[Federal Register Volume 77, Number 213 (Friday, November 2, 2012)]
[Rules and Regulations]
[Pages 66219-66286]
[FR Doc No: 2012-26407]

Vol. 77

Friday,

No. 213

November 2, 2012

Part II

 Securities and Exchange Commission

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17 CFR Part 240

 Clearing Agency Standards; Final Rule

Federal Register / Vol. 77 , No. 213 / Friday, November 2, 2012 /
Rules and Regulations

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-68080; File No. S7-08-11]
RIN 3235 AL13

Clearing Agency Standards

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting a new rule in accordance with the
Securities Exchange Act of 1934 (``Exchange Act''), and the Dodd-Frank
Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-Frank
Act''). The new rule establishes minimum requirements regarding how
registered clearing agencies must maintain effective risk management
procedures and controls as well as meet the statutory requirements
under the Exchange Act on an ongoing basis.

DATES:  Effective Date: January 2, 2013.

FOR FURTHER INFORMATION CONTACT: Jeffrey Mooney, Assistant Director;
Katherine Martin, Senior Special Counsel; Doyle Horn, Special Counsel;
Stephanie Park, Special Counsel; or Justin Byrne, Attorney-Advisor;
Office of Clearance and Settlement, Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-7010 at<PHONE_NUMBER>.

SUPPLEMENTARY INFORMATION: The Commission is adopting rules for the
operation of a registered clearing agency that identify minimum
standards designed to enhance the regulatory framework for clearing
agency supervision.

Table of Contents

I. Background
    A. Statutory Framework for the Regulation of Clearing Agencies
    1. Introduction
    2. Section 17A of the Exchange Act
    3. The Dodd-Frank Act
    a. Title VII of the Dodd-Frank Act
    b. Title VIII of the Dodd-Frank Act
    B. International Considerations
II. Overview of Proposal and General Comments Received on the
Proposing Release and Commission Response
    A. Summary of the Clearing Agency Standards Proposing Release
    B. General Comments Received on the Proposing Release and the
Commission Response
    1. Timing of Implementation
    2. Special Attention to Risk Management Standards
    3. Coordinated U.S. Domestic and International Standards
    4. Appropriate Distinctions Between Clearing Agencies
III. Description of Rule 17Ad-22
    A. Overview and Scope
    B. Definitions--Rule 17Ad-22(a)
    C. Risk Management Requirements for Central Counterparties:
Rules 17Ad-22(b)(1)-(4)
    1. Rule 17Ad-22(b)(1): Measurement and Management of Credit
Exposures
    2. Rule 17Ad-22(b)(2): Margin Requirements
    3. Rule 17Ad-22(b)(3): Financial Resources
    4. Rule 17Ad-22(b)(4): Model Validation
    D. Participant Access Standards for Central Counterparties:
Rules 17Ad-22(b)(5)-(7)
    1. Rule 17Ad-22(b)(5): Non-Dealer Member Access
    2. Rule 17Ad-22(b)(6): Portfolio Size and Transaction Volume
Thresholds Restrictions
    3. Rule 17Ad-22(b)(7): Net Capital Restrictions
    E. Record of Financial Resources and Annual Audited Financial
Statements: Rules 17Ad-22(c)(1)-(2)
    1. Rule 17Ad-22(c)(1): Record of Financial Resources for Central
Counterparties
    2. Rule 17Ad-22(c)(2): Clearing Agency Annual Audited Financial
Statements
    F. Minimum Standards for Clearing Agencies: Rules 17Ad-22(d)(1)-
(15)
    1. Rule 17Ad-22(d)(1): Transparent and Enforceable Rules and
Procedures
    2. Rule 17Ad-22(d)(2): Participation Requirements
    3. Rule 17Ad-22(d)(3): Custody of Assets and Investment Risk
    4. Rule 17Ad-22(d)(4): Identification and Mitigation of
Operational Risk
    5. Rule 17Ad-22(d)(5): Money Settlement Risks
    6. Rule 17Ad-22(d)(6): Cost-Effectiveness
    7. Rule 17Ad-22(d)(7): Links
    8. Rule 17Ad-22(d)(8): Governance
    9. Rule 17Ad-22(d)(9): Information on Services
    10. Rule 17Ad-22(d)(10): Immobilization and Dematerialization of
Securities Certificates
    11. Rule 17Ad-22(d)(11): Default Procedures
    12. Rule 17Ad-22(d)(12): Timing of Settlement Finality
    13. Rule 17Ad-22(d)(13): Delivery Versus Payment
    14. Rule 17Ad-22(d)(14): Risk Controls To Address Participants'
Failure To Settle
    15. Rule 17Ad-22(d)(15): Physical Delivery Risks
IV. Paperwork Reduction Act
    A. Overview and Burden Estimate Comparison To Proposing Release
    B. Summary of Collection of Information, Use of Information and
Comments Received
    C. Total Initial and Annual Reporting and Recordkeeping Burdens
    D. Collection of Information Is Mandatory
    E. Confidentiality
V. Economic Analysis
    A. Overview
    B. Baseline
    C. Consideration of Costs, Benefits, and the Effect on
Efficiency, Competition and Capital Formation
VI. Regulatory Flexibility Act Certification
VII. Statutory Authority and Text of Rule 17Ad-22

I. Background

A. Statutory Framework for the Regulation of Clearing Agencies

1. Introduction
    Congress directed the Commission to facilitate the establishment of
a national system for the prompt and accurate clearance and settlement
of securities transactions when it added Section 17A to the Exchange
Act as part of the Securities Acts Amendments of 1975.\1\ The
Commission's ability to achieve this goal and its supervision of
securities clearance and settlement systems is based upon the
regulation of registered clearing agencies. Over the years, clearing
agencies registered with the Commission have become an essential part
of the infrastructure of the U.S. securities markets. Clearing agencies
help reduce the costs of securities trading and are required to be
carefully structured to manage and reduce counterparty risk.
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    \1\ See 15 U.S.C. 78q-1 and S. Rep. No. 94-75, at 4 (1975) (the
Senate Committee on Banking, Housing and Urban Affairs urging that
``[t]he Committee believes the banking and security industries must
move quickly toward the establishment of a fully integrated national
system for the prompt and accurate processing and settlement of
securities transactions'').
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    The Commission used this experience with regulating clearing
agencies to help address developments recently in the over-the-counter
(``OTC'') derivatives markets. In December 2008, the Commission acted
to facilitate the central clearing of credit default swaps (hereinafter
referred to as ``credit default swaps'' or ``CDS''), the largest
category of OTC security-based swaps, by permitting certain entities
that performed central counterparty (``CCP'') services to clear and
settle credit default swaps on a temporary, conditional basis.\2\
Consequently, some credit

