reasonably designed to include a not-less-than-annual review of the
sufficiency of a covered clearing agency's collateral haircuts and
concentration limits.\311\
---------------------------------------------------------------------------

    \311\ See CCA Standards proposing release, supra note 5, at
29528.
---------------------------------------------------------------------------

b. Comments Received
    Commenters were generally supportive of the proposed approach, but
two commenters supported further clarification regarding the type of
collateral a covered clearing agency can accept.\312\
---------------------------------------------------------------------------

    \312\ See CFA Institute at 8; OCC at 9.
---------------------------------------------------------------------------

    One commenter stressed that the ability to accept equity securities
as collateral is critically important to its systemic risk mitigation
efforts and believes that it should be permitted to continue accepting
such securities as collateral within its existing framework.\313\ The
commenter sought to clarify that an appropriately designed portfolio
margining system that permits the use of equity collateral complies
with the requirements of proposed Rule 17Ad-22(e)(5) with respect to
quality of collateral. In response, the Commission believes that, for a
portfolio margining system to comply with Rule 17Ad-22(e)(5), it would
necessarily have to consider whether such equity collateral has low
credit, liquidity, and market risk. This may require a consideration of
whether the collateral carries wrong-way risk. The Commission provides
further guidance on this point in Part II.C.5.c below.
---------------------------------------------------------------------------

    \313\ See OCC at 10.
---------------------------------------------------------------------------

    One commenter recommended that the Commission consider establishing
prescriptive standards for eligible collateral.\314\ Among other
things, the commenter recommended limiting initial margin to cash in
highly liquid currencies, obligations guaranteed by a sovereign that
are highly liquid, corporate bonds that are highly liquid, equities
that are highly liquid, and gold. The commenter further recommended
limiting the assets that a covered clearing agency may accept as
initial margin to collateral that a central bank would accept under an
ordinary-course facility, is deliverable against the collateralized
exposure, or is otherwise subject to conservative risk management
practices that the Commission has determined to be adequate to mitigate
the incremental risks associated with the collateral because a central
bank would not accept it under an ordinary-course facility and it is
not deliverable against the collateralized exposure. The commenter
further recommended aggregate limits on each type of collateral posted
as initial margin. The commenter also recommended that the Commission
prohibit a covered clearing agency from accepting as initial margin
securities issued by a participant or any of its affiliates.\315\
---------------------------------------------------------------------------

    \314\ See The Clearing House at 2-3, 9-11.
    \315\ See id. at 10.
---------------------------------------------------------------------------

    The Commission is mindful of the concerns raised by the commenter
but, given the range of products that covered clearing agencies clear,
declines to restrict the types of collateral to the assets identified
by the commenter. A covered clearing agency should have flexibility,
consistent with the requirements in Rule 17Ad-22(e)(5), to react to
changing market conditions. The Commission notes that a covered
clearing agency is required under Rule 17Ad-22(e)(5) to have policies
and procedures that assess what assets have low credit, liquidity, and
market risks in light of its broader risk management framework and,
likewise, what haircuts and concentration limits are necessary to
effectively manage its credit exposure.
c. Final Rule
    The Commission is adopting Rule 17Ad-22(e)(5) as proposed.\316\
Because the Commission recognizes that there may be a number of ways to
address compliance with Rule 17Ad-22(e)(5), the Commission is providing
the following guidance that a covered clearing agency generally should
consider in establishing and maintaining policies and procedures that
address collateral:
---------------------------------------------------------------------------

    \316\ See Rule 17Ad-22(e)(5), infra Part VI.
---------------------------------------------------------------------------

     Whether it has generally limited the assets it accepts as
collateral to those with low credit, liquidity, and market risks;
     whether it has established prudent valuation practices and
developed haircuts that are regularly tested and take into account
stressed market conditions;
     to reduce the need for procyclical adjustments, whether it
has established stable and conservative haircuts that have been
calibrated to include periods of stressed market conditions, to the
extent practical and prudent;
     whether it has avoided concentrated holdings of certain
assets where this would significantly impair the ability to liquidate
such assets quickly without significant adverse price affects;
     if it accepts cross-border collateral, whether it has
mitigated the risks associated with the use of cross-border collateral
and ensured that the collateral can be used in a timely manner; and
     whether it uses a collateral management system that has
been well-designed and is operationally flexible.

In assessing what assets have low credit, liquidity, and market risks,
a covered clearing agency's policies and procedures also generally
should account for wrong-way risk, such as the risk that arises from
accepting as initial margin securities issued by a participant or any
of its affiliates.\317\ Policies and procedures for haircuts and
concentration limits generally should account for wrong-way risk by
limiting the acceptance of collateral that would likely lose value in
the event that the participant providing the collateral defaults. For
example, this would be true when accepting equity securities of the
participant itself or its affiliates. Further, to reduce the need for
procyclical adjustments,\318\ a covered clearing agency generally
should consider establishing stable and

conservative haircuts that are calibrated to include periods of
stressed market conditions, to the extent practicable and prudent.
---------------------------------------------------------------------------

    \317\ Wrong-way risk can be either general or specific. General
wrong-way risk arises at a CCP when the potential losses of either a
participant's portfolio or a participant's collateral is correlated
with the default probability of that participant. Specific wrong-way
risk arises at a CCP when an exposure to a participant is highly
likely to increase when the creditworthiness of that participant is
deteriorating.
    \318\ In this context, procyclicality typically refers to
changes in risk-management practices that are positively correlated
with market, business, or credit cycle fluctuations that may cause
or exacerbate financial stability. While changes in collateral
values tend to be procyclical, collateral arrangements can increase
procyclicality if haircut levels fall during periods of low market
stress and increase during periods of high market stress.
---------------------------------------------------------------------------

    In addition, with respect to policies and procedures for reviewing
the sufficiency of its collateral haircuts and concentration limits not
less than annually, a covered clearing agency generally should perform
the review not less than once every twelve months using persons who are
independent from management and have appropriate technical skills.
6. Rule 17Ad-22(e)(6): Margin
a. Proposed Rule
    As proposed, Rule 17Ad-22(e)(6) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to cover
its credit exposures to its participants by establishing a risk-based
margin system that is monitored by management on an ongoing basis and
regularly reviewed, tested, and verified.\319\ Proposed Rule 17Ad-
22(e)(6)(i) would require a covered clearing agency that provides CCP
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in a margin system that,
at a minimum, considers and produces margin levels commensurate with
the risks and particular attributes of each relevant product,
portfolio, and market. Proposed Rule 17Ad-22(e)(6)(ii) would require a
covered clearing agency that provides CCP services to establish
implement, maintain and enforce written policies and procedures
reasonably designed to ensure that the margin system would mark
participant positions to market and collect margin, including variation
margin or equivalent charges if relevant, at least daily, and include
the authority and operational capacity to make intraday margin calls in
defined circumstances. Proposed Rule 17Ad-22(e)(6)(iii) would require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to calculate margin sufficient to cover its
potential future exposure to participants in the interval between the
last margin collection and the close out of positions following a
participant default. The Commission also proposed Rule 17Ad-22(a)(14)
to define ``potential future exposure'' to mean the maximum exposure
estimated to occur at a future point in time with an established
single-tailed confidence level of at least 99% with respect to the
estimated distribution of future exposure.\320\ Proposed Rule 17Ad-
22(e)(6)(iv) would require a covered clearing agency that provides CCP
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it uses reliable
sources of timely price data and procedures and sound valuation models
for addressing circumstances in which pricing data are not readily
available or reliable. Proposed Rule 17Ad-22(e)(6)(v) would require a
covered clearing agency that provides CCP services to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to ensure the use of an appropriate method for
measuring credit exposure that accounts for relevant product risk
factors and portfolio effects across products.
---------------------------------------------------------------------------

    \319\ See CCA Standards proposing release, supra note 5, at
29528-31.
    \320\ See id. at 29529. The Commission received no comments
regarding the proposed definition and is adopting it as proposed.
Because of other modifications to Rule 17Ad-22(a), the definition of
``potential future exposure'' is being moved to Rule 17Ad-22(a)(13).
See infra Part VI.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(6)(vi) would require a covered clearing
agency that provides CCP services to establish, implement, maintain and
enforce written policies and procedures reasonably designed to
regularly review, test, and verify its risk-based margin system by
conducting backtests at least once each day and conducting a conforming
sensitivity analysis of its margin resources and its parameters and
assumptions for backtesting at least monthly, and considering
modifications to ensure the backtesting practices are appropriate for
determining the adequacy of its margin resources. Proposed Rule 17Ad-
22(e)(6)(vi) would also require a covered clearing agency's policies
and procedures to include conducting a conforming sensitivity analysis
more frequently than monthly when the products cleared or markets
served display high volatility or become less liquid, and when the size
or concentration of positions held by participants increases or
decreases significantly. Proposed Rule 17Ad-22(e)(6)(vi) would also
require a covered clearing agency to establish, implement, maintain and
enforce written policies and procedures reasonably designed to report
the results of such conforming sensitivity analysis to appropriate
decision makers at the covered clearing agency, including its risk
management committee or board of directors, and use these results to
evaluate the adequacy of and adjust its margin methodology, model
parameters, and any other relevant aspects of its credit risk
management policies and procedures.\321\
---------------------------------------------------------------------------

    \321\ See id. at 29530.
---------------------------------------------------------------------------

    With respect to proposed Rule 17Ad-22(e)(6)(vi), the Commission
proposed Rule 17Ad-22(a)(1) to define ``backtesting'' to mean an ex-
post comparison of actual outcomes with expected outcomes derived from
the use of margin models.\322\ The Commission received no comments
regarding the proposed definition and is adopting it as proposed.\323\
The Commission also proposed to define ``sensitivity analysis'' to mean
an analysis that involves analyzing the sensitivity of a model to its
assumptions, parameters, and inputs.\324\ The Commission also proposed
to define ``conforming sensitivity analysis'' to mean a sensitivity
analysis that considers the impact on the model of both moderate and
extreme changes in a wide range of inputs, parameters, and assumptions,
including correlations of price movements or returns if relevant, which
reflect a variety of historical and hypothetical market conditions and
actual and hypothetical portfolios of proprietary positions and, where
applicable, customer positions.\325\ Under the proposed definition, a
conforming sensitivity analysis, when performed by or on behalf of a
covered clearing agency involved in activities with a more complex risk
profile, would consider the most volatile relevant periods, where
practical, that have been experienced by the markets served by the
clearing agency. The proposed definition would also require a
conforming sensitivity analysis to test the sensitivity of the model to
stressed market conditions, including the market conditions that may
ensue after the default of a member and other extreme but plausible
conditions as defined in a covered clearing agency's risk
policies.\326\
---------------------------------------------------------------------------

    \322\ See id.
    \323\ See Rule 17Ad-22(a)(1), infra Part VI.
    \324\ See CCA Standards proposing release, supra note 5, at
29530.
    \325\ See id.
    \326\ See CCA Standards proposing release, supra note 5, at
29530. The Commission received no comments regarding the proposed
definitions, and the Commission is combining them into one
definition of ``sensitivity analysis'' to avoid the use of both
``sensitivity analysis'' and ``conforming sensitivity analysis'' in
Rule 17Ad-22, as discussed further below. See infra Part II.C.6.c.
---------------------------------------------------------------------------

    Finally, proposed Rule 17Ad-22(e)(6)(vii) would require a covered
clearing agency that provides CCP services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to require not less than annually a conforming model
validation of the

covered clearing agency's margin system and related models.\327\
---------------------------------------------------------------------------

