containment
or remediation. In these cases, the Board would expect to receive any
available information that the designated FMU has at the time of
notification.
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\39\ The Board recognizes that, ``immediately'' poses a
heightened requirement for notification by designated FMUs relative
to banking organizations subject to the interagency rule. This
heightened requirement is consistent with the systemic importance of
designated FMUs and in line with expectations for designated FMUs
for which the SEC is the Supervisory Agency. SEC Regulation SCI
provides for immediate notification to the SEC upon any
``responsible SCI personnel'' having a reasonable basis to conclude
that an ``SCI event'' has occurred. See 17 CFR 242.1002(b)(1).
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Except as described above, the Board continues to believe that
notification is appropriate when a designated FMU has a reasonable
basis to conclude that there is (1) an actual or likely disruption or
material degradation to any critical operations or services, or to its
ability to fulfill its obligations on time or (2) an unauthorized
entry, or a vulnerability that could allow unauthorized entry, into the
designated FMU's computer, network, electronic, technical, automated,
or similar systems that
[[Page 18756]]
affects or has the potential to affect its critical operations or
services. The Board appreciates commenters' interest in harmonizing
notice requirements. However, the Board notes that the interagency
notification rule applies to banking organizations and bank service
providers broadly, whereas Regulation HH applies to FMUs that have been
designated as systemically important by the FSOC. The Board
acknowledges that CIRCIA provides for after-the-fact reporting of
incidents. The Board believes receiving notices of actual and likely
incidents as soon as the designated FMU is aware of them is appropriate
given the Board's supervisory role and the systemic importance of
designated FMUs.
For the same reasons, the Board does not believe it is appropriate
to limit notice to the Board with respect to unauthorized entries, or
vulnerabilities that could allow unauthorized entry, to situations that
could result in a serious detriment to participants or other relevant
entities or to afford designated FMUs discretion to determine
appropriate circumstances for notice based on the probability and
severity of an event.
Similarly, the Board understands that activation of a business
continuity plan does not mean an actual incident must have occurred.
Activation does mean, however, that the probability of an event
occurring that could adversely impact the designated FMU's continued
operations was high enough to meet the threshold for the designated FMU
to trigger its business continuity plan.\40\ Accordingly, the Board
believes a designated FMU should notify the Board when it activates its
business continuity plan.
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\40\ For example, if a designated FMU activates its business
continuity plan in anticipation of an extreme weather event, the
Board would expect to be notified. The Board should be made aware if
the designated FMU anticipates non-business-as-usual actions or
operations.
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3. Incident Notification to Participants and Other Relevant Entities--
Section 234.3(a)(17)(vi)(B)
(a) Summary of Comments
As noted above with respect to notices required to be made to the
Board, one commenter noted it was judicious and sensible to require
designated FMUs to immediately notify affected participants of material
operational incidents. Two commenters requested clarification of the
term ``immediately'' as used regarding notification of material
operational incidents in proposed Sec. 234.3(a)(17)(vi)(B)(1). One
commenter suggested revising the proposed notification requirement in
Sec. 234.3(a)(17)(vi)(B)(1), for the same reasons outlined in their
comments for proposed Sec. 234.3(a)(17)(vi)(A)(1), by limiting it to
actual disruptions or material degradations to a designated FMU's
critical operations or services, or to the designated FMU's ability to
fulfill its settlement obligations on time, that could result in a
serious detriment to participants or other relevant entities. The
commenter suggested that the addition of the italicized language would
permit the designated FMU to comply with the regulatory requirements
while liaising with supervisors to ensure the notification provided to
participants and other entities meets supervisory expectations.
One commenter expressed concern that the requirements under
proposed Sec. 234.3(a)(17)(vi)(B)(2) could result in false alarms to
third parties, give an impression of unreliability, or desensitize
parties to notifications. The commenter proposed that Sec.
234.3(a)(17)(vi)(B)(2) be amended to only require notification for
actual incidents or actual unauthorized entries.
(b) Final Rule
The Board is adopting proposed Sec. 234.3(a)(17)(vi)(B) with
certain revisions to clarify the circumstances in which the Board
expects a designated FMU to provide notice of material operational
incidents to participants (including unaffected participants) and other
relevant entities, consistent with the concept of ``responsible
disclosure,'' and to respond to commenters' concerns that disclosure
under proposed Sec. 234.3(a)(17)(vi)(B) could result in false alarms
to third parties, give an impression of unreliability, or desensitize
parties to notifications.
With respect to Sec. 234.3(a)(17)(vi)(B)(2), the Board believes
there are scenarios where all participants and identified relevant
entities should be informed of likely disruptions or vulnerabilities
that could allow for unauthorized entry into the designated FMU's
computer, network, electronic, technical, automated, or similar
systems, even where no incident or unauthorized access happens. The
Board recognizes, though, that notification of certain likely incidents
or vulnerabilities may not be required. Under the final rule, a
designated FMU should establish criteria and processes for timely
communication and responsible disclosure that guide whether and when it
is appropriate to notify in a responsible manner entities of a
particular incident. For example, consistent with the concept of
responsible disclosure, the Board recognizes that there might be risks
to providing early disclosures under Sec. 234.3(a)(17)(vi)(B)(2) to a
broad audience regarding certain types of material operational issues.
The Board would expect a designated FMU, in practicing responsible
disclosure, to account for both the benefit of the information to be
provided in a notification and the potential risk of disclosing that
information. For example, if a designated FMU identifies a cyber
vulnerability, the designated FMU might weigh the risk of disclosure as
sufficiently great to delay notification under Sec.
234.3(a)(17)(vi)(B)(2) or tailor the information provided under Sec.
234.3(a)(17)(vi)(B)(1) or (2) to avoid exposing the designated FMU to a
cyberattack. The Board also recognizes the risks of over-notification
and of reporting false alarms to a broad audience. Notice under Sec.
234.3(a)(17)(vi)(B)(2) of incidents that are resolved without
disruption may provide little benefit to participants or identified
relevant entities. In addition, a designated FMU that provides
notification to the Board under the ``reasonable basis'' standard set
forth in Sec. 234.3(a)(17)(vi)(A) may subsequently determine there to
have been a false alarm. Under such circumstances, a designated FMU
could determine that broad disclosure under Sec.
234.3(a)(17)(vi)(B)(2) is not appropriate. Consistent with concerns
raised by one commenter, a designated FMU could incorporate
consultation with its supervisors in the development of criteria and
processes with respect to novel or complex incidents.
When designing its communication plan, the Board would expect a
designated FMU to consider the timing, content, recipients, and method
of notification for a range of potential material operational
incidents. In determining the scope of disclosure for a particular
incident, the Board would expect a designated FMU to consider factors
such as the risk-mitigation benefits arising from early warning to the
financial system, the safety and soundness of the designated FMU, and
any financial stability implications of disclosure.
4. Examples of Material Operational Incidents
The following is a non-exhaustive list of operational incidents
that the Board would consider to be material for purposes of the final
rule.\41\ The Board
[[Page 18757]]
would expect examples 1-3 to trigger immediate notifications to the
Board and to the designated FMU's affected participants (and
notification in a timely manner to unaffected participants and other
relevant entities identified in the designated FMU's plan for
notification and communication of material operational incidents, as
applicable).
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\41\ The NPRM included a list of examples. The Board did not
receive any specific comments on the examples. The Board has
expanded on that list to provide further clarity.
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(1) A failed system upgrade or change results in widespread user
outages for participants and designated FMU employees.
(2) Large-scale distributed denial of service attacks that prevent
the designated FMU from receiving its participants' payment
instructions.
(3) A severe weather event or other natural disaster that causes
significant damage to a designated FMU's production site and disrupts
core payment, clearing, or settlement processes, necessitating failover
to another site during the business day.
The Board would expect examples 4-7 to trigger immediate
notification to the Board, but a designated FMU would determine when
and whether to notify participants and other relevant entities based on
the criteria in its notification and communication plan.
(4) A severe weather event or other natural disaster that causes
significant damage to a designated FMU's production site and
necessitates failover to another site during the business day, but the
designated FMU's core payment, clearing, or settlement processes remain
available to participants.
(5) Malware on a designated FMU's network that poses an imminent
threat to its critical operations or services (such as its core
payment, clearing, or settlement processes, or collateral management
processes), or that may require the designated FMU to disengage any
compromised products or information systems that support the designated
FMU's critical operations and services from internet-based network
connections.
(6) A ransom malware attack that encrypts a critical system or
backup data.
(7) A zero-day vulnerability on software that the designated FMU
uses and has determined, if exploited, could lead to a disruption to or
material degradation of its critical operations or services.