default swaps transactions were centrally cleared prior to the
enactment of the Dodd-Frank Act.
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    \2\ The Commission authorized five entities to clear credit
default swaps. See Exchange Act Release Nos. 60372 (July 23, 2009),
74 FR 37748 (July 29, 2009), 61973 (Apr. 23, 2010), 75 FR 22656
(Apr. 29, 2010) and 63389 (Nov. 29, 2010), 75 FR 75520 (Dec. 3,
2010) (CDS clearing by ICE Clear Europe Limited); 60373 (July 23,
2009), 74 FR 37740 (July 29, 2009), 61975 (Apr. 23, 2010), 75 FR
22641 (Apr. 29, 2010) and 63390 (Nov. 29, 2010), 75 FR 75518 (Dec.
3, 2010) (CDS clearing by Eurex Clearing AG); 59578 (Mar. 13, 2009),
74 FR 11781 (Mar. 19, 2009), 61164 (Dec. 14, 2009), 74 FR 67258
(Dec. 18, 2009), 61803 (Mar. 30, 2010), 75 FR 17181 (Apr. 5, 2010)
and 63388 (Nov. 29, 2010), 75 FR 75522 (Dec. 3, 2010) (CDS clearing
by Chicago Mercantile Exchange, Inc.); 59527 (Mar. 6, 2009), 74 FR
10791 (Mar. 12, 2009), 61119 (Dec. 4, 2009), 74 FR 65554 (Dec. 10,
2009), 61662 (Mar. 5, 2010), 75 FR 11589 (Mar. 11, 2010) and 63387
(Nov. 29, 2010), 75 FR 75502 (Dec. 3, 2010) (CDS clearing by ICE
Trust US LLC); 59164 (Dec. 24, 2008), 74 FR 139 (Jan. 2, 2009)
(temporary CDS clearing by LIFFE A&M and LCH.Clearnet Ltd.)
(collectively, ``CDS Clearing Exemption Orders''). LIFFE A&M and
LCH.Clearnet Ltd. allowed their order to lapse without seeking
renewal.
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2. Section 17A of the Exchange Act
    Section 17A of the Exchange Act \3\ and Rule 17Ab2-1 \4\ require
entities to register with the Commission prior to performing the
functions of a clearing agency. Under the statute, the Commission is
not permitted to grant registration unless it determines that the rules
and operations of the clearing agency meet the standards set forth in
Section 17A.\5\ If the Commission registers a clearing agency, the
Commission oversees the clearing agency to facilitate compliance with
the Exchange Act using various tools that include, among other things,
the rule filing process for self-regulatory organizations (``SROs'')
and on-site examinations by Commission staff. Section 17A(d) also gives
the Commission authority to adopt rules for clearing agencies as
necessary or appropriate in the public interest, for the protection of
investors, or otherwise in furtherance of the purposes of the Exchange
Act and prohibits a registered clearing agency from engaging in any
activity in contravention of these rules and regulations.\6\ Pursuant
to Section 21(a) of the Exchange Act, the Commission can invoke its
enforcement powers to initiate and conduct investigations to determine
violations of the federal securities laws, including those specifically
applicable to clearing agencies.\7\ In so doing, the Commission may
institute civil actions seeking injunctive and other equitable remedies
and/or administrative proceedings to, among other things, suspend or
revoke registration, impose limitations upon a clearing agency's
activities, functions, or operations, or impose other sanctions.\8\
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    \3\ See 15 U.S.C. 78q-1(b). See also Public Law 111-203 Sec.
763(b) (adding subparagraph (g) to Section 17 of the Exchange Act).
    \4\ See 17 CFR 240.17Ab2-1.
    \5\ Specifically, Sections 17A(b)(3)(A)-(I) identify
determinations that the Commission must make about the rules and
structure of a clearing agency prior to granting registration. See
15 U.S.C. 78q-1(b)(3)(A)-(I). The staff of the Commission provided
guidance on meeting the requirements of Section 17A in its
Announcement of Standards for the Registration of Clearing Agencies.
See Exchange Act Release No. 16900 (June 17, 1980), 45 FR 41920
(June 23, 1980).
    \6\ See 15 U.S.C. 78q-1(d).
    \7\ See 15 U.S.C. 78u.
    \8\ See id.; see also 15 U.S.C. 78s(h).
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3. The Dodd-Frank Act
    On July 21, 2010, President Barack Obama signed the Dodd-Frank Act
into law.\9\ The Dodd-Frank Act was enacted to, among other things,
promote the financial stability of the United States by improving
accountability and transparency in the financial system.\10\
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    \9\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
    \10\ See id.
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a. Title VII of the Dodd-Frank Act
    Title VII of the Dodd-Frank Act (``Title VII'') provides the
Commission and the Commodity Futures Trading Commission (``CFTC'') with
enhanced authority to regulate certain OTC derivatives in response to
the recent financial crisis.\11\ The Dodd-Frank Act is intended to
bolster the existing regulatory structure and provide regulatory tools
to oversee the OTC derivatives market, which has grown exponentially in
recent years and is capable of affecting significant sectors of the
U.S. economy. Title VII provides that the CFTC will regulate ``swaps,''
the Commission will regulate ``security-based swaps,'' and the CFTC and
the Commission will jointly regulate ``mixed swaps.'' \12\
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    \11\ See id. secs. 701-774.
    \12\ Section 712(d) of the Dodd-Frank Act provides that the
Commission and the CFTC, in consultation with the Board of Governors
of the Federal Reserve System, shall further define the terms
``swap,'' ``security-based swap,'' ``swap dealer,'' ``security-based
swap dealer,'' ``major swap participant,'' ``major security-based
swap participant,'' ``eligible contract participant'' and
``security-based swap agreement.'' The Commission and the CFTC
jointly adopted rules to further define the terms ``swap dealer,''
``security-based swap dealer,'' ``major swap participant,'' ``major
security-based swap participant'' and eligible contract
participant.'' Further Definition of ``Swap Dealer,'' ``Security-
Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-
Based Swap Participant'' and ``Eligible Contract Participant'',
Securities Exchange Act Release No. 34-66868 (Apr. 27, 2012).
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    Title VII was designed to provide greater certainty that, wherever
possible and appropriate, swap and security-based swap contracts
formerly traded exclusively in the OTC market are centrally
cleared.\13\ The swap and security-based swap markets traditionally
have been characterized by privately negotiated transactions entered
into by two counterparties, in which each assumes the credit risk of
the other counterparty.\14\ Clearing of swaps and security-based swaps
was at the heart of Congressional reform of the derivatives markets in
Title VII.\15\ Clearing agencies are broadly defined under the Exchange
Act and undertake a variety of functions.\16\ One such function is to
act as a CCP, which is an entity that interposes itself between the
counterparties to a trade.\17\ For example, when a security-based swap
contract between two counterparties that are members of a CCP is
executed and submitted for clearing, it is typically replaced by two
new contracts--separate contracts between the CCP and each of the two
original counterparties. At that point, the original parties to the
transaction are no longer counterparties to each other. Instead, each
acquires the CCP as its counterparty, and the CCP assumes the
counterparty credit risk of each of the original counterparties that
are members of the CCP.\18\ Structured and operated appropriately, CCPs
may improve the management of counterparty risk and may provide
additional benefits such as multilateral netting of trades.\19\ The
Dodd-Frank Act