    \327\ See CCA Standards proposing release, supra note 5, at
29531; see also supra note 305 and accompanying text (modifying the
term ``conforming model validation'' to ``model validation,'' and
moving it to Rule 17Ad-22(a)(9)).
---------------------------------------------------------------------------

b. Comments Received and Commission Response
i. Minimum Liquidation Periods for Initial Margin
    One commenter expressed the view that the requirements in Rule
17Ad-22(e)(6) are reasonable.\328\ In contrast, another commenter noted
that the proposed rules would address initial margin liquidation period
requirements through the Commission's supervisory process rather than
establish a minimum liquidation period as part of the covered clearing
agency's initial margin methodology.\329\ The commenter stated that, at
a minimum, the Commission should establish minimum liquidation period
standards that, as a supervisory matter, are transparent to the public.
To promote transparency and international consistency, the commenter
also stated that the Commission should modify Rule 17Ad-22(e)(6)(iii)
to establish minimum liquidation periods for initial margin calculation
that are consistent with international standards.\330\
---------------------------------------------------------------------------

    \328\ See CFA Institute at 1, 8-9.
    \329\ See The Clearing House at 14.
    \330\ See id. at 3, 14, 15.
---------------------------------------------------------------------------

    The Commission is declining to establish minimum liquidation
periods as part of a covered clearing agency's initial margin
methodology. The Commission recognizes that liquidation periods are a
critical assumption for any margin methodology and vary by product
type. Accordingly, liquidation periods generally should be tailored to
the market conditions and risks of the products being cleared. Because
market conditions vary and the risks of the products being cleared over
time may change, the Commission believes that a rule or rules
establishing criteria for minimum liquidation periods may not be
sufficiently tailored to changing circumstances as financial markets
evolve. A covered clearing agency generally should consider reviewing
liquidation periods as part of its regular review, testing, and
verification of its margin system under Rule 17Ad-22(e)(6).
ii. Model Validation
    One commenter supported the proposed requirement that a qualified
person who is free from influence should perform the annual model
validation for credit and margin risk, but the commenter asked the
Commission to go further with the ``free from influence''
requirement.\331\ The commenter noted the inevitable and indirect
pressures employees may face and suggested that the models be validated
annually by a qualified and independent organization with no financial
stake in the outcome.\332\ The Commission previously addressed comments
on this topic when it adopted Rule 17Ad-22(b)(4). At that time, the
Commission stated that it was not persuaded that model validation must
be performed by an outside, independent expert.\333\ The Commission
believes that objectivity can be preserved where the person performing
the model validation is an employee of the covered clearing agency by a
variety of means, including, for example, separating employees
responsible for model validation from those in the covered clearing
agency responsible for the day-to-day functioning of the model and the
business lines that use the model. As a general matter, mechanisms
ensuring that any employees responsible for model validation remain
independent from those responsible for using the model on a day-to-day
basis would satisfy this requirement of the rule.
---------------------------------------------------------------------------

    \331\ See Better Markets at 9. The Commission notes that this
``free from influence'' requirement applies to model validation
requirements in Rules 17Ad-22(e)(4), (e)(6), and (e)(7). See Rule
17Ad-22(a)(9), infra Part VI.
    \332\ See Better Markets at 9-10.
    \333\ See Clearing Agency Standards adopting release, supra note
5, at 66238.
---------------------------------------------------------------------------

iii. Intraday Margin on a Net Basis and Multilateral Netting Across
CCPs
    One commenter supported intraday margin on a net basis and
encouraged multilateral netting across CCPs. The commenter stated that,
to prevent intraday variation margin calls from having destabilizing
effects, the Commission should, pending the development of market-wide
solutions, require a covered clearing agency making an intraday margin
call to simultaneously net variation margin that is payable to
participants.\334\
---------------------------------------------------------------------------

    \334\ See The Clearing House at 3, 14.
---------------------------------------------------------------------------

    After careful consideration, the Commission declines to accept the
commenter's suggestion because it would be inconsistent with the
overall approach to Rule 17Ad-22(e). The Commission notes that the
circumstances that could give rise to intraday margin calls at a
covered clearing agency may vary significantly (e.g., intraday
volatility, large changes in participant positions), and may present
varied challenges. Although there may be circumstances where it would
be appropriate for a covered clearing agency to incorporate policies
and procedures such as those suggested by the commenter, the
Commission's approach to Rule 17Ad-22(e) is to provide flexibility to
covered clearing agencies, subject to their obligations and
responsibilities as SROs under the Exchange Act, to design and
structure their policies and procedures to take into account the
differences among clearing agencies. With respect to intraday margin as
a general matter, Rule 17Ad-22(e)(6)(ii) requires policies and
procedures for having the capacity to collect intraday margin in
defined circumstances, which generally would include margin calls on
both a scheduled and unscheduled basis.
c. Final Rule
    As previously discussed, the Commission is adopting the definitions
of ``backtesting'' and ``potential future exposure'' as proposed.\335\
As noted above, the Commission is combining the definitions of
``sensitivity analysis'' and ``conforming sensitivity analysis.'' In
addition, the Commission believes that while hypothetical portfolios
are often useful and important in conducting a sensitivity analysis,
hypothetical portfolios may not be appropriate in certain cases. The
Commission is modifying the definition so that, under new Rule 17Ad-
22(a)(16), ``sensitivity analysis'' means an analysis that involves
analyzing the sensitivity of a model to its assumptions, parameters,
and inputs that: (i) Considers the impact on the model of both moderate
and extreme changes in a wide range of inputs, parameters, and
assumptions, including correlations of price movements or returns if
relevant, which reflect a variety of historical and hypothetical market
conditions. Sensitivity analysis must use actual and, where applicable,
hypothetical portfolios that reflect the characteristics of proprietary
positions and customer positions; (ii) when performed by or on behalf
of a covered clearing agency involved in activities with a more complex
risk profile, considers the most volatile relevant periods, where
practical, that have been experienced by the markets served by the
clearing agency; and (iii) tests the sensitivity of the model to
stressed market conditions, including the market conditions that may
ensue after the default of a member and other extreme but plausible

conditions as defined in a covered clearing agency's risk
policies.\336\ The Commission believes that this reduces the potential
for confusion resulting from the use of two separate definitions.
---------------------------------------------------------------------------

    \335\ See supra notes 320 and 323. Due to modifications to Rule
17Ad-22(a), the definition of ``potential future exposure'' is being
moved to Rule 17Ad-22(a)(13). The definition of ``backtesting''
remains in Rule 17Ad-22(a)(1). See infra Part VI.
    \336\ See Rule 17Ad-22(a)(16), infra Part VI.
---------------------------------------------------------------------------

    The Commission is also adopting modifications to Rule 17Ad-
22(e)(6).\337\ First, the Commission is modifying Rule 17Ad-22(e)(6) to
remove references to ``conforming'' consistent with the modification to
the definitions of ``sensitivity analysis'' discussed above and of
``model validation'' discussed in Part II.C.4.c. Second, to improve
clarity, the Commission is modifying Rule 17Ad-22(e)(6)(v) to require
policies and procedures that use reliable sources of timely price data
and that ``use'' procedures and sound valuation models for addressing
circumstances in which pricing data are not readily available or
reliable. Third, because backtests are conducted with respect to the
margin model and not the margin resources themselves, the Commission is
modifying Rule 17Ad-22(e)(6)(vi)(A) to replace the phrase ``margin
resources'' with ``margin model.'' Fourth, to avoid conflating
sensitivity analysis with backtesting, the Commission is modifying
Rules 17Ad-22(e)(6)(vi)(B) and (C) to clarify that a sensitivity
analysis should be conducted of the margin model and not of margin
resources. Specifically, the rule text will replace the phrase ``margin
resources'' with the phrase ``margin model.'' The modifications to
Rules 17Ad-22(e)(6)(vi)(A), (B), and (C) are consistent with the
discussion of the proposed rule in the CCA Standards proposing
release.\338\ Fifth, the Commission is modifying Rule 17Ad-
22(e)(6)(vi)(C) to replace ``and'' with ``or'' so that the criteria for
conducting analysis more frequently than monthly are disjunctive rather
than conjunctive, since the criteria described may not be correlated to
each other. This modification is consistent with the Commission's
description of the proposed rule in the CCA Standards proposing
release.\339\
---------------------------------------------------------------------------

    \337\ See Rule 17Ad-22(e)(6), infra Part VI.
    \338\ See CCA Standards proposing release, supra note 5, at
29530-31.
    \339\ See id. at 29530.
---------------------------------------------------------------------------

    Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(6), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures for margin:
     Whether its margin system has established margin levels
commensurate with the risks and particular attributes of each product,
portfolio, and market it serves;
     whether it has a reliable source of timely price data for
its margin system and policies and procedures, including sound
valuation models, for addressing circumstances in which pricing data
are not readily available or reliable;
     whether it has adopted initial margin models and
parameters that are risk-based and generate margin requirements
sufficient to cover its potential future exposure to participants in
the interval between the last margin collection and the close out of
positions following a participant default;
     whether initial margin meets an established single-tailed
confidence level of at least 99 percent with respect to the estimated
distribution of future exposure; whether, if it calculates margin at
the portfolio level, this applies to each portfolio's distribution of
future exposure; whether, if it calculates margin at more granular
levels, such as at the sub-portfolio level or by product, this is met
for the corresponding distributions of future exposure; and whether the
model (i) uses a conservative estimate of the time horizons for the
effective hedging or close out of the particular types of products
cleared by the covered clearing agency (including in stressed market
conditions), (ii) has an appropriate method for measuring credit
exposure that accounts for relevant product risk factors and portfolio
effects across products, and (iii) to the extent practicable and
prudent, limits the need for destabilizing, procyclical changes;
     whether it marks participant positions to market and
collects variation margin at least daily to limit the build-up of
current exposures and has the authority and operational capacity to
make intraday margin calls and payments, both scheduled and
unscheduled, to participants;
     in calculating margin requirements, whether it allows
offsets or reductions in required margin across products that it clears
or between products that it and another clearing agency clear, if the
risk of one product is significantly and reliably correlated with the
risk of the other product; and where two or more clearing agencies are
authorized to offer cross-margining, whether they have appropriate
safeguards and harmonized overall risk management systems;
     whether it analyzes and monitors its model performance and
overall margin coverage by conducting rigorous daily backtesting and at
least monthly, and more frequent when appropriate, sensitivity
analysis; whether it regularly conducts an assessment of the
theoretical and empirical properties of its margin model for all
products it clears; in conducting sensitivity analysis of the model's
coverage, whether the covered clearing agency has taken into account a
wide range of parameters and assumptions that reflect possible market
conditions, including the most volatile periods that have been
experienced by the markets the covered clearing agency serves and
extreme changes in the correlations between prices; and
     whether it regularly reviews and validates its margin
system.
    With respect to Rule 17Ad-22(e)(6)(iii), and policies and
procedures related to margin calculations, a covered clearing agency
generally should consider whether it calculates margin sufficient to
cover its potential future exposure to each participant.
    With respect to Rule 17Ad-22(e)(6)(iv) and policies and procedures
for price data, the Commission notes that in selecting price data
sources, a covered clearing agency generally should consider the
ability of the provider to provide data in a variety of market
conditions, including periods of market stress, and not select data
sources based on their cost alone to ensure that such price data
sources are reliable.
    With respect to Rule 17Ad-22(e)(6)(v) and policies and procedures
for measuring portfolio effects, the Commission notes that measuring
portfolio effects across products means a covered clearing agency
generally should take into account netting procedures or offsets
through which credit exposure may be reduced in measuring credit
exposure, including the use of portfolio margining procedures across
products where applicable.
    With respect to Rule 17Ad-22(e)(6)(vii) and policies and procedures
for performing the model validation not less than annually, a covered
clearing agency generally should perform the model validation not less
than once every twelve months using persons who are independent from
management and have appropriate technical skills.
7. Rule 17Ad-22(e)(7): Liquidity Risk
a. Proposed Rule
    As proposed, Rule 17Ad-22(e)(7) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to effectively measure, monitor, and
manage the liquidity risk that arises in or is borne

by it, by meeting, at a minimum, the ten requirements specified in the
rule.\340\
---------------------------------------------------------------------------