E. Business Continuity Management and Planning
Section 234.3(a)(17)(vi) of the current rule (under the proposal,
renumbered as Sec. 234.3(a)(17)(vii)) requires that a designated FMU
have business continuity management that provides for rapid recovery
and timely resumption of its critical operations and fulfillment of its
obligations, including in the event of a wide-scale or major
disruption.\42\ Section 234.3(a)(17)(vii) of the current rule (under
the proposal, renumbered Sec. 234.3(a)(17)(viii)) elaborates on
certain requirements for a designated FMU's business continuity plan.
The Board proposed to amend current Sec. 234.3(a)(17)(vii) to provide
further detail in Regulation HH related to business continuity
management and planning in order to promote robust risk management,
reduce systemic risks, increase safety and soundness, and support the
stability of the broader financial system.
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\42\ The Board proposed a technical revision to that section, as
described in section III.G.2, infra.
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Specifically, the Board proposed to amend current Sec.
234.3(a)(17)(vii)(A) to update terminology related to required backup
sites. The Board proposed to replace the references to a ``secondary
site'' and ``primary site'' with a general reference to ``two sites
providing for sufficient redundancy supporting critical operations and
services'' that are located at a sufficient geographical distance from
``each other'' to have a distinct risk profile (collectively, ``two
sites with distinct risk profiles'').
The Board did not propose substantive amendments to the
requirements under current Sec. 234.3(a)(17)(vii)(B) and (C)
(renumbered as Sec. 234.3(a)(17)(viii)(B) and (C)), which require a
designated FMU's business continuity plan to be designed to enable
recovery and resumption no later than two hours following disruptive
events and completion of settlement by the end of the day of the
disruption, even in case of extreme circumstances. The Board proposed a
technical amendment to Sec. 234.3(a)(17)(vii)(B) to clarify that the
two-hour recovery time objective applies to critical operations and
services.\43\
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\43\ See section III.G.2, infra.
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In Sec. 234.3(a)(17)(viii)(D), the Board proposed to require that
a designated FMU's business continuity plan set out criteria and
processes that address the reconnection of a designated FMU to its
participants and other entities following a disruption to the
designated FMU's critical operations or services.
The Board proposed to separate current Sec. 234.3(a)(17)(vii)(D)
of Regulation HH, which requires the business continuity plan to be
``tested at least annually,'' into two requirements (renumbered as
Sec. 234.3(a)(17)(viii)(E) and (F)). In Sec. 234.3(a)(17)(viii)(E),
the Board proposed to maintain the requirement for at least annual
testing and clarify that this requirement covers the designated FMU's
business continuity arrangements, including the people, processes, and
technologies of the two sites with distinct risk profiles.\44\ The
Board proposed to require a designated FMU's testing to demonstrate
that the designated FMU is able to run live production at the two sites
with distinct risk profiles; that its solutions for data recovery and
data reconciliation enable it to meet its objectives to recover and
resume operations two hours following a disruption and enable
settlement by the end of the day of the disruption even in case of
extreme circumstances, including if there is data loss or corruption;
and that it has geographically dispersed staff who can effectively run
the operations and manage the business of the designated FMU.
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\44\ These tests would be subject to the general testing
requirements described in section III.C.1 above.
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In Sec. 234.3(a)(17)(viii)(F), the Board proposed to require a
designated FMU to review its business continuity plans, pursuant to the
general review requirements described in section III.C.1 above, at
least annually, to: (1) incorporate lessons learned from actual and
averted disruptions, and (2) update the scenarios considered and
assumptions built into the plan in order to ensure responsiveness to
the evolving risk environment and incorporate new and evolving sources
of operational risk (e.g., extreme cyber events).
1. Two Sites Providing for Sufficient Redundancy--Section
234.3(a)(17)(viii)(A)
(a) Summary of Comments
The Board received no comments on proposed Sec.
234.3(a)(17)(viii)(A).
(b) Final Rule
The Board is adopting Sec. 234.3(a)(17)(viii)(A) as proposed. This
amendment accommodates data center arrangements with multiple
production sites, rather than reflecting only the traditional
arrangement where one site is considered ``primary'' and another site
is treated distinctly as a backup site. A designated FMU will still be
required, however, to maintain a minimum of two locations that are
sufficiently geographically distant from each other to have distinct
risk profiles. Consistent with the Board's explanation when it adopted
the current text of Regulation HH in 2014, the Board noted in the
[[Page 18758]]
NPRM that it would consider sites to have ``distinct risk profiles''
if, for example, they are not located in areas that would be
susceptible to the same severe weather event (e.g., the same hurricane
zone) or on the same earthquake fault line. These sites would likely
also have distinct power and telecommunications providers and be
operated by geographically dispersed staff.
2. Recovery and Resumption--Section 234.3(a)(17)(viii)(B) and (C)
(a) Summary of Comments
Two commenters suggested that the Board incorporate into the text
of Regulation HH the Board's statement in the NPRM that the recovery
time objectives set forth in Sec. 234.3(a)(17)(vii)(B) and (C)
(renumbered as Sec. 234.3(a)(17)(viii)(B) and (C)) should not be
interpreted as a requirement for a designated FMU to resume operations
in a compromised or otherwise untrusted state.\45\ One of these
commenters expressed the concern that, absent clarification of the text
of Regulation HH, a designated FMU could be required under Regulation
HH to resume critical operations in an untrusted state in order to
comply with the recovery time objectives.
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\45\ See 87 FR 60314, 60320 (Oct. 5, 2022).
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(b) Final Rule
The Board is adopting this section as proposed, without substantive
change from the previous version of the rule. Regulation HH requires a
designated FMU to have a business continuity plan that is designed to
enable the designated FMU to meet these objectives. The Board
reiterates that the recovery time objectives should not be interpreted
as a requirement for a designated FMU to resume operations in a
compromised or otherwise untrusted state.
Since the Board established these requirements in Regulation HH,
the two-hour recovery time objective has been a particular area of
focus during bilateral discussions with Board-supervised designated
FMUs, as well as in broader domestic and international fora,
specifically in the context of extreme cyber events. At the center of
those discussions is the balance between (i) timely recovery and
resumption of critical operations and (ii) appropriate assurance that
critical operations are restored to a trusted state. The Board
continues to believe it is imperative to financial stability that a
designated FMU be able to recover and resume its critical operations
and services quickly after disruptive events, both physical and cyber,
and to complete settlement by the end of the day of the disruption. In
related discussions with Board-supervised designated FMUs, and
supported by provisions in the CPMI-IOSCO Cyber Guidance, Board staff
has emphasized that recovery time objectives are necessary and critical
targets around which plans, systems, and processes should be
designed.\46\ However, these recovery time objectives should not be
interpreted as a requirement for a designated FMU to resume operations
in a compromised or otherwise untrusted state.
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\46\ For example, paragraph 6.2.2 of the Cyber Guidance notes
that the objectives for resuming operations set goals for,
ultimately, the sound functioning of the financial system, which
should be planned for and tested against. It further notes the
criticality of the recovery and resumption objectives under
Principle 17, Key Consideration 6 of the PFMI, while also
acknowledging that financial market infrastructures should exercise
judgment in effecting resumption so that risks to itself or its
ecosystem do not thereby escalate. For additional details, see CPMI-
IOSCO, Guidance on Cyber Resilience for Financial Market
Infrastructures (June 2016) at section 6, <a href="https://www.bis.org/cpmi/publ/d146.htm">https://www.bis.org/cpmi/publ/d146.htm</a> (``Response and Recovery'').
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Threats to designated FMUs' operations continue to evolve, and the
Board expects that a designated FMU will update on an ongoing basis the
scenarios in its plan to reflect evolving threats. The Board also
expects that a designated FMU will seek and implement solutions that
are designed to enable it to meet its recovery and resumptions
objectives. For many types of disruptive scenarios, technologies and
methods already exist to enable a designated FMU to recover and resume
operations within two hours of the disruption. For example, if an
earthquake damages a designated FMU's infrastructure and disrupts
operations at one data center, the designated FMU may continue to
operate from or fail over to another location that is outside the
earthquake radius.
The Board recognizes, however, that certain threats to designated
FMUs' operations, as well as the technology to mitigate those threats,
are continually evolving. In areas where threats and technology are
still evolving, such as is the case for extreme cyberattacks (e.g.,
where significant data loss or corruption occurs across its data
centers), the Board recognizes that a designated FMU will need to take
a holistic approach that integrates protective, detective, and
containment measures with response, recovery, and resumption solutions.
The Board continues to expect that a designated FMU's business
continuity planning will be a dynamic process in which the designated
FMU works on an ongoing basis to update its plan to recover and resume
operations in light of these evolving threats. Federal Reserve
supervisors will also continue to work with designated FMUs through the
supervisory process as designated FMUs identify reasonable approaches
to prepare for and recover from such attacks. As development of
adequate solutions for extreme cyberattacks continues, designated FMUs
should also plan for contingency scenarios in which planned recovery
and resumption objectives cannot be achieved. Planning for such
scenarios would be in accordance with national policies aimed at
improving the cybersecurity posture of U.S. critical
infrastructures.\47\
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\47\ See, e.g., Presidential Policy Directive/PPD-21, Critical
Infrastructure Security and Resilience (Feb. 12, 2013), <a href="https://obamawhitehouse.archives.gov/the-press-office/2013/02/12/presidential-policy-directive-critical-infrastructure-security-and-resil">https://obamawhitehouse.archives.gov/the-press-office/2013/02/12/presidential-policy-directive-critical-infrastructure-security-and-resil</a>.