amended the Exchange Act to require, among other things, that
transactions in security-based swaps must be cleared through a clearing
agency if they are of a type that the Commission determines must be
cleared, unless an exemption from mandatory clearing applies.\20\ Title
VII of the Dodd-Frank Act also added new provisions to the Exchange Act
that require entities that act as a clearing agency with respect to
security-based swaps (``security-based swap clearing agencies'') to
register with the Commission \21\ and require the Commission to adopt
rules with respect to security-based swap clearing agencies.\22\
Compliance with any such rules is a prerequisite to the registration of
a clearing agency with the Commission and is also a condition to the
maintenance of its continued registration.\23\ Finally, Title VII
provided that some of the entities that the Commission permitted to
clear and settle credit default swaps on a temporary, conditional basis
prior to the July 21, 2010, enactment of the Dodd-Frank Act were deemed
to be registered clearing agencies (the ``Deemed Registered
Provision'').\24\
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    \13\ See, e.g., Report of the Senate Committee, supra note 11,
at 34 (stating that ``[s]ome parts of the OTC market may not be
suitable for clearing and exchange trading due to individual
business needs of certain users. Those users should retain the
ability to engage in customized, uncleared contracts while bringing
in as much of the OTC market under the centrally cleared and
exchange-traded framework as possible.'').
    \14\ See, e.g., Financial Stability Board, Implementing OTC
Derivatives Market Reforms (Oct. 25, 2010), available at http://www.financialstabilityboard.org/publications/r_101025.pdf.
    \15\ As previously noted, the Dodd-Frank Act seeks to ensure
that, wherever possible and appropriate, derivatives contracts
formerly traded exclusively in the OTC market be cleared. See supra
note 11.
    \16\ Section 3(a)(23)(A) of the Exchange Act defines the term
``clearing agency'' to mean any person who acts as an intermediary
in making payments or deliveries or both in connection with
transactions in securities or who provides facilities for the
comparison of data regarding the terms of settlement of securities
transactions to reduce the number of settlements of securities
transactions or the allocation of securities settlement
responsibilities. Such term also means any person, such as a
securities depository, who (i) acts as a custodian of securities in
connection with a system for the central handling of securities
whereby all securities of a particular class or series of any issuer
deposited within the system are treated as fungible and may be
transferred, loaned or pledged by bookkeeping entry without physical
delivery of securities certificates, or (ii) otherwise permits or
facilitates the settlement of securities transactions or the
hypothecation or lending of securities without physical delivery of
securities certificates. 15 U.S.C. 78c(a)(23)(A).
    \17\ See id. An entity that acts as a CCP for securities
transactions is a clearing agency as defined in the Exchange Act and
is required to register with the Commission.
    \18\ See Cecchetti, Gyntelberg and Hollanders, Central
Counterparties for Over-the-Counter Derivatives, Bank for
International Settlement Quarterly Review (Sept. 2009), available at
http://www.bis.org/publ/qtrpdf/r_qt0909f.pdf.
    \19\ See id. at 46; see also Bank for International Settlements'
Committee on Payment and Settlement Systems and Technical Committee
of the International Organization of Securities Commissions,
Guidance on the Application of the 2004 CPSS-IOSCO Recommendations
for Central Counterparties to OTC Derivatives CCPs: Consultative
Report (May 2010), available at http://www.bis.org/publ/cpss89.pdf.
    \20\ See 15 U.S.C. 78c-3; Exchange Act Release No. 34-63557
(Dec. 15, 2010), 75 FR 82490 (Dec. 30, 2010); Exchange Act Release
No. 34-67286 (June 28, 2012); 34-63556 (Dec. 15, 2010), 75 FR 79992
(Dec. 21, 2010).
    \21\ 15 U.S.C. 78q-1(g) (adding subparagraph (g) to Section 17A
of the Exchange Act). Pursuant to Section 774 of the Dodd-Frank Act,
the requirement in Section 17A(g) of the Exchange Act for security-
based swap clearing agencies to be registered with the Commission
took effect on July 16, 2011.
    \22\ 15 U.S.C. 78q-1(i) and (j). Public Law 111-203 sec. 763(b)
(adding subparagraphs (i) and (j) to Section 17A of the Exchange
Act).
    \23\ Under the Exchange Act, a clearing agency can be registered
with the Commission only if the Commission makes a determination
that the clearing agency satisfies the requirements set forth in
paragraphs (A) through (I) of Section 17A(b)(3) of the Exchange Act.
15 U.S.C. 78q-1(b)(3).
    \24\ See 15 U.S.C. 78q-1(l). The Deemed Registered Provision
applies to certain depository institutions that cleared swaps as
multilateral clearing organizations and certain derivatives clearing
organizations (``DCOs'') that cleared swaps pursuant to an exemption
from registration as a clearing agency. As a result, ICE Clear
Credit LLC, ICE Clear Europe Limited and the Chicago Mercantile
Exchange, Inc. were deemed registered clearing agencies with the
Commission on July 16, 2011, solely for the purpose of clearing
security-based swaps. Under this Deemed Registered Provision, an
eligible clearing agency is deemed registered for the purpose of
clearing security-based swaps and is therefore required to comply
with all requirements of the Exchange Act, and the rules thereunder,
applicable to registered clearing agencies, including, for example,
the obligation to file proposed rule changes under Section 19(b) of
the Exchange Act.
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b. Title VIII of the Dodd-Frank Act
    In addition to the provisions from Title VII that expand the
Commission's authority under the Exchange Act to include activities
related to security-based swaps, Title VIII of the Dodd-Frank Act,
entitled the Payment, Clearing, and Settlement Supervision Act of 2010
(``Clearing Supervision Act''), establishes an enhanced supervisory and
risk control system for systemically important clearing agencies and
other financial market utilities (``FMUs'').\25\ In part, the Clearing
Supervision Act provides that the Commission, considering relevant
international standards and existing prudential requirements, may
prescribe regulations that contain risk management standards for the
operations related to payment, clearing, and settlement activities
(``PCS Activities'') \26\ of a Designated Clearing Entity or the
conduct of designated activities by a Financial Institution.\27\ In
prescribing such standards, the Commission must consult the Board of
Governors of the Federal Reserve System (``Federal Reserve'' or ``the
Board'') and the Financial Stability Oversight Council (``Council'').
On July 11, 2011, the Council published a final rule concerning its
authority to designate FMUs as systemically important,\28\ and on July
18, 2012, the Council designated The Depository Trust Company
(``DTC''), Fixed Income Clearing Corporation (``FICC''), National
Securities Clearing Corporation (``NSCC'') and The Options Clearing
Corporation (``OCC'') as systemically important.\29\
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    \25\ See infra note 29. Under Section 803 of the Clearing
Supervision Act, clearing agencies may be FMUs. Therefore, the
Commission may be the Supervisory Agency of a clearing agency that
is designated as systemically important (``Designated Clearing
Entity'') by the Financial Stability Oversight Council
(``Council''). See 12 U.S.C. 5463. The definition of ``FMU,'' which
is contained in Section 803(6) of the Clearing Supervision Act,
contains a number of exclusions including, but not limited to,
designated contract markets, registered futures associations, swap
data repositories, swap execution facilities, national securities
exchanges, national securities associations, alternative trading
systems, security-based swap data repositories, security-based swap
execution facilities, brokers, dealers, transfer agents, investment
companies and futures commission merchants. 12 U.S.C. 5462(6)(B).
The designation of systemic importance hinges on a determination by
the Council that the failure of, or a disruption to, the functioning
of the FMU could create, or increase, the risk of significant
liquidity or credit problems spreading among financial institutions
or markets and thereby threaten the stability of the financial
system of the United States. See 12 U.S.C. 5463(a)(2)(A)-(E). The
designation of an FMU is significant, in part, because it will
subject such designated entity to heightened oversight consistent
with the terms of the Clearing Supervision Act. For example, the
Clearing Supervision Act requires the Supervisory Agency to examine
at least once annually any FMU that the Council has designated as
systemically important. The Commission intends to conduct such
annual statutory cycle examinations on the Commission's fiscal year
basis. The Commission staff anticipates conducting the first annual
statutory cycle examination of any designated FMU for which it is
the Supervisory Agency in the annual cycle following such
designation.
    \26\ Certain post-trade processing activities that are not
captured by the Clearing Supervision Act may nevertheless be subject
to regulation by the Commission under the Exchange Act. See infra
note 100 and accompanying text.
    \27\ See Section 805(a)(2) of the Clearing Supervision Act.
Those regulations may govern ``(A) the operations related to
payment, clearing, and settlement activities of such designated
clearing entities; and (B) the conduct of designated activities by
such financial institutions.'' 12 U.S.C. 5464(a)(2). PCS Activities
are defined in Section 803(7) of the Clearing Supervision Act. 12
U.S.C 5462(7).
    The definition of ``financial institution,'' which is contained
in Section 803(5) of the Clearing Supervision Act, outlines numerous
exclusions but defines financial institution as a branch or agency
of a foreign bank, an organization operating under Section 25 or 25A
of the Federal Reserve Act, a credit union, a broker or dealer, an
investment company, an insurance company, an investment adviser, a
futures commission merchant, commodity trading advisor or commodity
pool operator and any company engaged in activities that are
financial in nature or incidental to a financial activity. 12 U.S.C.
5462(5)(A).
    \28\ See 76 FR 44763 (July 27, 2011) (the Council also expects
to address the designation of payment, clearing, or settlement
activities as systemically important in a separate rulemaking).
    \29\ See 12 U.S.C. 5321 (establishing the Council and
designating its voting and nonvoting members); see also 12 U.S.C.
5463 (designation of systemic importance). In accordance with
Section 804 of the Clearing Supervision Act, the Council has the
authority, on a non-delegable basis and by a vote of not fewer than
two-thirds of the members then serving, including the affirmative
vote of its chairperson, to designate those FMUs that the Council
determines are, or are likely to become, systemically important. The
Council may, using the same procedures, rescind such designation if
it determines that the FMU no longer meets the standards for
systemic importance. Before making either determination, the Council
is required to consult with the Board and the relevant Supervisory
Agency as determined in accordance with Section 803(8) of the
Clearing Supervision Act. Section 804 also sets forth procedures
that give entities 30 days advance notice and an opportunity for a
hearing prior to being designated as systemically important.
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B. International Considerations