    \340\ See CCA Standards proposing release, supra note 5, at
29531-37.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(i) would require that a covered
clearing agency's policies and procedures be reasonably designed to
ensure that it maintains sufficient liquid resources in all relevant
currencies to effect same-day and, where appropriate, intraday and
multiday settlement of payment obligations with a high degree of
confidence under a wide range of potential stress scenarios that
includes the default of the participant family that would generate the
largest aggregate payment obligation for it in extreme but plausible
market conditions.\341\
---------------------------------------------------------------------------

    \341\ See id. at 29531.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(ii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that it holds qualifying
liquid resources sufficient to meet the minimum liquidity resource
requirement in each relevant currency for which the covered clearing
agency has payment obligations owed to clearing members.\342\ The
Commission also proposed Rule 17Ad-22(a)(15) to define ``qualifying
liquid resources,'' which would include three types of assets, in each
relevant currency:
---------------------------------------------------------------------------

    \342\ See id.
---------------------------------------------------------------------------

     Cash held either at the central bank of issue or at
creditworthy commercial banks;
     assets that are readily available and convertible into
cash through either:
    [cir] Prearranged funding arrangements without material adverse
change limitations, such as committed lines of credit, foreign exchange
swaps, and repurchase agreements, or
    [cir] other prearranged funding arrangements determined to be
highly reliable even in extreme but plausible market conditions by the
board of directors of the covered clearing agency following a review
conducted for this purpose not less than annually; and
     other assets that are readily available and eligible for
pledging to (or conducting other appropriate forms of transactions
with) a relevant central bank, if the covered clearing agency has
access to routine credit at such central bank.\343\
---------------------------------------------------------------------------

    \343\ See id.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(iii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it uses accounts and
services at a Federal Reserve Bank, pursuant to Section 806(a) of the
Clearing Supervision Act,\344\ or other relevant central bank, when
available and where determined to be practical by the board of
directors of the covered clearing agency, to enhance its management of
liquidity risk.
---------------------------------------------------------------------------

    \344\ See 12 U.S.C. 5465(a).
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(iv) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure it undertakes due
diligence to confirm that it has a reasonable basis to believe each of
its liquidity providers, whether or not such liquidity provider is a
clearing member, has sufficient information to understand and manage
the liquidity provider's liquidity risks, and the capacity to perform
as required under its commitments to provide liquidity.
    Proposed Rule 17Ad-22(e)(7)(v) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency maintains and, on at least an annual basis, tests with each
liquidity provider, to the extent practicable, its procedures and
operational capacity for accessing each type of relevant liquidity
resource.
    Proposed Rule 17Ad-22(e)(7)(vi)(A) through (C) would require a
covered clearing agency to establish, implement, maintain and enforce
written policies and procedures reasonably designed to determine the
amount and regularly test the sufficiency of the liquid resources held
for purposes of meeting the minimum liquid resource requirement of
proposed Rule 17Ad-22(e)(7)(i) by (A) conducting a stress test of its
liquidity resources at least once each day using standard and
predetermined parameters and assumptions; (B) conducting a
comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources, and considering modifications to ensure
they are appropriate for determining the covered clearing agency's
identified liquidity needs and resources in light of current and
evolving market conditions at least once each month; and (C) conducting
a comprehensive analysis of the existing stress testing scenarios,
models, and underlying parameters and assumptions used in evaluating
liquidity needs and resources more frequently when products cleared or
markets served display high volatility or become less liquid, when the
size or concentration of positions held by participants increases
significantly, or in other circumstances described in the covered
clearing agency's policies and procedures. Proposed Rule 17Ad-
22(e)(7)(vi)(D) would also require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to result in reporting the results of
the analyses performed under proposed Rule 17Ad-22(e)(7)(vi)(B) and (C)
to appropriate decision makers, including the risk management committee
or board of directors, at the covered clearing agency for use in
evaluating the adequacy of and adjusting its liquidity risk management
framework.\345\
---------------------------------------------------------------------------

    \345\ See CCA Standards proposing release, supra note 5, at
29534.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(vii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to result in performing an annual or
more frequent conforming model validation of its liquidity risk
models.\346\
---------------------------------------------------------------------------

    \346\ See id.; see also supra notes 275-305 and accompanying
text (discussing generally the requirements accompanying the
definition of ``model validation'').
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(viii) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to address foreseeable liquidity
shortfalls that would not be covered by its liquid resources and seek
to avoid unwinding, revoking, or delaying the same-day settlement of
payment obligations.
    Proposed Rule 17Ad-22(e)(7)(ix) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to describe its process for
replenishing any liquid resources that it may employ during a stress
event.\347\
---------------------------------------------------------------------------

    \347\ See CCA Standards proposing release, supra note 5, at
29534.
---------------------------------------------------------------------------

    Finally, proposed Rule 17Ad-22(e)(7)(x) would require a covered
clearing agency to establish, implement, maintain and enforce written
policies and procedures reasonably designed to ensure that it, at least
once a year, evaluates the feasibility of maintaining sufficient liquid
resources at a minimum in all relevant currencies to effect same-day
and, where appropriate, intraday and multiday settlement of payment
obligations with a high degree of confidence under a wide range of
foreseeable stress scenarios that includes, but is not limited to, the
default of the two participant families that would potentially cause
the largest

aggregate payment obligation for the covered clearing agency in extreme
but plausible market conditions if the covered clearing agency provides
CCP services and is either systemically important in multiple
jurisdictions or a clearing agency involved in activities with a more
complex risk profile.
b. Comments Received and Commission Response
i. General Approach
    Six commenters expressed general support for the proposed
rule.\348\ Of these, one commenter stated that proposed Rule 17Ad-
22(e)(7) was prudent and appropriate in light of the need for covered
clearing agencies to maintain adequate liquidity to minimize systemic
risks and that, by requiring ongoing testing and monitoring of
underlying assumptions, covered clearing agencies should be able to
identify potential problems with sufficient time to respond without
significant disruptions.\349\ Four commenters expressed support for the
Commission's proposed approach to qualifying liquid resources other
than committed funding arrangements,\350\ which is discussed further
below in Part II.C.7.b.iii.
---------------------------------------------------------------------------

    \348\ See, e.g., Barnard at 1 (supporting the proposal,
especially as to its proposed financial risk management and
liquidity risk requirements); CFA Institute at 9; CME at 4; DTCC at
6; The Clearing House at 3, 13; OCC at 11.
    \349\ See CFA Institute at 9.
    \350\ See CME at 4; DTCC at 6 (noting the appropriate balance in
the proposed rule between the need to have sufficient reliable
liquidity resources to meet ongoing settlement obligations in the
event of participant default, and the realities of the availability
and costs of committed liquidity funding); OCC at 11 (supporting the
expansion of qualifying liquid resources beyond committed funding
arrangements); The Clearing House at 3, 13 (noting that the proposed
rule's use of highly reliable funding arrangements, in addition to
committed arrangements, provides needed flexibility and is
consistent with the PFMI).
---------------------------------------------------------------------------

ii. Due Diligence for Liquidity Providers
    Two commenters stated that the requirement in proposed Rule 17Ad-
22(e)(7)(iv) regarding policies and procedures to perform due diligence
of liquidity providers must take into account the context of the due
diligence being performed.\351\ One of these commenters stated that
commercial lenders are not likely to provide their borrowers with non-
public information on their internal policies and controls,\352\ and
that accordingly covered clearing agencies should not be expected to
evaluate a commercial lender's internal risk controls.\353\ First, in
the experience of Commission staff, liquidity facilities may not
consist only of traditional commercial loans. For example, a covered
clearing agency may seek out committed repurchase agreement facilities
with counterparties other than traditional commercial lenders. In such
a circumstance, the commenter's experience with such counterparties may
be different than with a traditional commercial lender.\354\
Accordingly, in contrast to the commenter's assertion, a covered
clearing agency may engage in a relationship with a liquidity provider
that is not a typical commercial lender and therefore may be more
willing to facilitate due diligence. Second, while the Commission
acknowledges that a lender may choose not to provide their borrowers
with non-public information on certain internal policies and controls,
the proposed rule does not require a covered clearing agency's policies
and procedures regarding due diligence for liquidity providers to
specifically review all internal policies and controls. Rather, it
requires due diligence policies and procedures that confirm the covered
clearing agency has a reasonable basis to believe that a liquidity
provider understands and manages the liquidity provider's liquidity
risks and the capacity to perform as required under its commitments to
provide liquidity to the covered clearing agency. If, in performing due
diligence consistent with its policies and procedures formulated in
accordance with the rule, a covered clearing agency cannot confirm that
it has a reasonable basis to believe both of the required criteria,
then the covered clearing agency would not have a liquidity provider
consistent with Rule 17Ad-22(e)(7)(iv).
---------------------------------------------------------------------------

    \351\ See DTCC at 7; LCH at 4.
    \352\ See DTCC at 7.
    \353\ See id.
    \354\ See infra Part II.C.7.b.iii (further discussing such
repurchase agreement facilities).
---------------------------------------------------------------------------

    The second commenter stated that it is not appropriate to require a
covered clearing agency to perform due diligence on a central bank
acting as its liquidity provider and requests that the rules clarify
that the requirements under Rule 17Ad-22(e)(7)(iv) do not apply where a
central bank is a liquidity provider for a covered clearing
agency.\355\ The Commission does not believe that the rule needs to be
modified to account for this circumstance, however, as the policies and
procedures of the covered clearing agency could account for the
different circumstances that arise when a central bank is acting as a
liquidity provider.
---------------------------------------------------------------------------

    \355\ See LCH at 4.
---------------------------------------------------------------------------

    A third commenter expressed the view that the Commission should
clarify the due diligence requirements of proposed Rule 17Ad-
22(e)(7)(iv) to expressly require a covered clearing agency to take
into account the potential wrong-way risk associated with reliance on
participants or their affiliates as liquidity providers.\356\ The
commenter further stated that the Commission should take additional
steps to mitigate wrong-way risk by requiring a covered clearing agency
to ensure the appropriate diversification of its liquidity providers
and limit its reliance on its participants or their affiliates as
potential sources of liquidity.\357\ The Commission believes that
diversifying liquidity providers may be helpful because such
diversification would result in less concentrated, and potentially more
manageable, financial commitments among a covered clearing agency's
liquidity providers. For example, a covered clearing agency generally
should conduct an assessment of the liquidity provider's business in
light of both the covered clearing agency's own business and the
composition of its existing liquidity providers. In turn, a covered
clearing agency could assess the likelihood that a liquidity provider
might be unable to meet its own liquidity demands at the same time as
the covered clearing agency was facing a liquidity shortfall and
attempting to draw on liquidity from its liquidity provider, allowing
the covered clearing agency to account for the potential wrong-way risk
associated with reliance on participants or their affiliates as
liquidity providers. Although there may be circumstances where it would
be appropriate for a covered clearing agency to incorporate the
policies and procedures such as those suggested by the commenter, the
Commission's approach to Rule 17Ad-22(e) focuses on principles. The
circumstances may vary, and a covered clearing agency should
appropriately manage its risks as they arise, considering the full set
of tools available and its risk management framework. Accordingly,
after careful consideration, the Commission declines to accept the
commenter's suggestion with respect to wrong-way risk because it would
be inconsistent with the overall approach to Rule 17Ad-22(e).\358\
---------------------------------------------------------------------------

    \356\ See The Clearing House at 13.
    \357\ See id. at 3.
    \358\ See supra Part II.B.
---------------------------------------------------------------------------