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3. Reestablishment of Availability After a Disruption to the Designated
FMU's Critical Operations or Services--Section 234.3(a)(17)(viii)(D)
(a) Summary of Comments
One commenter expressed support for the proposal's requirement that
a designated FMU have plans in place regarding reconnection to its
participants following a cybersecurity disruption. Another commenter
indicated that the criteria and processes for reconnection should be
risk-based to account for the fact that a reconnection process may not
be necessary for all disruptions or that aspects of such a process may
not be needed in all cases. Another commenter suggested removing the
term ``reconnection'' because not all disruptions result in a
disconnection, thus a reconnection may not be required. This commenter
suggested revising proposed Sec. 234.3(a)(17)(viii)(D) to use the
phrase ``resumption of access'' rather than ``reconnection,'' and to
specify that resumption of access to the designated FMU includes
resumption of access to relevant functionalities. The commenter noted
that, in a cyberattack scenario, in addition to disconnection, risk
mitigants might include limiting or restricting a participant's access
to the designated FMU or a particular functionality.
(b) Final Rule
The Board has amended the text of proposed Sec.
234.3(a)(17)(viii)(D) to require a designated FMU's business continuity
plan to set out criteria and processes by which the designated
financial market utility will ``reestablish availability'' for
``affected'' participants and other entities following a disruption to
the designated FMU's critical
[[Page 18759]]
operations or services.\48\ In the NPRM, the Board noted that it would
consider a disruption to a designated FMU's critical operations or
services broadly as a form of ``disconnection'' to external parties.
However, some disruptions may not, as a technical matter, result in a
designated FMU severing a participant's or other entity's connection to
the designated FMU.
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\48\ The NIST definitions of ``availability'' and ``disruption''
are consistent with the final rule. The NIST glossary, which can be
found at <a href="https://csrc.nist.gov/glossary">https://csrc.nist.gov/glossary</a>, defines ``availability'' as
``timely, reliable access to data and information services for
authorized users'' and ``disruption'' as ``an unplanned event that
causes an information system to be inoperable for a length of time
(e.g., minor or extended power outage, extended unavailable network,
or equipment or facility damage or destruction).'' <a href="https://csrc.nist.gov/glossary">https://csrc.nist.gov/glossary</a>, defines ``availability'' as ``timely,
reliable access to data and information services for authorized
users'' and ``disruption'' as ``an unplanned event that causes an
information system to be inoperable for a length of time (e.g.,
minor or extended power outage, extended unavailable network, or
equipment or facility damage or destruction).''
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The Board believes that the term ``reestablish availability''
better captures the Board's expectations for designated FMUs. Proposed
Sec. 234.3(a)(17)(viii)(D) was intended to emphasize the importance of
ex ante criteria and processes addressing when and how a designated FMU
will make itself available to participants and other entities after a
disruption causes the designated FMU's critical operations or services
to become unavailable--regardless of whether there is a technical
disconnection. This would include situations, as noted in the NPRM, in
which a designated FMU deliberately takes itself offline such that
participants cannot access its services (e.g., if it experiences a
major cyberattack that it needs to contain); it would also include
situations where a designated FMU becomes unavailable due to another
type of external event (e.g., if its production site loses power due to
a severe weather event in its region). In such situations, there may be
a gap in availability, but not a disconnection by the designated FMU of
participants or other entities from its services. The Board has also
clarified that a designated FMU's criteria and processes should address
resumption of availability to ``affected'' participants and other
entities.
For the reasons discussed in section III.A, supra, the Board has
not referred to a risk-based and proportionate approach in the final
rule. Nevertheless, the Board recognizes that the way in which a
designated FMU applies its criteria and processes for reestablishing
availability may differ from one type of disruption to another. Some
disruptions may be more straightforward and pose little risk to
participants or other entities, while others may present greater risk
of contagion. Given the current threat landscape and the ability for
malware to spread, the Board believes it is crucial for a designated
FMU to balance the need to quickly recover and resume its critical
operations against the risk of contagion to its ecosystem should it
resume operations in a compromised or otherwise untrusted state. For
cyber incidents, it is particularly important for a designated FMU to
be prepared to assure its participants, other connected entities, and
regulator(s) that it has achieved an uncompromised and trusted
state.\49\ A designated FMU should consider establishing a phased
approach to reestablishing availability, transaction testing with
selected participants, and heightened monitoring for an appropriate
period of time after reestablishing availability.
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\49\ A designated FMU might consider leveraging third-party
experts to verify its remediation efforts.
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4. Business Continuity Testing and Review--Section
234.3(a)(17)(viii)(E) and (F)
(a) Summary of Comments
Two commenters noted that there may be circumstances in which
recovery within two hours following disruptive events is not currently
possible. One commenter expressed concern specifically with respect to
Sec. 234.3(a)(17)(viii)(E)(2), which proposed to require a designated
FMU to demonstrate that its solutions for data recovery and
reconciliation would enable it to meet its recovery and resumption
objectives, even in case of extreme circumstances, including in the
event of data loss or data corruption. That commenter encouraged the
Board to amend proposed Sec. 234.3(a)(17)(viii)(E)(2) to recognize the
ever-evolving nature of cyber-threats and solutions to address them.
Specifically, the commenter recommended that Sec.
234.3(a)(17)(viii)(E)(2) be amended to require a designated FMU, in
consultation with its supervisors, to identify reasonable approaches to
prepare for and recover from extreme cyber-attacks.
The Board did not receive comments on the proposed requirements for
business continuity testing and review in Sec.
234.3(a)(17)(viii)(E)(1) or (3) or (a)(17)(viii)(F).
(b) Final Rule
The Board recognizes the ever-evolving nature of cyber threats and
acknowledges that there are certain cyber scenarios which may result in
extreme data loss or data corruption for which the designated FMU may
not be able to demonstrate that its solutions for data recovery and
data reconciliation enable it to meet the recovery and resumption
objectives under Sec. 234.3(a)(17)(viii)(B) and (C). The Board has
therefore amended the final rule text in Sec.
234.3(a)(17)(viii)(E)(2), and made conforming edits in Sec.
234.3(a)(17)(viii)(E)(1) and (3), to clarify that a designated FMU's
testing should assess the capability of its systems and the
effectiveness of its procedures for data recovery and data
reconciliation to meet the recovery and resumption objectives under
Sec. 234.3(a)(17)(viii)(B) and (C), even in case of extreme
circumstances, including in the event of data loss or data corruption.
Designated FMUs should continue to plan for and test extreme
scenarios from which they may need to recover, including wide-scale and
major disruptions. Scenario testing should include functional testing
of the designated FMU's ability to recover and resume settlement in the
case of extreme cyber-based scenarios that cause data loss or data
corruption. In some circumstances, a designated FMU may not be able to
demonstrate that it can recover and resume operations within two hours,
or complete settlement by end of day. The designated FMU should be able
to demonstrate to supervisors, however, that (1) it is assessing the
capability of its systems and effectiveness of its procedures against
its recovery, resumption, and settlement objectives; and (2) it has an
understanding of the circumstances in which it may not be able to
recover and resume critical operations and services within two hours
following disruptive events or complete settlement by the end of the
day. The designated FMU should also be able to demonstrate that it is
working to increase the capability of its systems and effectiveness of
its procedures to be able to meet those objectives in the future. The
Board reiterates that Federal Reserve supervisors will continue to work
with designated FMUs through the supervisory process as designated FMUs
identify reasonable approaches to prepare for and recover from extreme
cyber-attacks.
[[Page 18760]]
F. Third-Party Risk Management
The Board expects a designated FMU to conduct its activities--
whether conducted directly by the designated FMU or through a service
provider--in a safe and sound manner.\50\ Accordingly, the Board
proposed to establish third-party risk management requirements in Sec.
234.3(a)(17)(ix). The Board proposed these requirements because of the
importance of ensuring that a designated FMU's activities do not become
less safe when they are outsourced to third parties and because of the
importance of managing operational risk associated with third-party
relationships, including ``supply chain risk.'' \51\
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\50\ The Board believes that this expectation is consistent with
section 807(b) of the Dodd-Frank Act, which provides each
Supervisory Agency of a designated FMU with authority to examine the
provision of any service integral to the operation of the designated
FMU for compliance with applicable law, rules, orders, and standards
to the same extent as if the designated FMU were performing the
service on its own premises. 12 U.S.C. 5466(b).