    Section 17A(i) of the Exchange Act provides that the Commission, in
establishing clearing agency standards and in its oversight of clearing
agencies, may conform such standards and such oversight to reflect
evolving international standards.\30\ Section 805(a) of the Clearing
Supervision Act directs the Commission to take into consideration
relevant international standards and existing prudential requirements
for clearing agencies that are designated as FMUs.\31\ The current
international standards most relevant to risk management of clearing
agencies

are the standards developed by the International Organization of
Securities Commissions (``IOSCO'') and the Committee on Payment and
Settlement Systems (``CPSS'') that are contained in the report entitled
Principles for Financial Market Infrastructures (``FMI Report'').\32\
The final FMI Report was published on April 16, 2012, and replaces CPSS
and IOSCO's previous standards applicable to clearing agencies that
were contained in the following reports: Recommendations for Securities
Settlement Systems (2001) (``RSSS'') and Recommendations for Central
Counterparties (2004) (``RCCP'') (collectively, ``CPSS-IOSCO
Recommendations'').\33\ These international standards were formulated
by securities regulators and central banks to promote sound risk-
management practices and encourage the safe design and operation of
entities that provide clearance and settlement services. The FMI Report
harmonizes and, where appropriate, strengthens the previous
international standards; it also incorporates additional guidance for
OTC derivatives CCPs.\34\
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    \30\ 15 U.S.C. 78q-1(i).
    \31\ 12 U.S.C. 5464(a)(1).
    \32\ CPSS-IOSCO, Principles for Financial Market Infrastructures
(Apr. 2012), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf.
    \33\ The complete RSSS and RCCP Reports are available on the Web
site of the Bank for International Settlements at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD123.pdf and http://www.iosco.org/library/pubdocs/pdf/IOSCPD176.pdf respectively.
     The Board applies these standards in its supervisory process
and expects systemically important systems, as determined by the
Board and subject to its authority, to complete a self-assessment
against the standards set forth in the policy. See Policy on Payment
System Risk, 72 FR 2518 (Jan. 12, 2007).
    \34\ See FMI Report, supra note 32.
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II. Overview of Proposal and General Comments Received on the Proposing
Release and Commission Response