    In addition, the commenter stated that the reliance on committed
funding arrangements in proposed Rule 17Ad-22(a)(15) may lead to this
overreliance on participants or their affiliates for liquidity.\359\
The Commission addresses

this aspect of the comment below in Part II.C.7.b.iii.
---------------------------------------------------------------------------

    \359\ See The Clearing House at 3.
---------------------------------------------------------------------------

iii. Qualifying Liquid Resources
    Commenters generally supported the Commission's proposed approach
to determining qualifying liquid resources. One commenter supported the
Commission's overall approach and, in particular, the inclusion of
assets that are readily available and convertible into cash through
repurchase agreements.\360\ Another commenter supported the
Commission's approach to the definition of ``qualifying liquid
resources,'' and expressed the view that expansion of qualifying liquid
resources beyond committed funding arrangements is necessary to ensure
the proper functioning of covered clearing agencies.\361\ The commenter
noted that a committed liquidity facility would generally be preferable
over a non-committed facility, but the commenter also acknowledged that
other aspects of a facility (e.g., size or cost of the facility) may
tip the balance toward selection of the non-committed facility. In
particular, the commenter emphasized the unique liquidity needs of
clearing entities, the limited number and capacity of liquidity
providers in the market that are willing and able to participate in
committed liquidity facilities for clearing entities, and the
commercial and regulatory realities that could constrain the
availability of committed facilities for covered clearing
agencies.\362\ The Commission is mindful of these concerns, but notes
that policies and procedures providing for the use of uncommitted
facilities must also satisfy the terms of Rule 17Ad-22(e)(15) to
address general business and operational risk that could arise from
such uncommitted facilities.
---------------------------------------------------------------------------

    \360\ See CME at 4.
    \361\ See OCC at 11.
    \362\ See id. at 11-12.
---------------------------------------------------------------------------

    One commenter stated that requiring covered clearing agencies to
rely on committed funding arrangements in all cases could increase a
covered clearing agency's reliance on its participants or their
affiliated banks and potentially exacerbate a liquidity crisis by
transferring the risk of a covered clearing agency to its liquidity
providers and vice versa.\363\ However, the comment assumes that the
rule prohibits reliance on other types of facilities or prearranged
funding arrangements, which is not the case. To some degree, the
purpose of a liquidity facility is to transfer risk from the covered
clearing agency to its liquidity providers. Further, the resources
described in the definition of ``qualifying liquid resources'' should
be viewed as part of a hierarchy, where cash should be the primary
source of liquid resources, followed first by prearranged funding
arrangements and last by other assets readily available and eligible
for pledging to a relevant central bank in a jurisdiction that permits
such pledges. In addition, within the class of prearranged funding
arrangements, available committed arrangements without material adverse
change (``MAC'') provisions generally should be obtained before seeking
to obtain other prearranged funding arrangements determined to be
highly reliable even in extreme but plausible market conditions by the
covered clearing agency's board of directors. The Commission believes
that a covered clearing agency generally should consider having
policies and procedures that establish a preference for cash and
prearranged funding arrangements, but the Commission acknowledges that
a covered clearing agency's policies and procedures may need to account
for the extent to which such resources are available to them given the
size of their liquidity demands.
---------------------------------------------------------------------------

    \363\ See The Clearing House at 13.
---------------------------------------------------------------------------

    With respect to whether and how repurchase agreements might fit
within the definition of qualifying liquid resources, one commenter
stated that prearranged and highly reliable funding arrangements may be
demonstrated through non-committed repurchase agreement facilities with
major bank-dealers.\364\ According to the commenter, a covered clearing
agency relying on such a facility would need to ensure that it is
structured appropriately to be highly reliable, taking into account the
fact that a facility may be used in a clearing member default scenario
in extreme market circumstances. The commenter also stated that a
covered clearing agency's procedures for making draws on uncommitted
repurchase facilities should specifically contemplate the timing of
close-out arrangements for defaulted clearing members and should
provide for draws on such facilities to be made by specified times
during business day mornings to ensure that dealer banks have
sufficient time to facilitate liquidation of the U.S. Treasury
securities. The commenter believed this approach would be fully
consistent with the PFMI.\365\ The Commission notes that this type of
approach, reflected in the policies and procedures of a covered
clearing agency as part of a broader attempt to define qualifying
liquid resources comprehensively, could be consistent with the
Commission's definition of prearranged funding arrangements determined
to be highly reliable even in extreme but plausible market conditions
by the board of directors of the covered clearing agency, assuming it
was subject to a not less than annual review.\366\ The Commission
believes that the board of directors of a covered clearing agency
generally should rely on rigorous analysis of the properties of a
prearranged funding arrangement, in making a determination that it was
highly reliable in extreme but plausible market conditions.
---------------------------------------------------------------------------

    \364\ See ISDA at 4.
    \365\ See id.
    \366\ Such policies and procedures should also address the due
diligence of the liquidity provider, as discussed above. See supra
Part II.C.7.b.ii.
---------------------------------------------------------------------------

    With respect to the rule's reference to ``material adverse change
provisions,'' two commenters recommended that the reference be removed.
One commenter noted that the proposed rule text appears to be in
tension with the preamble of the CCA Standards proposing release
because it includes, among qualifying liquid resources, prearranged
funding arrangements other than committed arrangements, but only where
such arrangements have no MAC provisions.\367\ The commenter stated
that, by definition, a non-committed facility is uncommitted and
therefore MAC provisions are inapplicable.\368\ The commenter further
noted that this is a liquidity standard not set forth in the PFMI,
which will lead to confusion and inconsistency in attempting to apply
the standard. The commenter recommended that the reference to MAC
clauses in the proposed definition of ``qualifying liquid resources''
be removed.\369\ The second commenter similarly recommended that the
Commission remove the reference to MAC clauses in the definition of
qualifying liquid resources for prearranged funding arrangements other
than committed arrangements, noting that Master Repurchase Agreements
do not have MAC clauses because they are uncommitted facilities.\370\
---------------------------------------------------------------------------

    \367\ See ISDA at 5.
    \368\ See id.
    \369\ See id.
    \370\ See CME at 4.
---------------------------------------------------------------------------

    In response to the comments, the Commission is modifying the
proposed definition of ``qualifying liquid resources'' so that only
paragraph (A) includes a prohibition on MAC clauses. For uncommitted
facilities, because they are by their terms uncommitted, the party
providing an uncommitted facility generally would have no need to
include a MAC clause. In contrast, a party providing a committed
facility could choose to contract into an

arrangement with or without a MAC clause, at the party's discretion. As
noted above, the Commission believes that a covered clearing agency
generally should consider having policies and procedures that establish
a preference for cash and prearranged funding arrangements. Within the
category of prearranged funding arrangements, the Commission also
believes that a covered clearing agency generally should preference
committed arrangements over other types of prearranged funding
arrangements, and that within the category of committed arrangements, a
covered clearing agency generally should preference those without MAC
clauses over those with MAC clauses. The Commission notes that a
covered clearing agency would, when relying on a committed funding
arrangement with a MAC clause pursuant to the definition of
``qualifying liquid resources,'' also need to have policies and
procedures demonstrating that such committed facility was a prearranged
funding arrangement determined to be highly reliable even in extreme
but plausible market conditions by the board of directors following a
review conducted for this purpose no less than annually. The Commission
also believes that, as a general matter, policies and procedures
regarding qualifying liquid resources, including those related to
prearranged funding arrangements, would constitute a proposed rule
change under Section 19(b) of the Exchange Act and, for designated
clearing agencies, an advance notice under the Clearing Supervision
Act.
c. Final Rule
    The Commission is adopting two modifications to the definition of
``qualifying liquid resources'' and, because of other modifications to
Rule 17Ad-22(a), moving the definition to Rule 17Ad-22(a)(14).\371\ The
Commission is modifying paragraph (ii) so that the reference to MAC
clauses is tied to committed arrangements rather than prearranged
funding arrangements more generally, as previously described in Part
II.C.7.b.iii. In addition, because not all central banks permit
pledging certain assets that are readily available and eligible for
pledging, the Commission is modifying paragraph (iii) to clarify that
practices with respect to routine credit at a central bank may vary
across jurisdictions.
---------------------------------------------------------------------------

    \371\ See Rule 17Ad-22(a)(14), infra Part VI.
---------------------------------------------------------------------------

    The Commission is also adopting Rule 17Ad-22(e)(7) with
modifications.\372\ First, the Commission is modifying Rule 17Ad-
22(e)(4)(vi)(A) to refer to ``stress testing'' rather than ``a stress
test'' to improve consistency with the definition of ``stress testing''
in Rule 17Ad-22(a)(17). Second, the Commission is modifying Rule 17Ad-
22(e)(7)(vi)(C) in two ways. To improve consistency with Rule 17Ad-
22(e)(4)(vi)(C), the Commission is adding ``or'' to link ``display high
volatility'' with ``become less liquid'' because these concepts are
intended to describe events related to the products cleared or markets
served. This change corrects a typographical error in the CCA Standards
proposing release.\373\ The Commission is also replacing ``and'' with
``or'' in Rule 17Ad-22(e)(7)(vi)(C) so that the criteria for conducting
analysis more frequently than monthly are disjunctive rather than
conjunctive, since the list of criteria is open to other appropriate
circumstances described in a covered clearing agency's policies and
procedures and may not be correlated. Third, the Commission is making
two modifications in adopting Rule 17Ad-22(e)(7)(vi)(D) to correct
technical errors in the proposed rule text: (i) References to
paragraphs (e)(6)(vii)(B) and (C) will be changed to paragraphs
(e)(7)(vi)(B) and (C) respectively; and (ii) the rule will refer to the
covered clearing agency's ``liquidity'' risk management framework,
rather than its ``credit'' risk management framework. These
modifications are consistent with the Commission's discussion of the
proposed rule in the CCA Standards proposing release.\374\ Fourth, the
Commission is striking ``conforming'' from Rule 17Ad-22(e)(7)(vii) to
be consistent with the modifications to the definition of ``model
validation'' discussed in Part II.C.4.c.
---------------------------------------------------------------------------

    \372\ See Rule 17Ad-22(e)(7), infra Part VI.
    \373\ See CCA Standards proposing release, supra note 5, at
29534.
    \374\ See id.
---------------------------------------------------------------------------

    Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(7), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address liquidity risk:
     Whether it has a robust framework to manage its liquidity
risks from its participants, settlement banks, nostro agents, custodian
banks, liquidity providers, and other entities;
     whether it has effective operational and analytical tools
to identify, measure, and monitor its settlement and funding flows on
an ongoing and timely basis, including its use of intraday liquidity;
     whether it maintains sufficient liquid resources in all
relevant currencies to settle securities-related payments, make
required variation margin payments, and meet other payment obligations
on time with a high degree of confidence under a wide range of
potential stress scenarios, including but not limited to the default of
the participant and its affiliates that would generate the largest
aggregate payment obligation to the covered clearing agency in extreme
but plausible market conditions;
     for the purpose of meeting its minimum liquid resource
requirement, whether its qualifying liquid resources in each currency
include cash at the central bank of issue and at creditworthy
commercial banks, committed lines of credit, committed foreign exchange
swaps, and committed repos, as well as highly marketable collateral
held in custody and investments that are readily available and
convertible into cash with prearranged and highly reliable funding
arrangements, even in extreme but plausible market conditions;
     whether it supplements its qualifying liquid resources
with other forms of liquid resources and, if so, whether these liquid
resources are in the form of assets likely to be saleable or acceptable
as collateral for lines of credit, swaps, or repos on an ad hoc basis
following a default, even if this cannot be reliably prearranged or
guaranteed in extreme market conditions;
     if it does not have access to routine central bank credit,
whether it takes account of what collateral is typically accepted by
the relevant central bank, as such assets may be more likely to be
liquid in stressed circumstances, and does not assume the availability
of emergency central bank credit as a part of its liquidity plan;
     whether it obtains a high degree of confidence, through
rigorous due diligence, that each provider of its minimum required
qualifying liquid resources, whether a participant of the FMI or an
external party, has sufficient information to understand and to manage
its associated liquidity risks, and that it has the capacity to perform
as required under its commitment;
     where relevant to assessing a liquidity provider's
performance reliability with respect to a particular currency, whether
a liquidity provider's potential access to credit from the central bank
of issue may be taken into account;
     whether it regularly tests its procedures for accessing
its liquid resources at a liquidity provider;

     if it has access to central bank accounts, payment
services, or securities services, whether it uses these services, where
practical, to enhance its management of liquidity risk;
     whether it determines the amount and regularly tests the
sufficiency of its liquid resources through rigorous stress testing;
whether it has clear procedures to report the results of its stress
tests to appropriate decision makers at the covered clearing agency and
to use these results to evaluate the adequacy of and adjust its
liquidity risk-management framework;
     in conducting stress testing, whether it considers a wide
range of relevant scenarios, including relevant peak historic price
volatilities, shifts in other market factors such as price determinants
and yield curves, multiple defaults over various time horizons,
simultaneous pressures in funding and asset markets, and a spectrum of
forward-looking stress scenarios in a variety of extreme but plausible
market conditions;
     whether such scenarios take into account the design and
operation of the covered clearing agency, include all entities that
might pose material liquidity risks to the covered clearing agency
(such as settlement banks, nostro agents, custodian banks, liquidity
providers, and linked clearing agencies), and where appropriate, cover
a multiday period, and, whether, in all cases, it documents its
supporting rationale for, and has appropriate governance arrangements
relating to, the amount and form of total liquid resources it
maintains;
     whether it has explicit rules and procedures that enable
the covered clearing agency to effect same-day and, where appropriate,
intraday and multiday settlement of payment obligations on time
following any individual or combined default among its participants;
     whether these rules and procedures address unforeseen and
potentially uncovered liquidity shortfalls and should aim to avoid
unwinding, revoking, or delaying the same-day settlement of payment
obligations; \375\ and
---------------------------------------------------------------------------

    \375\ The Commission notes that while Rule 17Ad-22(e)(7)(viii)
requires policies and procedures to address foreseeable liquidity
shortfalls, a covered clearing agency also generally should consider
how best to identify unforeseen and potentially uncovered liquidity
shortfalls. For example, a covered clearing agency may be able to
identify unforeseen liquidity shortfalls using hypothetical stress
scenarios and reverse stress testing of liquid resources.
---------------------------------------------------------------------------

     whether these rules and procedures indicate the covered
clearing agency's process to replenish any liquidity resources it may
employ during a stress event, so that it can continue to operate in a
safe and sound manner.

In addition, with respect to creditworthy commercial banks under Rule
17Ad-22(a)(14), a covered clearing agency generally should assess the
creditworthiness of its commercial banks, such as by considering their
particular circumstances in which they operate and the markets which
they service.
    With respect to assets convertible into cash under Rule 17Ad-
22(a)(14), the Commission notes that the mere ownership of assets that
a covered clearing agency may consider readily available and
convertible into cash--based on factors such as the historical volume
of trading in a particular market for such asset--depending on the
circumstances may not count towards its ``qualifying liquid resources''
unless one of the prearranged funding arrangements in place would allow
the covered clearing agency to receive cash in a timely manner. With
respect to the requirements for qualifying liquid resources more
generally, the Commission notes that a covered clearing agency
generally should consider the lower of the value of the assets capable
of being pledged and the amount of the commitment (or the equivalent
availability under a highly reliable prearranged facility) as the
amount that counts towards qualifying liquid resources in the event
there is any expected difference between the two.\376\
---------------------------------------------------------------------------

    \376\ For purposes of complying with Rule 17Ad-22(e)(7)(ii),
factors that may be relevant for a covered clearing agency to
consider when defining its qualifying liquid resources could include
(i) the portion of its default fund that is held as cash, (ii) the
portion of its default fund that is held as securities, (iii) the
portion of any excess default fund contributions held as cash that
could be used by the covered clearing agency to meet liquidity
needs, (iv) the portion of any excess default fund contributions
held as securities that could be used by the covered clearing agency
to meet liquidity needs, (v) the amount at any given time of
securities or cash delivered by members that a covered clearing
agency may be able to use to meet liquidity needs upon the default
of a member, and (vi) the borrowing limits under any committed
funding arrangement.
---------------------------------------------------------------------------

    With respect to Rule 17Ad-22(e)(7)(ii), the Commission notes that,
for example, if payment obligations were denominated in U.S. dollars,
the minimum liquidity resource requirement would refer to a U.S. dollar
amount.
    With respect to Rule 17Ad-22(e)(7)(iii) and access to routine
credit at a central bank, the Commission notes that a covered clearing
agency is not required to use central bank account services but,
rather, is required to establish, implement, maintain and enforce
written policies and procedures reasonably designed facilitate such use
when available and practical. As noted above, whether the services are
available or considered to be practical may vary across
jurisdictions.\377\ Access to routine credit at a relevant central
bank, and the collateral required by such central bank to be posted to
secure a loan, may be determined at the discretion of the central bank.
---------------------------------------------------------------------------

    \377\ The Commission notes that the term ``central bank'' is not
limited to a Federal Reserve Bank. A covered clearing agency based
in or operating outside of the United States that has access to
routine credit at other central banks would be able to take this
into consideration when assessing the amount of its qualifying
liquid resources.
---------------------------------------------------------------------------

    With respect to Rule 17Ad-22(e)(7)(iv) and the policies and
procedures for due diligence required thereunder, ``due diligence'' has
the same meaning as is commonly understood by market participants. A
covered clearing agency generally should not rely solely on
representations made by a liquidity provider but instead should conduct
an assessment of the liquidity provider's business, in light of the
covered clearing agency's own business and the composition of its
existing liquidity providers. Policies and procedures to develop a
reasonable basis under Rule 17Ad-22(e)(7)(iv) could include
interviewing the liquidity provider's staff and reviewing both public
and non-public documents that would allow the covered clearing agency
to gather information about relevant factors, including but not limited
to the strength of the liquidity provider's financial condition, its
risk management capabilities, and its internal controls.
    With respect to Rule 17Ad-22(e)(7)(v), a covered clearing agency
generally should test its access to liquidity resources by verifying
that a liquidity provider is able to provide the relevant liquidity
resources in the manner intended under the terms of a funding
arrangement and without undue delay by, for example, promptly funding a
draw on the covered clearing agency's credit facility. The Commission
recognizes that testing procedures also could include test draws funded
by the liquidity provider or tests of electronic connectivity between
the covered clearing agency and the liquidity provider. Testing with
liquidity providers may not always be practicable in the absence of
committed liquidity arrangements. In addition, a covered clearing
agency generally should conduct the testing not less than once every
twelve months.

    With respect to Rule 17Ad-22(e)(7)(vii) and policies and procedures
for performing the model validation not less than annually, a covered
clearing agency generally should perform the model validation not less
than once every twelve months.
    With respect to Rule 17Ad-22(e)(7)(viii) and foreseeable liquidity
shortfalls, foreseeable liquidity shortfalls could include potential
shortfalls that can be identified through testing a covered clearing
agency's financial resources.\378\ The Commission recognizes that
foreseeable liquidity shortfalls could occur even when a covered
clearing agency is in compliance with the proposed requirements of Rule
17Ad-22(e)(7), such as when the covered clearing agency is unable to
obtain liquidity pursuant to prearranged funding arrangements that are
uncommitted.
---------------------------------------------------------------------------

    \378\ See supra note 375.
---------------------------------------------------------------------------

    With respect to Rule 17Ad-22(e)(7)(x), a covered clearing agency is
not required to adopt a ``cover two'' standard for liquidity risk but
is responsible for undertaking such an analysis at least once a year,
pursuant to the covered clearing agency's policies and procedures under
Rule 17Ad-22(e)(7)(x). In making any determination regarding the sizing
of a covered clearing agency's liquid resources to exceed ``cover
one,'' a covered clearing agency could consider, among other things,
(i) the business model of the covered clearing agency, such as a
utility model (which may be also referred to as an ``at cost'' model)
versus a for-profit model; (ii) diversification of its members'
business models as they impact the members' ability to supply liquidity
to the covered clearing agency; (iii) concentration of membership of
the covered clearing agency, as the breadth of the membership may
affect the ability to draw liquidity from members; (iv) levels of usage
of the covered clearing agency's services by members, as the
concentration of demand on the covered clearing agency's services may
bear upon potential liquidity needs; (v) the relative concentration of
members' market share in the cleared products; (vi) the degree of
alignment of interest between member ownership of the covered clearing
agency and the provision of funding to the covered clearing agency; and
(vii) the nature of, and risks associated with, the products cleared by
the covered clearing agency.
8. Rule 17Ad-22(e)(8): Settlement Finality
a. Proposed Rule
    As proposed, Rule 17Ad-22(e)(8) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to define the point at which
settlement is final no later than the end of the day on which the
payment or obligation is due and, where necessary or appropriate,
intraday or in real time.\379\
---------------------------------------------------------------------------

    \379\ See CCA Standards proposing release, supra note 5, at
29537-38.
---------------------------------------------------------------------------

b. Comments Received
    The Commission received no comments regarding the proposed rule.
c. Final Rule
    The Commission is adopting Rule 17Ad-22(e)(8) with one
modification.\380\ To remove potential ambiguity as to the timing of
settlement finality under the rule, the Commission is modifying Rule
17Ad-22(e)(8) to state that the point at which settlement is final is
``to be'' no later than the end of the day on which the payment or
obligation is due and, where necessary or appropriate, intraday or in
real time. As modified, Rule 17Ad-22(e)(8) identifies the point at
which settlement is final, which must be defined in a covered clearing
agency's written policies and procedures, and removes the potential
ambiguity that could have allowed an alternative interpretation of the
rule that did not clearly link the concept of settlement finality to
``no later than the end of the day on which the payment or obligation
is due and, where necessary or appropriate, intraday or in real time.''
---------------------------------------------------------------------------

    \380\ See Rule 17Ad-22(e)(8), infra Part VI.
---------------------------------------------------------------------------

    Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(8), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address settlement finality:
     Whether its policies and procedures clearly define the
point at which settlement is final;
     whether it completes final settlement no later than the
end of the value date, and preferably intraday or in real time, to
reduce settlement risk; and
     whether it clearly defines the point after which unsettled
payments, transfer instructions, or other obligations may not be
revoked by a participant.