\51\ Supply chain risk encompasses the potential for harm or
compromise to a designated FMU that arises as a result of security
risks from its third parties' subcontractors or suppliers, as well
as the subcontractors' or suppliers' supply chains, and their
products or services (including software that may be used by the
third party or the designated FMU). This definition is consistent
with NIST's definition of ``supply chain risk'' in the NIST
computer-security incident handling guide. See NIST, Computer
Security Incident Handling Guide (Special Publication 800-61, rev.
2), <a href="https://nvlpubs.nist.gov/nistpubs/specialpublications/nist.sp.800-61r2.pdf">https://nvlpubs.nist.gov/nistpubs/specialpublications/nist.sp.800-61r2.pdf</a>. The Board identified supply chain risk as a
threat on which the Board is focused in its report on cybersecurity
and financial system resilience. See Board of Governors of the
Federal Reserve System, Report to Congress: Cybersecurity and
Financial System Resilience Report (September 2021), <a href="https://www.federalreserve.gov/publications/files/cybersecurity-report-202109.pdf">https://www.federalreserve.gov/publications/files/cybersecurity-report-202109.pdf</a>.
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Specifically, the Board proposed to add a definition of ``third
party'' in Sec. 234.2(n), and to add Sec. 234.3(a)(17)(ix) regarding
the management of risks associated with third-party relationships. In
Sec. 234.2(n), the Board proposed to define ``third party'' as ``any
entity with which a designated FMU maintains a business arrangement, by
contract or otherwise.'' \52\ For purposes of proposed Sec.
234.3(a)(17)(ix), the Board noted that it would consider third-party
relationships to include vendor relationships for products such as
software and arrangements for any services that third parties perform
for a designated FMU.
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\52\ This definition was consistent with the definition of
``third-party relationship'' in then-proposed interagency guidance
for banking organizations on third-party relationships. See 86 FR
38182, 38186-87 (July 19, 2021). The Board explained in the NPRM
that the Board viewed the requirements of proposed Sec.
234.3(a)(17)(ix) as broadly consistent with the proposed interagency
guidance. The Board, OCC, and FDIC have since adopted final
Interagency Guidance on Third-Party Relationships: Risk Management.
88 FR 37920 (June 9, 2023). The Board continues to believe that the
final amendments to Regulation HH remain broadly consistent with the
final interagency guidance. In examining designated FMUs under
Regulation HH, Board examiners will continue to reference guidance
on third-party risk management.
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In Sec. 234.3(a)(17)(ix), the Board proposed to require a
designated FMU to have systems, policies, procedures, and controls that
effectively identify, monitor, and manage risks associated with third-
party relationships. Additionally, for any service that is performed
for the designated FMU by a third party, a designated FMU's systems,
policies, procedures, and controls would need to ensure that risks are
identified, monitored, and managed to the same extent as if the
designated FMU were performing the service itself.\53\
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\53\ As noted in the NPRM, the Board believes that where a
designated FMU outsources the provision of services to a third
party, the designated FMU retains the responsibility for meeting the
risk-management standards in Regulation HH.
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In Sec. 234.3(a)(17)(ix)(A) and (B), the Board proposed specific
requirements for three components of third-party risk management: risk
assessments, information-sharing arrangements, and business continuity
management and testing. In Sec. 234.3(a)(17)(ix)(A), the Board
proposed to require a designated FMU to regularly conduct risk
assessments of its third-party relationships and establish, as
appropriate, information-sharing arrangements with third parties. In
Sec. 234.3(a)(17)(ix)(B), the Board proposed to require a designated
FMU to include third parties in its business continuity management and
testing, as appropriate.\54\
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\54\ In the final rule, the Board has reorganized risk
assessment, information sharing, and business continuity management
and testing into separate paragraphs (a)(17)(ix)(A), (B), and (C) of
Sec. 234.3, respectively. The headings used in this SUPPLEMENTARY
INFORMATION refer to these reorganized paragraphs.
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1. Definition of Third-Party Risk; Identification, Monitoring, and
Management of Risks Associated With Third-Party Relationships--Section
234.2(n); Section 234.3(a)(17)(ix)
(a) Summary of Comments
Two commenters supported the addition of the third-party risk
management rule to Regulation HH, but one of these commenters suggested
the rule incorporate concepts of proportionality and criticality. Two
commenters expressed concern with the scope of the definition of
``third party.'' These commenters suggested narrowing the definition in
a number of ways. One commenter suggested distinguishing between
services the commenter considered ``outsourced'' and other third-party
services. One commenter noted that the proposed definition may
unintentionally capture entities with which a designated FMU has a
business relationship, such as participants in a designated FMU and
employees, but which it does not treat as traditional service-providing
vendors. One commenter suggested that the ``third party'' definition
should include only entities that could have a material impact on the
designated FMU's designated activities.
One commenter suggested Sec. 234.3(a)(17)(ix) be amended to permit
the designated FMU to have risk-based systems, policies, procedures,
and controls and to be flexible in managing third party risk. Another
commenter explained that a designated FMU should be able to apply its
most stringent risk management controls to third parties that provide
services essential to performing the services for which the FMU was
designated as systemically important. Both of these commenters also
provided comments to the more specific requirements set forth in
proposed Sec. 234.3(a)(17)(ix)(A) and (B), which are addressed in
sections III.F.2 and III.F.3, infra.
Finally, these commenters noted that the definition of third party
would include central banks and other entities that may be unable or
unwilling to establish formal information-sharing relationships or
participate in a designated FMU's business continuity management and
testing. Both commenters suggested excluding central banks from the
definition, and one commenter recommended narrowing the definition by
expressly excluding real-time gross settlement systems and their
operators from the definition of ``third party.''
(b) Final Rule
After considering the comments received, the Board has made one
modification to the definition of ``third party.'' Additionally, the
Board is adopting as proposed the risk-management standards requirement
set forth in the introductory portion of Sec. 234.3(a)(17)(ix), but
the Board has amended the specific requirements set forth in proposed
Sec. 234.3(a)(17)(ix)(A) and (B) to more expressly recognize that not
all third parties present the same risk to a designated FMU.
As discussed in the NPRM, products and services provided by third
parties can include a wide variety of arrangements, from heating,
ventilation, and air conditioning (often referred to as HVAC) services
that support the physical infrastructure of a designated
[[Page 18761]]
FMU to technology platforms or financial risk management modeling that
are essential to executing a designated FMU's payment, clearing, or
settlement activities. The Board does not believe it is appropriate to
narrow the definition of third party to vendor, outsourcing, or other
types of arrangements for purposes of the Board's third-party risk-
management standards. Doing so could result in third-party risks being
overlooked. The Board is concerned that limitations to ``outsourced''
or ``traditional vendor'' activities could result in inconsistent
treatment of third parties, depending on how a particular designated
FMU decides to categorize various third-party relationships. Moreover,
the Board has observed that operational risk, and in particular cyber
risk, has the potential to arise from unexpected sources, which may not
be considered outsourced or even directly related to a designated FMU's
critical operations or services. Thus, the Board believes that a
designated FMU's systems, policies, procedures, and controls should
address third parties more broadly.
A broad definition of third party does not mean, however, that the
Board expects a designated FMU to address all third parties in the same
manner. Although the Board, for the reasons described in section III.A,
supra, has not expressly referred to a risk-based and proportionate
approach in the final rule, the Board believes that Sec.
234.3(a)(17)(ix) is consistent with such an approach. As the Board
stated in the NPRM, a designated FMU should adopt risk management
practices that are commensurate with the level of risk posed by its
third-party relationships, as identified through the risk assessments
it conducts.
While the Board generally believes a broad definition of third
party is appropriate, the Board has, in response to comments, clarified
in the final rule that relationships between a designated FMU and its
participants are not ``third-party'' relationships when the participant
is acting in that capacity only.\55\ If a participant maintains other
relationships with a designated FMU--such as acting as a provider of
pricing data, financial risk modeling services, liquidity, or asset
custody services--the participant would be within the scope of the
definition of ``third party'' as it relates to its other business
arrangements with the designated FMU.\56\
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\55\ The Board also does not consider the relationship between a
designated FMU and an employee to be a third-party relationship.
\56\ The Board acknowledges that recent interagency guidance for
banking organizations does not categorically exclude customer
relationships from the scope of ``business arrangements'' within the
scope of that guidance. 88 FR 37920, 37922 (June 9, 2023). In
adopting the final interagency guidance, the agencies explained that
some business relationships may incorporate elements or features of
a customer relationship. Whereas banking organizations may enter
into different types of arrangements, designated FMUs' arrangements
with their participants are standardized and governed by a uniform
set of terms applicable to each participant or class of
participants, and risk management of participants is addressed in
another section of Regulation HH. Specifically, Sec. 234.3(a)(18)
of Regulation HH requires a designated FMU to have objective, risk-
based, and publicly disclosed criteria for participation; monitor
compliance with its participation requirements on an ongoing basis;
and have the authority to impose risk controls on a participant in
situations where the designated FMU determines the participant poses
heightened risk to the designated FMU. 12 CFR 234.3(a)(18).