A. Summary of the Clearing Agency Standards Proposing Release

    On March 3, 2011, the Commission proposed for comment a series of
rules related to standards for the operation and governance of clearing
agencies (``Proposing Release'').\35\ The Proposing Release contained
the following proposals:
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    \35\ See Exchange Act Release No. 34-64017 (Mar. 3, 2011), 76 FR
14472 (Mar. 16, 2011) (``Proposing Release''), available at http://www.sec.gov/rules/proposed/2011/34-64017fr.pdf.
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    (1) Proposed Rule 17Ad-22, which would require certain minimum
standards for all clearing agencies registered with the Commission;
    (2) Proposed Rule 17Aj-1, which would require dissemination of
pricing and valuation information by security-based swap CCPs;
    (3) Proposed Rule 17Ad-23, which would require all clearing
agencies to have adequate safeguards and procedures to protect the
confidentiality of trading information of clearing agency participants;
    (4) Proposed Rule 17Ad-24, which would exempt certain security-
based swap dealers and security-based swap execution facilities from
the definition of clearing agency;
    (5) Proposed Rule 17Ab2-1, which would amend an existing Commission
rule concerning registration of clearing agencies to account for
security-based swap clearing agencies and to make other technical
changes;
    (6) Proposed Rule 17Ad-25, which would require all clearing
agencies to have procedures that identify and address conflicts of
interest;
    (7) Proposed Rule 17Ad-26, which would require clearing agencies to
set standards for all members of their boards of directors or
committees; and
    (8) Proposed Rule 3Cj-1, which is modeled on Section 3C(j) of the
Exchange Act and would require all clearing agencies to designate a
chief compliance officer.
    The Commission also noted in the Proposing Release that the
definition of clearing agency under Section 3(a)(23)(A) of Exchange Act
includes any person who:
     Acts as an intermediary in making payments or deliveries
or both in connection with transactions in securities;
     Provides facilities for the comparison of data regarding
the terms of settlement of securities transactions, to reduce the
number of settlements of securities transactions, or for the allocation
of securities settlement responsibilities;
     Acts as a custodian of securities in connection with a
system for the central handling of securities whereby all securities of
a particular class or series of any issuer deposited within the system
are treated as fungible and may be transferred, loaned, or pledged by
bookkeeping entry, without physical delivery of securities certificates
(such as a securities depository); or
     Otherwise permits or facilitates the settlement of
securities transactions or the hypothecation or lending of securities
without physical delivery of securities certificates (such as a
securities depository).\36\
---------------------------------------------------------------------------

    \36\ 15 U.S.C. 78c(a)(23)(A).

Based on the Exchange Act definition, the Commission stated its
preliminary view that certain post-trade processing services may fall
within the clearing agency definition and asked for comments regarding
the Commission's preliminary interpretation.
    Since the publication of the Proposing Release, the Commission has
received 25 comment letters on the Proposing Release from a broad range
of market participants, and the Commission and staff also had
discussions with representatives of clearing agencies, trade
associations, public interest groups and other interested parties.\37\
The Commission has taken into consideration international initiatives
and consulted with other U.S. financial regulators as appropriate,
including the

CFTC and the Federal Reserve, to inform the Commission's final actions.
Commenters generally supported the goals of the proposal. As further
discussed below, however, several commenters recommended that the
proposal be amended or clarified in certain respects.
---------------------------------------------------------------------------

    \37\ The comment file is published on the Commission's Web site,
available at http://www.sec.gov/comments/s7-08-11/s70811.shtml. See
Letter from American Benefits Council, dated May 6, 2011 (``ABC
Letter''); letter from Chris Barnard, dated March 21, 2011
(``Barnard Letter''); letter from Dennis M. Kelleher, President &
CEO and Steven W. Hall, Securities Specialist, Better Markets, Inc.,
dated April 29, 2011 (``Better Markets Letter''); letter from Joanne
Medero, Richard Prager and Supurna VedBrat, BlackRock, dated April
29, 2011 (``BlackRock Letter''); letter from Craig S. Donohue, CME
Group, dated April 29, 2011 (``CME Letter''); letter from Glenn
Davis, Senior Research Associate, Council of Institutional
Investors, dated April 14, 2011 (``CII Letter''); letter from Ernst
& Young, dated April 29, 2011 (``ENY Letter''); letter from Mark
Beeston, Chief Executive Officer of Portfolio Risk Services,
ICAP[supreg], dated July 7, 2011 (``ICAP Letter''); letter from R.
Trabue Bland, Intercontinental Exchange, Inc., dated April 29, 2011
(``ICE Letter''); letter from Robert Pickel, Executive Vice
Chairman, International Swaps and Derivatives Association, dated
April 29, 2011 (``ISDA Letter''); letter from Ian Axe, CEO,
LCH.Clearnet Group Limited, dated April 28, 2010 (``LCH Letter'');
letter from Stuart J. Kaswell and Carlotta King, Managed Funds
Association, dated March 24, 2011 (``MFA (Kaswell/King) Letter'');
letter from Stuart J. Kaswell, Executive Vice President & Managing
Director, General Counsel, Managed Funds Association, dated April
29, 2011 (``MFA (Kaswell) Letter''); letter from Kevin Gould,
President, MarkitTM, dated April 29, 2011
(``MarkitTM (April) Letter''); letter from Kevin Gould,
President, MarkitTM, dated July 26, 2011
(``MarkitTM (July) Letter''); letter from Jeff Gooch,
CEO, MarkitSERVTM, dated April 29, 2011
(``MarkitSERVTM (April) Letter''); letter from Jeff
Gooch, CEO, MarkitSERVTM, dated July 18, 2011
(``MarkitSERVTM (July) Letter''); letter from Norman
Reed, General Counsel, Omgeo, dated May 5, 2011 (``Omgeo Letter'');
letter from Larry E. Thompson, General Counsel, The Depository Trust
& Clearing Corporation, dated April 29, 2011 (``The DTCC (April)
Letter''); letter from Larry E. Thompson, General Counsel, The
Depository Trust & Clearing Corporation, dated July 21, 2011 (``The
DTCC (July) Letter''); letter from William H. Navin, Executive Vice
President, General Counsel and Secretary, The Options Clearing
Corporation, dated April 29, 2011 (``The OCC Letter''); letter from
James Cawley, Co-Founder, Swaps and Derivatives Market Association,
dated June 3, 2011 (``SDMA (June) Letter''); letter from Christoffer
Mohammar, General Counsel, TriOptima Group, dated April 29, 2011
(``TriOptima Letter''); letter from Richard H. Baker, President &
Chief Executive Officer, Managed Funds Association, dated March 24,
2011 (``MFA (Baker) Letter''); letter from James Cawley, Co-Founder,
Swaps and Derivatives Market Association, dated April 19, 2011
(``SDMA (April) Letter'').
---------------------------------------------------------------------------