In addition, clearly defining the point at which settlement is final
might include adopting policies and procedures (i) establishing that a
cut-off point after which unsettled payments, transfer instructions, or
other obligations may not be revoked by a clearing member and (ii)
providing clearing members with guidance regarding extensions for
members with operating problems, such as the approval or duration of
such extensions. Policies or procedures creating material uncertainty
regarding when final settlement will occur or that permit the back-
dating or ``as of'' dating of a transaction that settles after the end
of the day on which the payment or obligation is due generally would
not comply with Rule 17Ad-22(e)(8). With respect to policies and
procedures requiring intraday or real-time finality to reduce risk,
such efforts would be necessary and appropriate when, for example, the
risks in question are material or when the opportunity to require
intraday or real-time finality is available and would be reasonable,
whether in economic or other terms, to implement.
9. Rule 17Ad-22(e)(9): Money Settlements
    As proposed, Rule 17Ad-22(e)(9) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to conduct its money settlements in
central bank money, where available and determined to be practical by
the board of directors of the covered clearing agency, and minimizes
and manages credit and liquidity risk arising from conducting its money
settlements in commercial bank money if central bank money is not used
by the covered clearing agency.\381\
---------------------------------------------------------------------------

    \381\ See CCA Standards proposing release, supra note 5, at
29538-39.
---------------------------------------------------------------------------

    The Commission received no comments regarding the proposed rule and
is adopting it as proposed.\382\ Because the Commission recognizes that
there may be a number of ways to address compliance with Rule 17Ad-
22(e)(9), the Commission is providing the following guidance that a
covered clearing agency generally should consider in establishing and
maintaining policies and procedures that address money settlements:
---------------------------------------------------------------------------

    \382\ See Rule 17Ad-22(e)(9), infra Part VI.
---------------------------------------------------------------------------

     Whether it conducts its money settlements in central bank
money, where practical and available, to avoid credit and liquidity
risks;
     if it does not use central bank money, whether it conducts
its money settlements using a settlement asset with little or no credit
or liquidity risk;

     if it settles in commercial bank money, whether it
monitors, manages, and limits its credit and liquidity risks arising
from commercial settlement banks by, for example, establishing and
monitoring adherence to strict criteria for its settlement banks that
take account of, among other things, their regulation and supervision,
creditworthiness, capitalization, access to liquidity, and operational
reliability, and whether it monitors and manages the concentration of
credit and liquidity exposures to its commercial settlement banks;
     if it conducts money settlements on its own books, whether
it minimizes and strictly controls its credit and liquidity risks; and
     whether its legal agreements with any settlement banks
state clearly when transfers on the books of individual settlement
banks are expected to occur, that transfers are to be final when
effected, and that funds received are transferable as soon as possible
at a minimum by the end of the day, and ideally intraday, to enable the
covered clearing agency and its participants to manage credit and
liquidity risks.

While Rule 17Ad-22(e)(9) would permit a covered clearing agency to use
multiple settlement banks to monitor and manage concentration of
payments among its commercial settlement banks, in such circumstances
its policies and procedures generally should consider the degree to
which concentration of a covered clearing agency's exposure to a
commercial settlement bank is affected or increased by multiple
relationships with the settlement bank, including (i) where the
settlement bank is also a participant in the covered clearing agency,
or (ii) where the settlement bank provides back-up liquidity resources
to the covered clearing agency.
    In addition, the Commission believes that a covered clearing agency
generally should consider using commercial bank money only when central
bank money is not practicable or available. In some cases, the use of
central bank money may not be practical because direct access to
central bank accounts and payment services may not be available to all
clearing agencies or members in all circumstances. For example, when a
covered clearing agency operates in multiple currencies, certain
central bank accounts may not be operational at the time money
settlements occur.
10. Rule 17Ad-22(e)(10): Physical Delivery Risks
    As proposed, Rule 17Ad-22(e)(10) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to establish and maintain
transparent written standards that state its obligations with respect
to the delivery of physical instruments and operational practices that
identify, monitor, and manage the risk associated with such physical
deliveries.\383\
---------------------------------------------------------------------------

    \383\ See CCA Standards proposing release, supra note 5, at
29539-40.
---------------------------------------------------------------------------

    The Commission received no comments regarding the proposed rule and
is adopting it as proposed.\384\ Because the Commission recognizes that
there may be a number of ways to address compliance with Rule 17Ad-
22(e)(10), the Commission is providing the following guidance that a
covered clearing agency generally should consider in establishing and
maintaining policies and procedures that address physical delivery
risks:
---------------------------------------------------------------------------

    \384\ See Rule 17Ad-22(e)(10), infra Part VI.
---------------------------------------------------------------------------

     Whether its rules clearly state its obligations with
respect to the delivery of physical instruments or commodities; and
     whether it has identified, monitored, and managed the
risks and costs associated with the storage and delivery of physical
instruments or commodities.

The Commission notes that practices regarding physical delivery vary
based on the types of assets that a covered clearing agency settles.
Nevertheless, a covered clearing agency generally should consider
having policies and procedures that state clearly which asset classes
it accepts for physical delivery and the procedures surrounding the
delivery of each. In addition, physical delivery may require the
involvement of multiple parties, including the clearing agency itself,
its members, customers, custodians, and transfer agents. In particular,
a covered clearing agency generally should consider having policies and
procedures that address its relationship with transfer agents generally
and, in particular, with respect to instructions for deposit and
withdrawal at a custodian.
    A covered clearing agency could employ several different
arrangements pursuant to the requirements of Rule 17Ad-22(e)(10). For
example, if a covered clearing agency takes physical delivery of
securities from its members in return for payments of cash, then it
generally should inform its members of the extent of the clearing
agency's obligations to make payment. A covered clearing agency
generally should employ policies and procedures that clearly state any
obligations it incurs to members for losses incurred in the delivery
process. Policies and procedures generally should also clearly state
rules or obligations regarding definitions for acceptable physical
instruments, the location of delivery sites, rules for storage and
warehouse operations, and the timing of delivery. Such policies and
procedures can help mitigate operational risks associated with physical
deliveries by including provisions to review and assess the
qualifications of potential employees, including, among other things,
reference and background checks and employee training. Such policies
and procedures could also relate to theft, loss, counterfeiting,
deterioration of or damage to assets, and employee duties for the
recordkeeping for and holding of physical assets.
11. Rule 17Ad-22(e)(11): CSDs
a. Proposed Rule
    As proposed, Rule 17Ad-22(e)(11)(i) would require a covered
clearing agency that provides CSD services to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to maintain securities in an immobilized or dematerialized
form for their transfer by book entry, ensure the integrity of
securities issues, and minimize and manage the risks associated with
the safekeeping and transfer of securities. Proposed Rule 17Ad-
22(e)(11)(ii) would require a covered clearing agency that provides CSD
services to establish, implement, maintain and enforce written policies
and procedures reasonably designed to implement internal auditing and
other controls to safeguard the rights of securities issuers and
holders, prevent the unauthorized creation or deletion of securities,
and conduct periodic and at least daily reconciliation of securities
issues it maintains. Finally, proposed Rule 17Ad-22(e)(11)(iii) would
require a covered clearing agency that provides CSD services to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to protect assets against custody risk
through appropriate rules and procedures consistent with relevant laws,
rules, and regulations in jurisdictions where it operates.\385\
---------------------------------------------------------------------------

    \385\ See CCA Standards proposing release, supra note 5, at
29540-43.
---------------------------------------------------------------------------

b. Comment Received and Commission Response
    The Commission received one comment regarding proposed Rule 17Ad-
22(e)(11). The commenter expressed concern that the language in
proposed Rule 17Ad-22(e)(11)(i), which requires the policies and
procedures of a covered clearing agency providing

CSD services to be reasonably designed to ensure the integrity of
securities issues, differs materially from PFMI Principle 11 and FRB's
Regulation HH, both of which require that an entity ``help'' ensure the
integrity of securities issues.\386\ The commenter also expressed the
concern that no covered clearing agency is in a position to guarantee
the integrity of the securities.\387\ As a result, the commenter urged
the Commission to include the words ``to help'' before ``ensure,'' to
avoid any interpretation that clearing agencies providing CSD services
are held to a materially higher standard than the commenter believes is
the Commission's intention.\388\ In the alternative, the commenter
proposed the substitution of another phrase (e.g., ``to promote'' or
``to protect'') that accurately characterized the cooperative nature of
CSDs.\389\
---------------------------------------------------------------------------

    \386\ See DTCC at 7 (emphasis in original).
    \387\ See id. at 7.
    \388\ See id. at 8.
    \389\ See id.
---------------------------------------------------------------------------

    In response to the comment received, the Commission notes that the
rule text does not require a covered clearing agency to ensure or
guarantee the integrity of securities issues; rather, Rule 17Ad-
22(e)(11) requires policies and procedures reasonably designed to
ensure the integrity of securities issues. The Commission believes that
the policies and procedures nature of the rule mitigates the concern
raised by the commenter because the rule requires a covered clearing
agency to ensure that its policies and procedures are reasonably
designed to ensure the integrity of securities issues and it does not
require a covered clearing agency to ensure the integrity of securities
issues. The Commission is not modifying proposed Rule 17Ad-22(e)(11) to
add the words ``to help'' before ``ensure'' because, in the
Commission's view, such an addition would inappropriately weaken the
rule. Although the rule does not require a guarantee of the integrity
of securities issues, the rule does require reasonably designed
policies and procedures. Rule 17Ad-22(e)(11) recognizes that reasonably
designed policies and procedures with respect to the integrity of
securities issues is important for investor protection. In this regard,
the Commission believes that such policies and procedures generally
should be designed to prohibit overdrafts and debit balances in
securities accounts, which can create unauthorized issuances of
securities that undermine the integrity of the covered clearing
agency's services.
c. Final Rule
    The Commission is adopting Rule 17Ad-22(e)(11) as proposed.\390\
Because the Commission recognizes that there may be a number of ways to
address compliance with Rule 17Ad-22(e)(11), the Commission is
providing the following guidance that a covered clearing agency
generally should consider in establishing and maintaining policies and
procedures that address CSD services:
---------------------------------------------------------------------------

    \390\ See Rule 17Ad-22(e)(11), infra Part VI.
---------------------------------------------------------------------------

     Whether it has appropriate rules, procedures, and
controls, including robust accounting practices, to safeguard the
rights of securities issuers and holders, to prevent the unauthorized
creation or deletion of securities, and to conduct periodic and at
least daily reconciliation of the securities it maintains;
     whether it prohibits overdrafts and debit balances in
securities accounts;
     whether it maintains securities in an immobilized or
dematerialized form for their transfer by book entry and, where
appropriate, whether it provides incentives to immobilize or
dematerialize securities;
     whether it protects assets against custody risk through
appropriate rules and procedures consistent with its legal framework;
     whether it employs a robust system that ensures
segregation between its own assets and the securities of its
participants and segregation among the securities of participants; and
     whether it identifies, measures, monitors, and manages its
risks from other activities that it may perform and whether additional
tools may be necessary to address such risks.

In addition, the Commission notes that Rule 17Ad-22(e)(11)(i) is not
intended to prohibit a covered clearing agency from continuing to hold
physical certificates on behalf of its members where such securities
currently exist in paper form or from providing other custody-only
services.\391\ The Commission's rules do not prohibit, and in some
respects contemplate, the issuance of securities certificates. For
example, Rule 17Ad-22(e)(11)(i) would not prohibit a covered clearing
agency from holding American depositary shares in custody.\392\
---------------------------------------------------------------------------

    \391\ For example, the Commission understands that, in the
United States, CSD services currently include the provision of
custody-only services, in addition to book-entry transfer and
related services that may also include providing custody.
    \392\ An American depositary receipt (``ADR''), whether in a
program sponsored or unsponsored by a foreign issuer, is the
physical certificate that evidences American depositary shares,
which represent an ownership interest in a specified number of
securities of a foreign issuer that have been deposited with a
depositary. See Securities Act Release No. 33-6894 (May 23, 1991) 56
FR 24420, 24421 n.5 (May 30, 1991). The shares of a foreign issuer
that underlie an ADR are usually held by a custodian appointed by
the depositary in the country of incorporation of the foreign
issuer, may be in paper certificate form, and may be in the ultimate
custody of the CSD.
---------------------------------------------------------------------------