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2. Assessment of Third Party Risk--Section 234.3(a)(17)(ix)(A)
(a) Summary of Comments
As discussed in section III.F.1, commenters raised concerns about
the scope of the definition of third party. As an alternative to
definitional changes, one commenter suggested that the requirement to
conduct risk assessments could apply broadly, but that specific
information-sharing and business continuity testing requirements should
apply only to third parties that provide critical services. Comments on
the information-sharing and business continuity management and testing
requirements are discussed in section III.F.3, infra.
(b) Final Rule
The Board is adopting the risk assessment requirement in Sec.
234.3(a)(17)(ix)(A) substantially as proposed but has moved the
information sharing requirement to Sec. 234.3(a)(17)(ix)(B) (and,
consequently, the business continuity management and testing
requirement to Sec. 234.3(a)(17)(ix)(C)). To assess risk levels of
third parties and monitor any changes in these risk levels that may
affect a designated FMU and its ecosystem, the Board expects the
designated FMU to regularly conduct risk assessments for each third
party with which it maintains a business relationship. The Board
expects that a designated FMU could incorporate a risk-based approach
to prioritizing and determining the frequency and scope of risk
assessments.
In general, and as discussed in the NPRM, the Board expects a
designated FMU to take a rigorous and comprehensive approach to
identifying, monitoring, and managing risks associated with third-party
relationships. To do this effectively, it would be prudent for the
designated FMU to understand ex ante any risks associated with the
third party, including details on the services or products the third
party will provide and the security controls and business continuity
planning that the third party has in place. Before entering into a
third-party relationship, the designated FMU should have a plan in
place to address how it will effectively identify, monitor, and manage
the relationship and its associated risks, in order to ensure that the
designated FMU can continue to meet the risk-management requirements in
Regulation HH.
3. Information Sharing Arrangements and Business Continuity and
Testing--Section 234.3(a)(17)(ix)(B) and (C)
(a) Summary of Comments
Two commenters raised concerns about the requirement to enter into
information-sharing arrangements with third parties and include third
parties in business continuity and testing, as appropriate. One of the
commenters suggested that, in lieu of narrowing the proposed definition
of ``third party,'' the Board could apply information-sharing and
business continuity management and testing requirements only to third
parties that provide critical services. That commenter also requested
further clarification with respect to any specific expectations or
relevant objectives in connection with information-sharing arrangements
and business continuity management and testing.
The same commenters noted that a designated FMU may not have the
negotiating power to require certain third parties to enter into
information-sharing arrangements or participate in the designated FMU's
business continuity management and testing.\57\ One of the commenters
also raised concerns that third parties outside the United States could
have limitations on their ability to share information with a
designated FMU. To address these types of concerns, one commenter
suggested that a designated FMU could implement alternative risk
mitigants. For example, if a telecommunication provider would not enter
into an information-sharing arrangement, the commenter suggested that a
designated FMU could have
[[Page 18762]]
redundant or diverse telecommunication channels.
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\57\ One commenter proposed that the Board require the Federal
Reserve Banks to provide designated FMUs with necessary information
for the designated FMU to perform its third-party risk management.
---------------------------------------------------------------------------
The Board received a comment outside the scope of the proposal. The
commenter noted that several third parties provide services to multiple
designated FMUs and foreign systemically important FMIs. The commenter
suggested that the Board and its foreign counterparts arrange scenario
exercises involving designated FMUs and foreign FMIs. The commenter
also recommended that the Board evaluate whether to have direct or
collective oversight over certain third parties.
(b) Final Rule
The Board is adopting Sec. 234.3(a)(17)(ix)(B) and (C) with two
substantive revisions in response to comments received. In addition,
the Board has made structural changes to the rule text: the
information-sharing requirement has been moved from proposed Sec.
234.3(a)(17)(ix)(A) to Sec. 234.3(a)(17)(ix)(B) and the business
continuity management and testing requirement in proposed Sec.
234.3(a)(17)(ix)(B) has been moved to new Sec. 234.3(a)(17)(ix)(C).
First, the Board has amended the information-sharing and business
continuity management and testing requirements to apply only with
respect to third parties that provide services material to any of the
designated FMU's critical operations or services. The Board believes
that this limitation strikes an appropriate balance between effective
risk management and the efficient use of resources by designated FMUs.
A designated FMU should use the risk assessments conducted pursuant to
final rule Sec. 234.3(a)(17)(ix)(A) to inform its determinations of
which third parties are in scope for purposes of Sec.
234.3(a)(17)(ix)(B) and (C).
Second, the Board has amended the business continuity management
and testing requirement to accommodate more clearly approaches to
business continuity management and testing that do not include the
participation of each third party in a designated FMU's testing.
Specifically, the final rule provides that a designated FMU must
``address'' (rather than ``include'') in its business continuity
management and testing, as appropriate, third parties that provide
services material to any of the designated FMU's critical operations or
services. The Board recognizes that there are effective approaches to
testing that do not involve participation of a third party, such as
planning for alternatives to be used in the event of a third party's
unavailability. A designated FMU is expected to determine, through
internal risk analysis, an appropriate way to address each covered
third party, in business continuity management and testing, keeping in
mind the overall requirement in Sec. 234.3(a)(17)(ix) that the
designated FMU effectively identify, monitor, and manage risks
associated with third-party relationships.
The final rule, like the proposed rule, continues to apply an ``as
appropriate'' qualification to the provisions related to information-
sharing arrangements and business continuity management and testing. It
does not set forth prescriptive requirements that a designated FMU must
follow in all circumstances. The Board does not believe that
prescriptive requirements would be appropriate, in light of different
facts and circumstances a designated FMU may face with respect to each
of its covered third parties. A designated FMU should consider what is
appropriate in accordance with the risk-management standards
articulated in the introductory portion of Sec. 234.3(a)(17)(ix) and
the risk assessments it conducts pursuant to Sec. 234.3(a)(17)(ix)(A).
With respect to information-sharing arrangements, a designated FMU
should conduct appropriate due diligence on third parties and ensure it
obtains the information necessary to appropriately identify, monitor,
and manage third-party risk. Information-sharing arrangements should
include, where necessary, expectations related to when the designated
FMU will be notified of material operational incidents or outages. They
should also include, where appropriate, expectations with respect to
information regarding the third party's information security controls,
operational resilience objectives and capabilities, the third-party's
arrangements with its own vendors, and changes in security controls at
the third party. Consistent with a risk-based approach, a designated
FMU should consider heightened requirements where there is higher risk.
For example, with certain third parties that are essential to its
critical operations and services, a designated FMU might require
mandatory approval from the designated FMU before the service provider
may outsource any material elements of its service to another party, in
order to manage supply chain risks.
A designated FMU would generally be expected to make reasonable
efforts to enter into contractual information-sharing arrangements,
given the application of Sec. 234.3(a)(17)(ix)(B) to third parties
that provide services material to the designated FMU's critical
operations or services. The Board, however, understands that there may
be circumstances in which a designated FMU may not be able to negotiate
a contractual information sharing arrangement with certain third
parties or all of the designated FMU's desired terms. For example,
utility operators such as electricity providers, as well as central
banks or other operators of FMIs, may have particular needs for
uniformity in how they interact with participants and customers.
In such situations, a designated FMU should consider whether it is
appropriate to rely on non-contractual arrangements or other risk
mitigants. In some cases, such as with central banks, the designated
FMU may appropriately rely on informal information-sharing arrangements
or, where available, other factors that may mitigate the risk
associated with the lack of a contractual arrangement. For example, a
designated FMU could consider the availability of public information
about a third party or consider whether the designated FMU has
sufficient contingency arrangements that would allow the designated FMU
to continue to carry out its critical operations and services in a safe
and sound manner in the absence of contractual information-sharing
arrangements. A designated FMU might also consider the existence of
backups, redundant services, or other means of managing third-party
risk. If a designated FMU cannot with confidence ascertain and
demonstrate that informal arrangements or other mitigants are
sufficient, the designated FMU should consider whether it is
appropriate to transition to an alternative third party, if available,
or choose to keep a service in-house.
The Board expects that a designated FMU would evaluate the
sufficiency of its business continuity arrangements with a third party
in light of how the designated FMU addresses the third party in its
business continuity management and testing. In some circumstances, a
designated FMU may determine that it is appropriate for a third party
to participate directly in the designated FMU's scenario exercises to
ensure that the designated FMU can effectively manage any instances in
which the third party experiences an incident causing disruption or
material degradation to the designated FMU's critical operations or
services. For example, where a cyberattack on a third party could
impair the third party's ability to enable a designated FMU to fulfill
its obligations on time, it may be necessary for the designated FMU to
include the third party in scenario exercises to enable the designated
FMU
[[Page 18763]]
to be prepared to react, such as by switching to a contingency plan. If
a designated FMU determines that it is essential for a third party to
participate in business continuity testing, the Board would, in line
with the discussion above regarding information-sharing arrangements,
generally expect the designated FMU to make reasonable efforts to
require that participation by contract. It may be reasonable in some
circumstances for a designated FMU to rely on non-contractual
arrangements with third parties, such as central banks, to participate
in the designated FMU's business continuity planning.