    After careful review and consideration of the comments, the
Commission is today adopting Rule 17Ad-22, with certain modifications
discussed below, to address comments received. As adopted, Rule 17Ad-22
is meant to establish minimum requirements for registered clearing
agency risk management practices and operations with due consideration
given to equivalent standards of other regulators in the United States
\38\ and to international standards, as discussed above in Section I.B.
We expect to address separately the other proposed rules and matters
contained in the Proposing Release as explained in more detail in
Section II.B below.
---------------------------------------------------------------------------

    \38\ See Derivatives Clearing Organization General Provisions
and Core Principles 76 FR 69334 (Nov. 8, 2011) (CFTC adopting final
regulations to implement certain provisions of Title VII and Title
VIII of the Dodd-Frank Act governing DCO activities) (``DCO
Release''); Financial Market Utilities 76 FR 18445 (Apr. 4, 2011)
(notice of proposed rulemaking to promulgate risk-management
standards governing the operations related to the payment, clearance
and settlement activities of certain financial market utilities that
are designated systemically important by the Council).
---------------------------------------------------------------------------

B. General Comments Received on the Proposing Release and the
Commission Response

    The Proposing Release was published in the Federal Register on
March 16, 2011, and the comment period closed on April 29, 2011.\39\
The Proposing Release contained proposed rules that cover various
aspects of a clearing agency's operations and risk management that are
listed in full in Section II.A. In addition to specific comments
regarding the substance of the rules in the Proposing Release, a number
of the comments the Commission received concern the larger framework
for our rulemaking efforts involving clearing agencies and the manner
in which the rules may be implemented. These comments focus on issues
such as ensuring that: (1) Sufficient time be given to clearing
agencies to implement all new standards appropriately; (2) the
Commission's regulations relating to risk management standards in
particular be given careful consideration and recognize the complexity
of the issues involved; (3) the Commission's regulations are consistent
with those of other U.S. regulatory agencies and CPSS and IOSCO
initiatives; and (4) appropriate distinctions between clearing agencies
that provide CCP and central securities depository (``CSD'') services
from those that provide post-trade processing services are recognized
in the Commission's regulations.
---------------------------------------------------------------------------

    \39\ See supra note 35.
---------------------------------------------------------------------------

    Set forth below is a description of the comments received by the
Commission that express concerns about the general approach to clearing
agency reform reflected in the Proposing Release. The Commission has
carefully considered these general comments that were provided
concerning the larger framework for our rule making efforts involving
clearing agencies.\40\ To address the concerns they raise, we have
determined to take the actions described below.
---------------------------------------------------------------------------

    \40\ See supra note 9, at Preamble.
---------------------------------------------------------------------------

1. Timing of Implementation
a. Comments Received
    Three commenters asked for the implementation of the proposed rules
to be subject to appropriate phase-in periods.\41\ One commenter
suggested that the appropriate phases should be determined by the
Commission in consultation with the affected clearing agencies.\42\
Another commenter requested that if the rules are adopted as proposed
then they should not become effective for at least two years.\43\ Two
commenters stated that they believe that implementing all of the
proposed rules in the Proposing Release at the same time would require
extensive new policies and procedures, drafting, proposing and approval
of rules and rule changes, raising additional financial resources,
hiring and training of personnel, operational changes and many other
tasks that would require clearing agencies to simultaneously respond to
separate requirements promulgated under the Dodd-Frank Act.\44\
Accordingly, these commenters requested that the Commission provide
adequate time to implement necessary changes and expressed that phase-
in periods would be appropriate.
---------------------------------------------------------------------------

    \41\ See The DTCC (April) Letter at 5; The OCC Letter at 17; MFA
(Kaswell/King) Letter at 2.
    \42\ See The DTCC (April) Letter at 5.
    \43\ See The OCC Letter at 17 (adding that if the Commission
adopts a financial resources standard in Rule 17Ad-22(b)(3) to
require a security-based swaps clearing agency that performs CCP
services to have enough financial resources to be able to withstand
the default of its two largest participants in extreme but plausible
market conditions then that requirement should be subject to delayed
implementation of at least two years).
    \44\ See id.; The DTCC (April) Letter at 6.
---------------------------------------------------------------------------

    One commenter asked the Commission to publish any modifications it
may make to the proposed rules for an additional comment period.\45\
Others stressed that if the Commission makes significant changes to its
proposed rules, then the rules should be republished for further
comment.\46\
---------------------------------------------------------------------------

    \45\ See The DTCC (April) Letter at 2.
    \46\ See The OCC Letter at 17.
---------------------------------------------------------------------------

    One commenter stated that clearing agency rules such as those
related to governance, conflicts of interest, registration, and
financial resources should be adopted early in the implementation of
rules for the security-based swap market.\47\ The commenter also stated
that barriers to effective ``buy-side'' participation in CCPs must be
eliminated early in the phase-in process to enable ``buy-side''
participants to clear voluntarily at the same time as dealers.\48\
---------------------------------------------------------------------------

    \47\ See MFA (Kaswell/King) Letter at Annex A.
    \48\ See id.
---------------------------------------------------------------------------

b. Commission Response
    In light of the request by commenters for a phased approach to
implementation of the clearing agency standards set forth in the
Proposing Release,\49\ the Commission has decided to address the
standards in stages.
---------------------------------------------------------------------------

    \49\ See supra notes 41-44 and accompanying text.
---------------------------------------------------------------------------

     In the first stage, the Commission is adopting only Rule
17Ad-22. The compliance date for Rule 17Ad-22 will be sixty days from
publication in the Federal Register.
     The second planned stage in the implementation of
standards for clearing agencies is the consideration by the Commission
of rules that correspond to proposed Rules 17Aj-1; 17Ad-23; 17Ad-24;
17Ab2-1 and 3Cj-1 as well as the clearing agency governance and
conflict of interest concerns that its previous proposal addressed
through its proposal of Rule 17Ad-25, Rule 17Ad-26 and Regulation
MC.\50\
---------------------------------------------------------------------------

    \50\ Ownership Limitations and Governance Requirements for
Security-Based Swap Clearing Agencies, Security-Based Swap Execution
Facilities, and National Securities Exchanges with Respect to
Security-Based Swaps under Regulation MC, Exchange Act Release No.
344-63107 (Oct. 14, 2010), 75 FR 65882 (Oct. 26, 2010) (``Regulation
MC'').
---------------------------------------------------------------------------