    The Commission also notes that the custody risk described in Rule
17Ad-22(e)(11)(iii) may be related to both physical delivery risk and
operational risk, the latter including risks such as theft, loss,
counterfeiting, and deterioration or damage to assets. To mitigate such
risks, a covered clearing agency could consider obtaining insurance
coverage to help ensure that (i) records of securities held in custody
accurately reflect holdings, and (ii) employee duties for the
recordkeeping and holding of securities are separate and discrete
duties. The Commission notes that dematerialization of securities alone
does not eliminate the applicability of any requirements to protect
against custody risk and instead may create new sources of risk, such
as hacking or digital piracy.
12. Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems
    As proposed, Rule 17Ad-22(e)(12) would require a covered clearing
agency, for transactions that involve the settlement of two linked
obligations, to establish, implement, maintain and enforce written
policies and procedures reasonably designed to eliminate principal risk
by conditioning the final settlement of one obligation upon the final
settlement of the other, regardless of whether the covered clearing
agency settles on a gross or net basis and when finality occurs.\393\
---------------------------------------------------------------------------

    \393\ See CCA Standards proposing release, supra note 5, at
29543-44.
---------------------------------------------------------------------------

    In response to a request for comment as to whether there are
circumstances where it is not feasible or practicable, in an exchange-
of-value settlement context, to ensure that the settlement of one
obligation is final if and only if the settlement of the corresponding
obligation is final, the Commission received one comment. The commenter
stated that such a situation occurs when the settlement of a CDS
contract occurs following a credit event.\394\ In this case, the
commenter stated that there may be some non-delivery versus payment
obligations to be settled, such as loans, and that at least one CCP has
policies and procedures to address this situation to secure settlement.
The commenter expressed the belief that Rule 17Ad-

22(e)(12) should encompass this situation.\395\
---------------------------------------------------------------------------

    \394\ See LCH at 4.
    \395\ See id. at 4-5.
---------------------------------------------------------------------------

    In response, the Commission notes that the commenter has not
described a linked obligation as contemplated under Rule 17Ad-
22(e)(12), such as the delivery of securities against payment of either
cash or securities in connection with the purchase or sale of a
security, because the commenter has described a non-delivery versus
payment obligation. The Commission therefore believes that the comment
is not within the scope of the settlement mechanisms contemplated by
Rule 17Ad-22(e)(12). While the Commission believes that a covered
clearing agency generally should have policies and procedures to
address ``free-of-payment'' deliveries or the settlement of non-
delivery versus payment obligations if it accepts non-delivery versus
payment obligations, Rule 17Ad-22(e)(12) addresses settlement
mechanisms that eliminate principal risk by ensuring that the final
settlement of one obligation occurs if and only if the final settlement
of the linked obligation occurs.
    The Commission also notes that Rule 17Ad-22(e)(8) requires a
covered clearing agency to have policies and procedures to define the
point at which settlement is final. Where a covered clearing agency's
policies and procedures for ensuring settlement finality apply only
when settlement of the corresponding obligation is final, the covered
clearing agency may wish to consider corresponding policies and
procedures that address legal, contractual, operational, and other
risks.
    The Commission is adopting Rule 17Ad-22(e)(12) as proposed.\396\
---------------------------------------------------------------------------

    \396\ See Rule 17Ad-22(e)(12), infra Part VI.
---------------------------------------------------------------------------

13. Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures
a. Proposed Rule
    As proposed, Rule 17Ad-22(e)(13) would require a covered clearing
agency to establish, implement, maintain and enforce written policies
and procedures reasonably designed to ensure that the covered clearing
agency has the authority and operational capacity to take timely action
to contain losses and liquidity demands and continue to meet its
obligations in the event of a participant default. Proposed Rule 17Ad-
22(e)(13)(i) would require a covered clearing agency to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to address the allocation of credit losses it may
face if its collateral and other resources are insufficient to fully
cover its credit exposures, including the repayment of any funds the
covered clearing agency may borrow from liquidity providers. Proposed
Rule 17Ad-22(e)(13)(ii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to describe its process to replenish any
financial resources it may use following a member default or other
event in which use of such resources is contemplated. Finally, proposed
Rule 17Ad-22(e)(13)(iii) would require a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require the covered clearing agency's
participants and, when practicable, other stakeholders to participate
in the testing and review of its default procedures, including any
close-out procedures, at least annually and following material changes
thereto.\397\
---------------------------------------------------------------------------

    \397\ See CCA Standards proposing release, supra note 5, at
29544-46.
---------------------------------------------------------------------------

b. Comments Received and Commission Response
i. Limitations on Replenishment of Resources
    One commenter stated that the Commission's rule should explicitly
require that replenishment of resources through compulsory means (such
as assessments on clearing members) be subject to a well-defined
cap.\398\ The Commission is declining to modify Rule 17Ad-22(e)(13) to
impose a ``cap'' on the replenishment of resources by a covered
clearing agency. Consideration of whether a cap is appropriate depends
on a number of factors related to the covered clearing agency's
recovery plan as a whole and cannot be viewed in isolation, including,
in particular, what measures a covered clearing agency could implement
in the event that a covered clearing agency experienced losses that
exceeded the ``cap.'' Given this uncertainty and that each covered
clearing agency is structured and operated differently, and that
collectively they clear different products with different risk profiles
and employ different default management procedures, the Commission
believes that a cap may not be appropriate in all circumstances and
could potentially increase, rather than decrease, systemic risk because
it may impede the covered clearing agency's ability to replenish
resources to cover losses in the event of a participant default.\399\
---------------------------------------------------------------------------

    \398\ See ISDA at 4.
    \399\ See infra Part III.B.3.a.viii (discussing the economic
effects of Rule 17Ad-22(e)(13)).
---------------------------------------------------------------------------

    As a general matter, the Commission also believes that the
commenters' recommendation would be inconsistent with the principles-
based approach set forth in Rule 17Ad-22(e).\400\ The Commission
believes that establishing prescriptive standards (such as a cap) that,
on an absolute and ex ante basis, prohibit a covered clearing agency's
use of particular tools for replenishment would make it more difficult
for a covered clearing agency to maintain an appropriate balance
between affording its participants predictability and certainty, and
ensuring that the covered clearing agency can effectively manage risk.
The Commission also notes that policies and procedures related to such
caps or other alternative approaches to limitations on the
replenishment of resources would be related to the development of a
covered clearing agency's recovery and wind-down plans under Rule 17Ad-
22(e)(3).\401\ The Commission has previously stated in Part
II.C.3.b.iii above that, given the nature of recovery planning--as here
with caps--such plans are likely to closely reflect the unique
characteristics of the covered clearing agency and will vary depending
on the products cleared. The Commission believes that these mechanisms
under Rule 17Ad-22(e) would help a covered clearing agency to
appropriately consider, review, and address the need for a cap on
replenishment, pursuant to its governance arrangements.
---------------------------------------------------------------------------

    \400\ See supra Part II.B.
    \401\ See supra Part II.C.3.b.iii.
---------------------------------------------------------------------------

ii. Risks of Certain Loss Allocation and Limiting Participant Liability
    Two commenters recommended models for loss allocation to non-
defaulting customers of clearing members.\402\ One of these commenters
urged the Commission to provide clarification and guidance that Rule
17Ad-22(e)(13) would (i) ensure participant liability is limited,
ascertainable, and manageable and (ii) require a covered clearing
agency to adopt rules specifying and providing risk disclosure
regarding so-called ``end of waterfall'' scenarios.\403\ The commenter
stated that guidance is necessary to ensure that Rule 17Ad-22(e)(13)
complements the requirements

of Rule 17Ad-22(b)(1),\404\ certain guidance in the Consultative
Recovery Report,\405\ and a number of risk management practices
relevant for participants of covered clearing agencies.\406\ In this
regard, the commenter noted that participants are subject to single
counterparty credit limits, certain accounting criteria for netting
their positions cleared at a CCP, and regulatory capital
requirements.\407\ The commenter also noted that such guidance is
necessary to ensure that a covered clearing agency does not become a
transmission mechanism for systemic risk. As a general matter, the
commenter expressed opposition to any CCP risk management practice that
constitutes an unpredictable and uncontrollable loss allocation
arrangement or a restriction on participant withdrawal. For this
purpose, the commenter asked the Commission to adopt the following
clarification and guidance that: (i) A covered clearing agency must
address the consequences of circumstances in which the covered clearing
agency's credit losses upon the default of one or more participants
exceed the resources designated to absorb such losses; (ii) a covered
clearing agency may not provide for (1) the forced allocation of a
defaulted portfolio to a non-defaulting participant other than through
a successfully completed auction process or otherwise with the
participant's agreement, (2) invoicing to non-defaulting participants
of losses on cleared positions in the portfolio(s) of one or more
defaulting participants or (3) non-voluntary tear-ups of previously
matched and cleared positions; and (iii) a covered clearing agency must
clearly specify the process for, and effective time of, withdrawal from
participant status such that a participant may withdraw upon the later
of (1) the closeout or transfer of all its positions and (2) a
reasonable prior notice period, without subjecting such withdrawal to a
discretionary or subjective approval requirement or subjecting the
withdrawing participant to liability for increased exposures after the
effective time of withdrawal.\408\ The remainder of the requested
clarification and guidance would entail affording participants
increased certainty regarding what exposures and obligations might
arise where a CCP encounters an ``end of waterfall'' scenario. For this
reason, the commenter also asked the Commission to clarify that a
covered clearing agency may not redefine the economic terms of
outstanding cleared contracts without a reasonable prior notice and
transition period prior to effectiveness.\409\
---------------------------------------------------------------------------

    \402\ See The Clearing House at 4; Vanguard at 6-7.
    \403\ See The Clearing House at 4. With respect to these
comments, the Commission understands an ``end of waterfall''
scenario to be a scenario where a covered clearing agency suffers
losses that, due to the default of one or more participants, exceed
in the aggregate the loss-absorbing resources in the covered
clearing agency's default risk management waterfall.
    \404\ See 17 CFR 240.17Ad-22(b)(1). Rule 17Ad-22(b)(1) states
that a clearing agency that performs CCP services shall establish,
implement, maintain and enforce written policies and procedures
reasonably designed to measure its credit exposures to its
participants at least once a day and limit its exposures to
potential losses from defaults by its participants under normal
market conditions so that the operations of the clearing agency
would not be disrupted and non-defaulting participants would not be
exposed to losses that they cannot anticipate or control.
    \405\ See supra note 126.
    \406\ See The Clearing House at 4.
    \407\ See The Clearing House at 5.
    \408\ See id. at 6. The commenter has also sought clarification
and guidance regarding emergency authority or decision-making at
covered clearing agencies and disclosures regarding such decision-
making and participant-default rules and procedures. See The
Clearing House at 6-7. These comments have been addressed separately
in Parts II.C.2.b and II.C.23.b.
    \409\ See id. at 7.
---------------------------------------------------------------------------

    The second commenter urged the Commission to prohibit the use of
non-defaulting customer initial, variation and excess margin to aid in
the recovery of a covered clearing agency in the event of financial
stress, such as from credit losses, liquidity shortfalls, or other
losses.\410\ According to the commenter, in such a case losses would
effectively be allocated to participants who have not contributed to
the loss. The commenter contended that such exposure is not present in
the OTC swaps market, where customer assets are protected in segregated
custody accounts. The commenter also stated that participants have no
means to assess and mitigate such risk, since they do not have
transparency into the financial health and risk management practices of
their fellow participants, security-based swap dealers, or the covered
clearing agency itself. The commenter instead urged the Commission to
consider the development of enhanced recordkeeping and reporting,
enhanced oversight and compliance, enhanced risk management and
mitigation, increased contributions by SBSDs and increased
contributions to, and management of, the covered clearing agency
guaranty fund.\411\
---------------------------------------------------------------------------

    \410\ See Vanguard at 6-7.
    \411\ See id. at 7.
---------------------------------------------------------------------------