In other circumstances, a designated FMU may have contingencies in
place such that participation by a particular third party in business
continuity testing is not essential. If participation is not essential,
a designated FMU should consider whether its information-sharing
arrangements or other available sources of information afford the
designated FMU with access to sufficient information to effectively
address the third party in business continuity testing. The sufficiency
of information may depend on the services provided by the third party
and a designated FMU's ability to conduct critical operations and
services safely and soundly in contingency scenarios without the third
party. A designated FMU should consider the third party's business
continuity planning in any risk assessment of the third party that the
designated FMU completes, and, where appropriate, the designated FMU
should include information about a third party's own business
continuity planning in information-sharing arrangements it establishes
with a third party.
G. Technical Revisions
1. Definition of Operational Risk
(a) Proposed Rule
In Sec. 234.2(h), the Board proposed to add ``operational risk''
as a defined term in Regulation HH. The Board proposed to define this
term as ``the risk that deficiencies in information systems or internal
processes, human errors, management failures, or disruptions from
external events will result in the reduction, deterioration, or
breakdown of services provided by the designated financial market
utility.''
(b) Summary of Comments
The Board received one comment that supported the proposed
definition of operational risk.
(c) Final Rule
The Board is adopting the definition of ``operational risk'' as
proposed. This definition is consistent with the definition of
operational risk in the PFMI and the Board's definition in part I of
the Federal Reserve Policy on Payment System Risk (PSR policy).\58\ In
the supplementary information of its 2014 notice of proposed
rulemaking, the Board had provided this definition of operational risk
when it proposed amendments to Regulation HH based on the PFMI.\59\
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\58\ Part I of the PSR policy sets out the Board's views, and
related standards, regarding the management of risks in financial
market infrastructures, including those operated by the Reserve
Banks. The Board concurrently amended the risk-management standards
in Regulation HH and revised part I of the PSR policy based on the
PFMI in 2014. The PSR policy is available at <a href="https://www.federalreserve.gov/paymentsystems/files/psr_policy.pdf">https://www.federalreserve.gov/paymentsystems/files/psr_policy.pdf</a>.
\59\ 79 FR 3666, 3683 (Jan. 22, 2014).
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2. Definition of Critical Operations and Critical Services
(a) Proposed Rule
In Sec. 234.2(d), the Board proposed to add ``critical
operations'' and ``critical services'' as defined terms in Regulation
HH, in order to streamline references to these terms. Under the
proposal, these terms were defined as ``any operations or services that
the designated financial market utility identifies under 12 CFR
234.3(a)(3)(iii)(A).''
(b) Summary of Comments
The Board received one comment on the definition of critical
operations and critical services, which was supportive of the revision.
(c) Final Rule
The Board is adopting the definition of critical operations and
critical services as proposed. Under Sec. 234.3(a)(3)(iii)(A), a
designated FMU must identify its critical operations and services
related to payment, clearing, and settlement for purposes of developing
its integrated plans for recovery and orderly wind-down. The Board's
amendments to Sec. 234.3(a)(17), related to review and testing,
incident management and planning, and business continuity management
planning, refer to a designated FMU's critical operations and/or
services in multiple places. Amending Regulation HH to include
definitions of ``critical operations'' and ``critical services''
clarifies that the critical operations or services that the designated
FMU should consider under paragraph (a)(17) are the same set of
critical operations and services that the designated FMU has identified
under paragraph (a)(3).
3. Cross-Reference to ``Other Entities'' Identified in Sec.
234.3(a)(3) on Comprehensive Management of Risk
(a) Proposed Rule
The Board proposed to streamline and replace the reference to
``financial market utilities and trade repositories, if any'' in Sec.
234.3(a)(17)(ii) with the phrase ``relevant entities such as those
referenced in paragraph (a)(3)(ii).'' In connection with this, the
Board proposed to include ``trade repositories'' in the list of
entities listed under Sec. 234.3(a)(3)(ii).\60\
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\60\ Because of the differences in the definition for financial
market infrastructure in the PFMI, which includes trade
repositories, and the definition of FMU in the Dodd-Frank Act, which
does not, the Board had previously inadvertently excluded the
reference to ``trade repositories'' in Sec. 234.3(a)(3)(ii).
---------------------------------------------------------------------------
(b) Summary of Comments
One commenter had no objection to the addition of the term ``trade
repositories'' to Sec. 234.3(a)(3)(ii), but suggested changing the
term ``relevant entities'' as used in Sec. 234.3(a)(17)(ii) to
``identified entities.'' The commenter noted that change would allow
the word ``relevant'' to be used elsewhere in the rule when discussing
the entities referenced in Sec. 234.3(a)(17)(ii).
(c) Final Rule
The Board has adopted the proposed revisions to Sec.
234.3(a)(3)(ii) and (a)(17)(ii) but has removed the word ``relevant''
from the latter revision. Upon review, the Board believes that the
reference to entities listed in Sec. 234.3(a)(3)(ii) is sufficiently
clear without including a modifier like ``relevant'' or ``identified.''
The Board believes that, as adopted, Sec. 234.3(a)(17)(ii) is
consistent with the requirement under paragraph (a)(3)(ii) for the
designated FMU to identify, measure, monitor, and manage the material
risks that it poses due to interdependencies with other entities, such
as other FMUs, settlement banks, liquidity providers, and service
providers.
4. Operational Capabilities To Ensure High Degree of Security and
Operational Reliability
(a) Proposed Rule
Section 234.3(a)(17)(iii) requires a designated FMU to have
``policies and systems'' that are designed to achieve clearly defined
objectives to ensure a high degree of security and operational
reliability.
A designated FMU is implicitly required to have the operational
[[Page 18764]]
capability to achieve these objectives. In Sec. 234.3(a)(17)(iii), the
Board proposed to make this requirement explicit by clarifying that a
designated FMU must have ``operational capabilities''--in addition to
the existing reference to ``policies and systems''--that are designed
to achieve clearly defined objectives to ensure a high degree of
security and operational reliability.
(b) Summary of Comments
One commenter suggested removing the reference to ``operational
capabilities'' in proposed Sec. 234.3(a)(17)(iii) and instead adding a
reference to ``processes and controls,'' in addition to ``policies and
systems.'' The commenter noted this drafting would better align with
the terminology used throughout Regulation HH.
(c) Final Rule
Upon consideration of the comment, the Board has removed the term
``operational capabilities'' in proposed Sec. 234.3(a)(17)(iii) and
replaced it with ``procedures and controls.'' This change aligns the
language in Sec. 234.3(a)(17)(iii) with terminology used elsewhere in
Regulation HH. Regulation HH frequently uses the term ``procedures and
controls,'' and the Board believes the phrase achieves the suggested
drafting consistency and the intended meaning.
The Board expects a designated FMU to establish clearly defined
objectives to ensure a high degree of security and operational
reliability; to have systems, procedures, and controls designed to
achieve these objectives; and to have policies, such as benchmarks, in
place for the designated FMU to evaluate its systems' performance
against these objectives.
5. Identify, Monitor, and Manage Potential and Evolving Vulnerabilities
and Threats
(a) Proposed Rule
Section 234.3(a)(17)(v) requires a designated FMU to have
comprehensive physical, information, and cyber security policies,
procedures, and controls ``that address'' potential and evolving
vulnerabilities and threats. The Board proposed a technical change to
clarify what it means to ``address'' potential and evolving
vulnerabilities and threats. Specifically, the Board proposed to
replace the phrase ``that address'' with the phrase ``that enable the
designated financial market utility to identify, monitor, and manage''
potential and evolving vulnerabilities and threats.
(b) Summary of Comments
One commenter supported the proposed change. No other comments were
received in response to this proposed revision of Sec.
234.3(a)(17)(v).
(c) Final Rule
The Board is adopting the technical revision as proposed.
IV. Administrative Law Matters
A. Regulatory Flexibility Act Analysis
The Regulatory Flexibility Act (RFA) generally requires that, in
connection with a final rulemaking, an agency prepare and make
available a final regulatory flexibility analysis describing the impact
of the final rule on small entities.\61\ However, a final regulatory
flexibility analysis is not required if the agency certifies that the
final rule will not have a significant economic impact on a substantial
number of small entities.