     The third planned stage is for the Commission to consider
rules tailored to clearing agencies that perform certain post-trade
processing services. The Commission sought comment concerning these
types of clearing agencies in the Proposing Release and preliminarily
intends to propose rules addressed to them as described in more detail
in Sections II.B.4 and III.A below. As appropriate, the Commission may

also propose rules that will incorporate principles set forth in the
FMI Report.
    The Commission believes the phased approach to implementation
provides clearing agencies with the benefit of additional time with
respect to some of the requirements contemplated in the Proposing
Release, while putting into place minimum standards for operational and
risk management practices of registered clearing agencies. This
approach will allow the Commission to consider further the comments
received on the Proposing Release and evolution of clearance and
settlement activity in light of the requirements of Title VII and Title
VIII of the Dodd-Frank Act, including the implementation of the
mandatory clearing requirements with respect to security-based swaps
mandated by the Dodd-Frank Act. Because the Commission is adopting
17Ad-22 largely as proposed, the Commission is not republishing Rule
17Ad-22 for additional comments.
    We believe that the implementation of these standards is an
important first step in crafting regulatory changes contemplated by
Title VII and Title VIII of the Dodd-Frank Act as intended by Congress.
The adoption of Rule 17Ad-22 will also allow the Commission to
coordinate its activities as the supervisory agency for clearing
agencies designated as systemically important financial market
utilities under Title VIII of the Dodd-Frank Act with the complementary
responsibilities of the Federal Reserve.\51\ In addition, the
Commission believes that the adoption of standards for registered
clearing agencies at this time will help facilitate the development of
the security-based swap market. Rule 17Ad-22 establishes minimum
standards for a wide range of issues, including governance, financial
resources and membership. For example, Rules 17Ad-22(b)(5), (6) and (7)
are designed to prohibit membership practices that may limit
competition among market participants. In particular, Rule 17Ad-
22(b)(6) is designed to facilitate correspondent clearing, which will
allow buy-side participants to obtain access to CCP services without
having to become direct members of a clearing agency.
---------------------------------------------------------------------------

    \51\ Section 805 of the Clearing Supervision Act provides that
(i) the Commission may prescribe standards for designated clearing
entities in consultation with the Council and the Board and (ii) the
Board may determine that the Commission's existing prudential
requirements with respect to designated clearing entities are
insufficient to prevent or mitigate significant credit, liquidity,
operational or other risks to the financial markets or the financial
stability of the United States.
---------------------------------------------------------------------------

2. Special Attention to Risk Management Standards
a. Comments Received
    Generally, commenters supported the requirements of proposed Rules
17Ad-22(b)(1)-(4) that would govern the risk management standards and
practices of registered clearing agencies that perform CCP services or
CCPs.\52\ However, in several respects, commenters asked the Commission
to pay special attention to the technical nature of CCP risk management
practices that are addressed by these rules. The comments received by
the Commission span a range of views on these matters. But
thematically, many of them coalesce around a question of whether the
Commission should prescribe detailed specifications within these rules
to define compliance standards more clearly or take a less prescriptive
approach that affords clearing agencies greater discretion to
establish, implement, maintain and enforce policies and procedures
based on the facts and circumstances of the individual clearing agency.
---------------------------------------------------------------------------

    \52\ See discussion infra Section III.C.
---------------------------------------------------------------------------

    For instance, proposed Rule 17Ad-22(b)(1) would require a CCP to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to measure credit exposures to
participants at least once a day and limit exposures to potential
losses from defaults by its participants in normal market conditions so
that the operations of the clearing agency would not be disrupted and
non-defaulting participants would not be exposed to losses that they
cannot anticipate or control. Of those commenters who asked the
Commission to consider modifications to the proposed rule, two
suggested that public disclosure requirements should accompany any
choice made by a CCP to reduce margin requirements on the basis of an
inverse or offsetting correlation between participants' positions.\53\
Several others focused on what role the Commission should take in
defining ``normal market conditions'' for purposes of the rule \54\ as
well as how frequently a CCP should be required to measure its credit
exposures \55\ and whether such measurements should be required to
include the customers of participants.\56\
---------------------------------------------------------------------------

    \53\ See ISDA Letter at 7; Better Markets Letter at 3-4.
    \54\ See The OCC Letter at 7; Better Markets Letter at 3-4.
    \55\ See LCH Letter at 2; Better Markets Letter at 5.
    \56\ See LCH Letter at 2.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(b)(2) would require a CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to use margin requirements to limit its credit
exposures to participants under normal market conditions and use risk-
based models \57\ to set margin requirements and review them at least
monthly. One commenter argued that CCPs should be required to make
their margin-setting methodology available to customers to help them
understand the responsibilities that are commensurate with CCP
participation.\58\ Another commenter suggested clearing agencies should
have discretion when complying with the rule to decide which aspects of
a margin methodology are appropriate for monthly review.\59\ Still
other commenters concentrated on the extent to which the Commission
should prescribe the parameters of a CCP's margin model, such as the
confidence level, amount of data used to inform the standard of
``normal market conditions,'' and the use of factors such as liquidity
and concentration.\60\
---------------------------------------------------------------------------

    \57\ The term ``risk-based models'' is meant to encompass any
models, systems and associated parameters used by clearing agencies
to mitigate risks.
    \58\ See MFA (Kaswell) Letter at 2.
    \59\ See The OCC Letter at 7.
    \60\ See, e.g., ISDA Letter at 7; Better Markets Letter at 3-4;
The OCC Letter at 7.
---------------------------------------------------------------------------

    With respect to proposed Rule 17Ad-22(b)(3), commenters asked the
Commission to give further consideration to whether it is appropriate
to create different financial resources standards for a security-based
swap CCP. As proposed, the rule would require a CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to maintain sufficient financial resources to
withstand, at a minimum, a default by the participant to which it has
the largest exposure in extreme but plausible market conditions,
provided that a security-based swap clearing agency would be required
to maintain sufficient financial resources to withstand, at a minimum,
a default by the two participants to which it has the largest exposures
in extreme but plausible market conditions. One commenter argued that
characteristics of the instruments traded in the security-based swap
market support differentiating the requirements of the rule \61\ while
other commenters advanced reasons for why it may be appropriate for the
rule to employ only a single standard.\62\ Commenters also highlighted
that it is important for the Commission to account for the

international standards in this area \63\ and they expressed
contrasting views about how standardized and prescriptive the
Commission should be in specifying the meaning of ``extreme but
plausible market conditions.'' \64\
---------------------------------------------------------------------------

    \61\ See Better Markets Letter at 5.
    \62\ See LCH Letter at 2; The OCC Letter at 8; The DTCC (April)
Letter at 12.
    \63\ See The OCC Letter at 9; LCH Letter at 2-3.
    \64\ See Better Markets Letter at 5-6; The DTCC (April) Letter
at 10; The OCC Letter at 10.
---------------------------------------------------------------------------