    Much of the clarification and guidance sought by the commenters, in
the Commission's view, would entail broad, ex ante prohibitions on a
number of specific default management practices of CCPs, including the
use of uncapped assessment authority, prohibitions on the use of non-
defaulting customer initial, variation, and excess margin to aid in
recovery, forced allocations of defaulted clearing portfolios,
invoicing back of losses arising from a defaulting participant's
positions, and partial non-voluntary tear-ups of previously matched and
cleared positions. As discussed further above,\412\ Rule 17Ad-22(e)
does not prescribe a specific tool or arrangement to achieve its
requirements. The Commission believes that when determining the content
of its policies and procedures with respect to default management, each
covered clearing agency must have the ability to enhance its policies
and procedures to meet the evolving challenges and risks in the
securities market that the covered clearing agency serves. Consistent
with the goals sought by the commenters, the Commission has developed
through the amendments to Rule 17Ad-22 and new Rule 17Ab2-2, an
enhanced oversight and compliance framework that includes enhanced
requirements for the policies and procedures of a covered clearing
agency that govern financial risk management generally and, in
particular, the risk management of guaranty or clearing funds. The
Commission therefore is not adopting the changes sought by these
commenters.
---------------------------------------------------------------------------

    \412\ See supra Part II.B.
---------------------------------------------------------------------------

    The Commission believes that each covered clearing agency generally
should consider evaluating the strengths and weaknesses of respective
tools so that the covered clearing agency can choose the set most
appropriate for each relevant recovery scenario, including the sequence
in which they should be used. As previously noted in Part II.C.13.b.i,
ensuring that a covered clearing agency does not become a transmission
mechanism for systemic risk means, in part, striking an appropriate
balance between affording its participants predictability and
certainty, on the one hand, and ensuring that the covered clearing
agency can effectively manage risk so that it can effectively continue
its risk mitigating function within the broader financial system, on
the other. As a general matter, the Commission believes that striking
such a balance can be difficult using broadly prescriptive standards
that, on an absolute and ex ante basis, prohibit a covered clearing
agency's application of certain risk management tools. Furthermore,
particular requirements under Rule 17Ad-22(e) should not be viewed in
isolation but instead should be considered holistically and in light of
other requirements under the Exchange Act and the Clearing Supervision
Act.
    The Commission believes that policies and procedures for
participant default generally should be established,

maintained, and enforced pursuant to the covered clearing agency's
governance process, which must be consistent with the requirements of
Section 17A of the Exchange Act, Section 19 of the Exchange Act, and
the rules and regulations thereunder, including Rule 19b-4. The
individual topics raised by the commenters would have implications for
the development of a covered clearing agency's recovery and wind-down
plans; however, as noted in Part II.C.3.b.iii above in connection with
the Commission's prior discussion of recovery and wind-down plans, the
impact of such recovery tools the covered clearing agency's recovery
and wind-down plan can only be considered in the context of the plan as
a whole and not in isolation. The organizational and governance
structures of covered clearing agencies vary, as do the composition of
their members and the products they clear, and each is relevant to
consideration of potential loss allocation mechanisms.
iii. Stakeholder Participation in Periodic Testing
    One commenter expressed concern that the requirement in proposed
Rule 17Ad-22(e)(13)(iii) for policies and procedures to require
participants and, where practicable, other stakeholders in the covered
clearing agency to participate in periodic testing and review of its
default procedures may be read to require a covered clearing agency to
mandate the participation of all its participants in such tests.\413\
The commenter expressed concern that such a requirement would not be
realistically achievable, of sufficient benefit to outweigh the time
and costs, or appropriate given the sensitive nature of information
involved in such tests. The commenter expressed the belief that covered
clearing agencies can accomplish the objective of proposed Rule 17Ad-
22(e)(13)(iii) by methods other than mandating participation in annual
closeout tests and requested discretion and flexibility to achieve such
objective.\414\
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    \413\ See DTCC at 8-9.
    \414\ See id.
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    First, the Commission notes that the commenter provided no estimate
of the time or costs of testing.\415\ More generally, the Commission
notes that the testing requirements in proposed Rule 17Ad-
22(e)(13)(iii) are similar to requirements for members or participants
to participant in business continuity and disaster recovery plans
testing under Regulation SCI, and therefore registered clearing
agencies are already subject to requirements for members to participate
in such testing and have had to consider how to treat sensitive
material in such testing. As with Rule 1004 of Regulation SCI, the
Commission continues to believe that participation rates by members and
participants in voluntary industry-led testing has generally been low,
and that mandatory participation is the best means to achieve effective
and coordinated testing with assured participation by the more
significant members and participants.\416\ The Commission notes,
however, that proposed Rule 17Ad-22(e)(13)(iii) does not specify that
all participants in the clearing agency participate in every periodic
test and review of its default procedures. A covered clearing agency
may designate in its policies and procedures that certain participants,
or certain categories of participants, be designated for participation
in certain tests.
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    \415\ See supra Part III.B.3.a.viii (discussing the economic
effect of Rule 17Ad-22(e)(13)(iii)).
    \416\ See Regulation SCI adopting release, supra note 30, at
72349.
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c. Final Rule
    The Commission is adopting Rule 17Ad-22(e)(13) with one
modification.\417\ As previously noted,\418\ the Commission is moving
the requirements in proposed Rules 17Ad-22(e)(13)(i) and (ii) to Rules
17Ad-22(e)(4)(viii) and (ix), respectively, to consolidate requirements
for management of a covered clearing agency's default waterfall within
a single rule. The Commission believes this modification improves
consistency between Rules 17Ad-22(e)(4) and (7). Specifically, Rule
17Ad-22(e)(4) includes requirements intended to facilitate the
management of credit risk, and proposed Rules 17Ad-22(e)(13)(i) and
(ii) include requirements to address the allocation of credit losses
and the replenishment of funds. Similarly, Rule 17Ad-22(e)(7) includes
requirements intended to facilitate the management of liquidity risk,
and Rules 17Ad-22(e)(7)(viii) and (ix) include requirements to address
liquidity shortfalls and replenish liquid resources. In contrast, Rule
17Ad-22(e)(13) requires a covered clearing agency to have policies and
procedures addressing its authority and operational capacity to take
timely action to contain losses and liquidity demands, and proposed
Rule 17Ad-22(e)(13)(iii) included requirements for the testing of
default procedures. Accordingly, the rules have been reorganized.
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    \417\ See Rule 17Ad-22(e)(13), infra Part VI.
    \418\ See supra Part II.C.4.c.
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    Further, because the Commission recognizes that there may be a
number of ways to address compliance with Rule 17Ad-22(e)(13), the
Commission is providing the following guidance that a covered clearing
agency generally should consider in establishing and maintaining
policies and procedures that address participant-default rules and
procedures:
     Whether it has default rules and procedures that enable it
to continue to meet its obligations in the event of a participant
default and that address the replenishment of resources following a
default;
     whether it is well prepared to implement its default rules
and procedures, including any appropriate discretionary procedures
provided for in its rules;
     whether it publicly discloses key aspects of its default
rules and procedures;
     whether it involves its participants and other
stakeholders in the testing and review of its default procedures,
including any close-out procedures; and
     whether such testing and review is conducted at least
annually or following material changes to the rules and procedures to
ensure that the testing and review are practical and effective.

In addition, a covered clearing agency that has financial and
operational triggers for default generally should clearly define these
triggers.\419\ Where triggers are not automatic through the application
of objective standards or thresholds, the Commission believes the
discretion afforded a covered clearing agency to declare defaults
should be clearly defined. For example, a clear definition may include
defining which person or group exercises discretionary authority in the
event of default and providing specific examples of when the exercise
of discretion is appropriate.
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    \419\ See Clearing Agency Standards, supra note 5, at 29544. An
operational default may occur when a participant is not able to meet
its obligations due to an operational problem, such as a failure in
information technology systems. Rule 17Ad-22(e)(17) includes
requirements related to operational risk management. See infra Part
II.C.17. In addition, the Commission has also adopted Regulation
SCI, which establishes requirements for SROs, among other entities,
with respect to operational risk management. See supra note 30 and
accompanying text.
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    With respect to policies and procedures related to managing a
participant default, the Commission believes that such policies and
procedures generally should address, among other things (i) accessing
credit facilities, (ii) managing (which may include hedging open
positions and

funding collateral positions it is not prudent to close out
immediately), transferring (such as through allocation or auction to
other members) and/or closing out a defaulting member's positions; and
(iii) transferring and/or liquidating applicable collateral. Based on
its supervisory experience, the Commission believes that default
procedures would generally set forth (i) the action that may be taken
(e.g., exercising mutualization of losses); (ii) who may take those
actions (e.g., the division of responsibilities when clearing agencies
operate links to other clearing agencies); (iii) the scope of the
actions that may be taken (e.g., any limits on the total losses that
would be mutualized); (iv) potential changes to the normal settlement
practices, should these changes be necessary in extreme circumstances,
to ensure timely settlement; (v) the management of transactions at
different stages of processing; (vi) the sequencing of actions; (vii)
the roles, obligations, and responsibilities of the various parties,
including non-defaulting members; (viii) the mechanisms to address a
covered clearing agency's obligations to non-defaulting members (e.g.,
the process for clearing trades guaranteed by the covered clearing
agency to which a defaulting member is a party); and (ix) the
mechanisms to address the defaulting member's obligations to its
customers (e.g., the process for dealing with a defaulting member's
accounts).
    With respect to the operational capacity necessary to comply with
requirements to contain losses, the Commission believes that the
following measures could help promote operational capacity: (i)
Establishing training programs for employees involved in default
matters to ensure policies are well implemented; (ii) developing a
communications strategy for communicating with stakeholders, including
the Commission, concerning defaults; and (iii) making sure the proper
tools and resources (whether these are personnel or other) required are
available to close out, transfer, or hedge open positions of a
defaulting member promptly even in the face of rapid market movements.
    With respect to the policies and procedures for testing and review
of default procedures, including any close-out procedures, a covered
clearing agency generally should perform the testing and review not
less than once every twelve months. In addition, a covered clearing
agency generally should make efforts to secure the participation of all
stakeholders in testing and review of default procedures, but the
Commission recognizes that a covered clearing agency may have limited
ability to require said participation by all such stakeholders in all
circumstances.
14. Rule 17Ad-22(e)(14): Segregation and Portability
a. Proposed Rule
    As proposed, Rule 17Ad-22(e)(14) would apply only to a covered
clearing agency that is either a security-based swap clearing agency or
a complex risk profile clearing agency. Rule 17Ad-22(e)(14) would
require such a covered clearing agency to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to enable the segregation and portability of positions of a
member's customers and the collateral provided to the covered clearing
agency with respect to those positions, and effectively protect such
positions and related collateral from the default or insolvency of that
member.\420\
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    \420\ See CCA Standards proposing release, supra note 5, at
29546-47.
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b. Comments Received and Commission Response
    The Commission received multiple comments on Rule 17Ad-22(e)(14)
and, more generally, the Commission's regime for segregation and
portability in the U.S. securities markets. While some commenters
supported the Commission's proposed principles-based approach, a number
of commenters expressed a preference for an approach that would
prescribe, and in some instances mandate, a specific segregation and
portability framework. In addition, two commenters sought clarification
on certain aspects of the proposal relating to portability and
protection of customer assets held at a common covered clearing agency
participant. The Commission discusses these three groups of comments in
turn below.
    One commenter strongly supported efforts to improve the protection
of customer positions and collateral.\421\ Another commenter also
expressed general support for the Commission's objective of protecting
customer collateral posted in connection with clearing security-based
swaps, and stated that the implementation of a regulatory structure
that provided for appropriate protection of collateral would reduce
systemic risk by bolstering confidence that losses related to
counterparty risk would be manageable.\422\
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    \421\ See OCC at 12.
    \422\ See Fidelity at 1.
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    Several commenters, however, urged the Commission to modify the
proposed rule's approach to the treatment of customer positions,
particularly with respect to security-based swaps. Three commenters
noted the importance of coordinating efforts with other regulators to