---------------------------------------------------------------------------
\61\ 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------
The Small Business Administration (SBA) has adopted size standards
for determining whether a particular entity is considered a ``small
entity'' for purposes of the RFA. The Board believes that the most
appropriate SBA size standard to apply in determining whether a
designated FMU is a small entity is the SBA size standard for financial
transactions processing, reserve, and clearinghouse activities. Under
this standard, a designated FMU is considered a small entity if its
annual receipts are less than $47 million.\62\ The Board includes the
assets of all domestic and foreign affiliates in determining whether to
classify a designated FMU as a small entity.\63\ For the reasons
described below and under section 605(b) of the RFA, the Board
certifies that the final rule will not have a significant economic
impact on a substantial number of small entities.\64\
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\62\ 13 CFR 121.201 (subsector 522320). Alternatively, the SBA
size standards for (1) securities and commodities exchanges; (2)
trust, fiduciary, and custody activities; or (3) international,
secondary market, and all other nondepository credit intermediation
activities could also apply to certain designated FMUs; these size
standards are currently the same as the size standard for financial
transactions processing, reserve, and clearinghouse activities
(i.e., annual receipts of less than $47 million). Id. (subsectors
523210, 523991, and 522299).
\63\ 13 CFR 121.103.
\64\ 5 U.S.C. 605(b).
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In connection with the proposed rule, the Board stated that it did
not believe that the proposal would have a significant economic impact
on a substantial number of small entities. Nevertheless, the Board
published and invited comment on an initial regulatory flexibility
analysis of the proposal. No comments were received on the initial
regulatory flexibility analysis.
The Board is finalizing amendments to Regulation HH that would
affect the regulatory requirements that apply to designated FMUs other
than derivatives clearing organizations registered with the CFTC and
clearing agencies registered with the SEC. At present, the FSOC has
designated eight FMUs as systemically important; two of these
designated FMUs are subject to the Board's Regulation HH. The reasons
and justification for the final rule are described above in more detail
in this SUPPLEMENTARY INFORMATION.
The Board has considered whether to conduct a final regulatory
flexibility analysis in connection with the final rule. However, the
annual receipts of designated FMUs subject to this final rule exceed
the $47 million threshold under which a designated FMU is considered a
``small entity'' under SBA regulations. Because the final rule is not
likely to apply to any company with annual receipts of $47 million or
less, it is not expected to apply to any small entity for purposes of
the RFA. In light of the foregoing, the Board certifies that the final
rule will not have a significant economic impact on a substantial
number of small entities.
B. Competitive Impact Analysis
As a matter of policy, the Board conducts a competitive impact
analysis in connection with any operational or legal changes that could
have a substantial effect on payment system participants, even if
competitive effects are not apparent on the face of the proposal.
Pursuant to this policy, the Board assesses whether proposed changes
``would have a direct and material adverse effect on the ability of
other service providers to compete effectively with the Federal Reserve
in providing similar services'' and whether any such adverse effect
``was due to legal differences or due to a dominant market position
deriving from such legal differences.'' If, as a result of this
analysis, the Board identifies an adverse effect on competition, the
Board then assesses whether the associated benefits--such as
improvements to payment system efficiency or integrity--can be achieved
while minimizing the adverse effect on competition.\65\
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\65\ See Policies: The Federal Reserve in the Payments System
(issued 1984; revised 1990 and January 2001), <a href="https://www.federalreserve.gov/paymentsystems/pfs_frpaysys.htm">https://www.federalreserve.gov/paymentsystems/pfs_frpaysys.htm</a>.
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Designated FMUs are subject to the supervisory framework
established under Title VIII of the Dodd-Frank Act. The final rule
amends current
[[Page 18765]]
Regulation HH operational risk-management standards for certain
designated FMUs. At least one designated FMU that is currently subject
to Regulation HH competes with the Fedwire[supreg] \66\ Funds Service
provided by the Reserve Banks.
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\66\ Fedwire is a registered service mark of the Reserve Banks.
A list of marks related to financial service products that are
offered to financial institutions by the Reserve Banks is available
at <a href="http://FRBservices.org">FRBservices.org</a>.
---------------------------------------------------------------------------
Under the Federal Reserve Act, the Board has general supervisory
authority over the Reserve Banks, including the Reserve Banks'
provision of payment and settlement services. This general supervisory
authority is more extensive in scope than the Board's authority over
certain designated FMUs under Title VIII. In practice, Board oversight
of the Reserve Banks goes beyond the typical supervisory framework for
private-sector entities, including the framework provided by Title
VIII. The Fedwire Funds Service and Fedwire Securities Service
(collectively, Fedwire Services) are subject to the risk-management
standards in part I of the PSR policy, including applicable principles
from the PFMI as set forth in an appendix to the PSR policy. The Board
is guided by its interpretation of the corresponding provisions of
Regulation HH in its application of the risk management expectations in
the PSR policy.\67\
---------------------------------------------------------------------------
\67\ See section I.B.1 of the PSR policy.
---------------------------------------------------------------------------
One commenter expressed its appreciation for the Board's commitment
to apply risk-management standards to the Fedwire Funds Service that
are at least as stringent as those in Regulation HH, but asked the
Board to amend the appendix to the PSR policy to more closely align
with Regulation HH. The commenter also requested that the Board revise
the PSR policy to include the Reserve Banks' National Settlement
Service (NSS), along with the Fedwire Services, as a service subject to
the appendix of the PSR policy.
The Board recognizes the critical role that the Fedwire Services
play in the financial system and, as noted in the proposal, the Board
remains committed to applying risk-management standards to the Fedwire
Funds Service that are at least as stringent as the Regulation HH
standards that are applied to designated FMUs that provide similar
services. At the same time, however, the Board continues to believe
that a different level of detail is required for Regulation HH than for
part I of the PSR policy. Regulation HH is an enforceable rule
applicable to designated FMUs other than those supervised by the CFTC
or SEC, so additional detail provides greater clarity on the Board's
expectations. The PSR policy, on the other hand, is a policy statement
that provides guidance about (as relevant here) the Board's exercise of
its other supervisory or regulatory authority over other financial
market infrastructures (including those operated by the Reserve Banks)
or their participants.
The Board continues to believe that the current approach to the
appendix to the PSR policy is consistent with the purpose of the
document and the Board's long-standing supervisory approach under the
PSR policy. In light of the Federal Reserve's oversight framework for
the Fedwire Services, the Board does not believe that the amendments to
Regulation HH will have any direct and material adverse effect on the
ability of other service providers to compete with the Reserve Banks.
Finally, the Board does not believe that the exclusion of NSS from
the list of Federal Reserve services subject to the appendix of the PSR
policy has a direct and material effect on the ability of other service
providers to compete with the Reserve Banks. NSS provides services to a
number of financial market infrastructures, but is not itself a
competitor with other service providers, and in particular with any
service providers to which Regulation HH applies.
C. Paperwork Reduction Act Analysis
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CFR part 1320, appendix A, section 1), the Board reviewed the
final rule under the authority delegated to the Board by the Office of
Management and Budget. As noted in the NPRM, for purposes of the
Paperwork Reduction Act, a ``collection of information'' involves 10 or
more respondents. Any recordkeeping, disclosure, or reporting
requirement that is contained in a rule of general applicability or
that is addressed to all or a substantial majority of an industry is
presumed to involve 10 or more respondents (5 CFR 1320.3(c),
1320.3(c)(4)). Regulation HH applies to fewer than 10 persons, and
these persons do not represent all or a substantial majority of the
participants in payment, clearing, and settlement systems.
Additionally, Regulation HH is not a rule of general applicability.
Therefore, no collections of information under the Paperwork Reduction
Act are contained in the final rule. The Board did not receive any
comments on this analysis.
List of Subjects in 12 CFR Part 234
Banks, Banking, Credit, Electronic funds transfers, Financial
market utilities, Securities.
Authority and Issuance
For the reasons set forth in the preamble, the Board is amending
part 234 of chapter II of title 12 of the Code of Federal Regulations
as follows:
PART 234--DESIGNATED FINANCIAL MARKET UTILITIES (REGULATION HH)
0
1. The authority citation for part 234 continues to read as follows:
Authority: 12 U.S.C. 5461 et seq.
0
2. Revise Sec. 234.2 to read as follows:
Sec. 234.2 Definitions.
(a) Backtest means the ex post comparison of realized outcomes with
margin model forecasts to analyze and monitor model performance and
overall margin coverage.
(b) Central counterparty means an entity that interposes itself
between counterparties to contracts traded in one or more financial
markets, becoming the buyer to every seller and the seller to every
buyer.
(c) Central securities depository means an entity that provides
securities accounts and central safekeeping services.
(d) Critical operations and critical services refer to any
operations or services that the designated financial market utility
identifies under Sec. 234.3(a)(3)(iii)(A).
(e) Designated financial market utility means a financial market
utility that is currently designated by the Financial Stability
Oversight Council under section 804 of the Dodd-Frank Act (12 U.S.C.
5463).
(f) Financial market utility has the same meaning as the term is
defined in section 803(6) of the Dodd-Frank Act (12 U.S.C. 5462(6)).
(g) Link means, for purposes of Sec. 234.3(a)(20), a set of
contractual and operational arrangements between two or more central
counterparties, central securities depositories, or securities
settlement systems, or between one or more of these financial market
utilities and one or more trade repositories, that connect them
directly or indirectly, such as for the purposes of participating in
settlement, cross margining, or expanding their services to additional
instruments and participants.
(h) Operational risk means the risk that deficiencies in
information systems or internal processes, human errors, management
failures, or disruptions from external events will result in the
[[Page 18766]]
reduction, deterioration, or breakdown of services provided by the
designated financial market utility.
(i) Orderly wind-down means the actions of a designated financial
market utility to effect the permanent cessation, sale, or transfer of
one or more of its critical operations or services in a manner that
would not 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.
(j) Recovery means, for purposes of Sec. 234.3(a)(3) and (15), the
actions of a designated financial market utility, consistent with its
rules, procedures, and other ex ante contractual arrangements, to
address any uncovered loss, liquidity shortfall, or capital inadequacy,
whether arising from participant default or other causes (such as
business, operational, or other structural weaknesses), including
actions to replenish any depleted prefunded financial resources and
liquidity arrangements, as necessary to maintain the designated
financial market utility's viability as a going concern and to continue
its provision of critical services.
(k) Securities settlement system means an entity that enables
securities to be transferred and settled by book entry and allows
transfers of securities free of or against payment.
(l) Stress test means the estimation of credit or liquidity
exposures that would result from the realization of potential stress
scenarios, such as extreme price changes, multiple defaults, and
changes in other valuation inputs and assumptions.
(m) Supervisory Agency has the same meaning as the term is defined
in section 803(8) of the Dodd-Frank Act (12 U.S.C. 5462(8)).
(n) Third party means any entity, other than a participant of a
designated financial market utility acting in that capacity, with which
a designated financial market utility maintains a business arrangement,
by contract or otherwise.
(o) Trade repository means an entity that maintains a centralized
electronic record of transaction data, such as a swap data repository
or a security-based swap data repository.
0
3. In Sec. 234.3:
0
a. Revise the section heading;
0
b. Add the words ``trade repositories,'' after the words ``such as
other financial market utilities,'' in paragraph (a)(3)(ii);
0
c. Remove the word ``following'' and add in its place ``after'', in
paragraph (a)(3)(iii)(G);
0
d. Revise paragraph (a)(17); and
0
e. Remove the word ``following'' and add in its place the words ``to
reflect'', in paragraph (a)(23)(v).
The revisions read as follows:
Sec. 234.3 Standards for designated financial market utilities.
(a) * * *
(17) Operational risk. The designated financial market utility
manages its operational risks by establishing a robust operational
risk-management framework that is approved by the board of directors.
In this regard, the designated financial market utility--
(i) Identifies the plausible sources of operational risk, both
internal and external, and mitigates their impact through the use of
appropriate systems, policies, procedures, and controls--including
those specific systems, policies, procedures, or controls required
pursuant to this paragraph (a)(17)--that are reviewed, audited, and
tested periodically and after major changes such that--
(A) The designated financial market utility conducts tests--
(1) In accordance with a documented testing framework that
addresses, at a minimum, scope, frequency, participation,
interdependencies, and reporting; and
(2) That assess whether the designated financial market utility's
systems, policies, procedures, or controls function as intended;
(B) The designated financial market utility reviews the design,
implementation, and testing of affected and similar systems, policies,
procedures, and controls, after material operational incidents,
including the material operational incidents described in paragraph
(a)(17)(vi)(A) of this section, or after changes to the environment in
which the designated financial market utility operates that could
significantly affect the plausible sources or mitigants of operational
risk; and
(C) The designated financial market utility remediates as soon as
possible, following established governance processes, deficiencies in
systems, policies, procedures, or controls identified in the process of
review or testing;
(ii) Identifies, monitors, and manages the risks its operations
might pose to other entities such as those referenced in paragraph
(a)(3)(ii) of this section;
(iii) Has systems, policies, procedures, and controls that are
designed to achieve clearly defined objectives to ensure a high degree
of security and operational reliability;
(iv) Has systems that have adequate, scalable capacity to handle
increasing stress volumes and achieve the designated financial market
utility's service-level objectives;
(v) Has comprehensive physical, information, and cyber security
policies, procedures, and controls that enable the designated financial
market utility to identify, monitor, and manage potential and evolving
vulnerabilities and threats;
(vi) Has a documented framework for incident management that
provides for the prompt detection, analysis, and escalation of an
incident, appropriate procedures for addressing an incident, and
incorporation of lessons learned following an incident. This framework
includes a plan for notification and communication of material
operational incidents to identified relevant entities that ensures the
designated financial market utility--
(A) Immediately notifies the Board, in accordance with the process
established by the Board, when the designated financial market utility
activates its business continuity plan or has a reasonable basis to
conclude that--
(1) There is an actual or likely disruption, or material
degradation, to any critical operations or services, or to its ability
to fulfill its obligations on time; or
(2) There is unauthorized entry or a vulnerability that could allow
unauthorized entry into the designated financial market utility's
computer, network, electronic, technical, automated, or similar systems
that affects or has the potential to affect its critical operations or
services; and
(B) Establishes criteria and processes providing for timely
communication and responsible disclosure of material operational
incidents to the designated financial market utility's participants and
other relevant entities, such that--
(1) Affected participants are notified immediately of actual
disruptions or material degradations to any critical operations or
services, or to the designated financial market utility's ability to
fulfill its obligations on time; and
(2) Participants and other relevant entities, as identified in the
designated financial market utility's plan for notification and
communication, are notified in a timely manner of material operational
incidents described in paragraph (a)(17)(vi)(A) of this section, as
appropriate, taking into account the risks and benefits of the
disclosure to the designated financial market utility and such
participants and other relevant entities;
(vii) Has business continuity management that provides for rapid
recovery and timely resumption of critical operations and services and
[[Page 18767]]
fulfillment of its obligations, including in the event of a wide-scale
disruption or a major disruption;
(viii) Has a business continuity plan that--
(A) Incorporates the use of two sites providing for sufficient
redundancy supporting critical operations that are located at a
sufficient geographical distance from each other to have a distinct
risk profile;
(B) Is designed to enable critical systems, including information
technology systems, to recover and resume critical operations and
services no later than two hours following disruptive events;
(C) Is designed to enable it to complete settlement by the end of
the day of the disruption, even in case of extreme circumstances;
(D) Sets out criteria and processes by which the designated
financial market utility will reestablish availability for affected
participants and other entities following a disruption to the
designated financial market utility's critical operations or services;
(E) Provides for testing, pursuant to the requirements under
paragraphs (a)(17)(i)(A) and (C) of this section, at least annually, of
the designated financial market utility's business continuity
arrangements, including the people, processes, and technologies of the
sites required under paragraph (a)(17)(viii)(A) of this section, such
that--
(1) The designated financial market utility can demonstrate that it
can run live production at the sites required under paragraph
(a)(17)(viii)(A) of this section;
(2) The designated financial market utility assesses the capability
of its systems and effectiveness of its procedures for data recovery
and data reconciliation to meet the recovery and resumption objectives
under paragraphs (a)(17)(viii)(B) and (C) of this section, even in case
of extreme circumstances, including in the event of data loss or data
corruption; and
(3) The designated financial market utility can demonstrate that it
has geographically dispersed staff who can effectively run the
operations and manage the business of the designated financial market
utility; and
(F) Is reviewed, pursuant to the requirements under paragraphs
(a)(17)(i)(B) and (C) of this section, at least annually, in order to--
(1) Incorporate lessons learned from actual and averted
disruptions; and
(2) Update scenarios and assumptions in order to ensure
responsiveness to the evolving risk environment and incorporate new and
evolving sources of operational risk; and
(ix) Has systems, policies, procedures, and controls that
effectively identify, monitor, and manage risks associated with third-
party relationships, and that ensure that, for any service that is
performed for the designated financial market utility by a third party,
risks are identified, monitored, and managed to the same extent as if
the designated financial market utility were performing the service
itself. In this regard, the designated financial market utility--
(A) Regularly conducts risk assessments of third parties;
(B) Establishes information-sharing arrangements, as appropriate,
with third parties that provide services material to any of the
designated financial market utility's critical operations or services;
and
(C) Addresses in its business continuity management and testing, as
appropriate, third parties that provide services material to any of the
designated financial market utility's critical operations or services.
* * * * *
By order of the Board of Governors of the Federal Reserve
System.
Ann E. Misback,
Secretary of the Board.
[FR Doc. 2024-05322 Filed 3-14-24; 8:45 am]
BILLING CODE 6210-01-P
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</html>Indexed from Federal Register on March 15, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.