    Similarly, some commenters asked the Commission to reconsider how
prescriptive it should be in its approach to the requirements of Rule
17Ad-22(b)(4).\65\ The proposed rule would require a CCP to establish,
implement, maintain and enforce policies and procedures reasonably
designed to provide for an annual model validation consisting of the
evaluation of the performance of the clearing agency's margin models
and the related parameters and assumptions associated with such models
by a qualified person who does not perform functions associated with
the clearing agency's margin models (except as part of the annual model
validation) and does not report to a person who performs those
functions. In this area, commenters expressed contrasting views about
the appropriate level of detail that should be embedded within the rule
to guide clearing agency practices. The comments addressed matters
including how frequently a model validation should be performed \66\
and, when a model validation is performed, how a CCP should be required
to ensure that the process represents a candid, independent and
objective assessment.\67\
---------------------------------------------------------------------------

    \65\ See, e.g., The DTCC (April) Letter at 13; The OCC Letter at
11; Better Markets Letter at 6.
    \66\ See The DTCC (April) Letter at 13; Better Markets Letter at
6.
    \67\ See The DTCC (April) Letter at 13-15; The OCC Letter at 11;
Better Markets Letter at 6.
---------------------------------------------------------------------------

    A more complete discussion of these comments and others that
pertain to Rules 17Ad-22(b)(1)-(4) is contained in Section III.C below.
b. Commission Response
    The Commission acknowledges the many thoughtful comments we
received regarding the risk management standards and practices
reflected in the Proposing Release and agrees that the topic deserves
particular care and attention.\68\ We also agree with the commenters
who pointed out that:
---------------------------------------------------------------------------

    \68\ See discussion supra Section II.B.
---------------------------------------------------------------------------

     Many of the risk management standards and practices
underlying proposed Rule 17Ad-22 require relatively significant
judgments to be made and at times there are no established or
definitive sources of guidance to aid decision-making. Therefore, for a
CCP's risk management practices to be most effective, the CCP must have
some degree of flexibility to tailor the practices appropriately to
meet the demands of the specific financial markets it serves, and the
Commission's interpretation of Rule 17Ad-22 should not be rigidly
applied as uniform standards without variation.\69\
---------------------------------------------------------------------------

    \69\ See infra notes 82-84 and accompanying text.
---------------------------------------------------------------------------

     The specific risk management practices most appropriate
for any individual CCP and for registered clearing agencies generally
are unlikely to remain static.\70\ Rather, risk management practices
can be expected to evolve to keep pace with changes in technology,
market practices and financial professionals' understanding of the
characteristics of the markets.\71\
---------------------------------------------------------------------------

    \70\ See infra note 79 and accompanying text.
    \71\ See The DTCC (April) Letter at 6 (``As markets continue to
globalize and standards continue to evolve, the Commission should
consider additional modifications to its rules, as necessary and
appropriate, to meet the important objective that the Commission's
rules remain in alignment with global standards.'').
---------------------------------------------------------------------------

    For example, the Commission recognizes that a less prescriptive
approach can help promote efficient practices and encourage regulated
entities to consider how to manage their regulatory obligations and
risk management practices in a way that complies with Commission rules
while accounting for the particular characteristics of their business
and believes the approach reflected in proposed Rule 17Ad-22 is
consistent with this perspective.
    The Commission believes that one outgrowth of this less
prescriptive approach is that there may be additional questions from
the clearing agencies regarding how various regulatory requirements
apply with regard to clearance and settlement services for particular
instruments or products having different market characteristics.
Commenters were particularly concerned with the application of Rules
17Ad-22(b)(1)-(4) and with particular risk management standards,
including, but not limited to, the proper amount of financial
resources, measurement and management of credit exposures, back
testing, model validation, use of concentration, liquidity and other
factors to determine margin requirements, and the appropriate meaning
of ``extreme but plausible market conditions.''
    We note that the Commission or its staff may from time to time
issue additional guidance to the extent necessary to address questions
arising from the dynamic nature of clearing agency risk management
practices, changing market practices, and technological advances.
    To date, the Exchange Act and the related regulations promulgated
by the Commission have not established particularized requirements
regarding clearing agencies' risk management practices.\72\
Nevertheless, CCPs registered as clearing agencies generally adopt
margin requirements designed to cover potential losses under normal
market conditions to help ensure the financial safety of the
enterprise, protect the interests of clearing members, and meet or
exceed standards of risk management best practices recognized in the
financial services industry generally.\73\ Additional charges,
including, but not limited to, those contained in separately
constituted default or guaranty funds are also used to cover losses
beyond that (i.e., tail events associated with extreme but plausible
market conditions).\74\
---------------------------------------------------------------------------

    \72\ See generally Section 17A of the Exchange Act (15 U.S.C.
78q-1) and Standards for Clearing Agency Regulation (Exchange Act
Release No. 16900 (June 17, 1980), 45 FR 41920 (June 23, 1980)).
    \73\ See, e.g., NSCC's Assessment of Compliance with the CPSS/
IOSCO Recommendations for Central Counterparties (Nov. 14, 2011),
available at http://www.dtcc.com/legal/compliance/NSCC_Self_Assessment.pdf.
    \74\ See CME Group letter to CPSS-IOSCO regarding the
Consultation Report: Principles for Financial Market Infrastructures
(July 28, 2011), available at http://www.bis.org/publ/cpss94/cacomments/cmegroup.pdf.
---------------------------------------------------------------------------

    To meet this standard, the current practice of registered CCPs is
to calculate daily margin requirements using risk-based models to
ensure coverage at a 99% confidence interval over a designated time
horizon.\75\ Given the history of usage of this standard in CCP
practices and international standards,\76\ the Commission believes it
is appropriate to codify this commonly accepted practice as the minimum
benchmark for measuring credit exposures and setting margin
requirements. However, the Commission also recognizes that this minimum
standard may not be sufficient for all CCPs and believes the rules
allow flexibility for CCPs to adopt more conservative approaches when
appropriate given the nature of the financial product being cleared,
the preferences of their members, or other factors consistent with the
general responsibilities of clearing agencies under the Exchange Act to
perfect the national clearance and settlement system.
---------------------------------------------------------------------------

    \75\ See infra Section V.B.2 (discussion on current industry
baselines).
    \76\ See infra note 571 and accompanying text.
---------------------------------------------------------------------------

    Furthermore, the Commission notes that a CCP can develop rules and

procedures that are tailored to its practices and operations in order
to meet the demands of the specific financial markets it serves. When a
CCP proposes to make rule changes, rule changes are required to be
submitted to the Commission under Section 19(b) of the Exchange Act and
are subject to review, public comment and approval, as applicable. In
addition to the SRO rule filing process, the Commission works closely
with each clearing agency it oversees from the point of its application
for registration with the Commission and thereafter through
examinations and periodic monitoring of the clearing agency's risk
management framework and operations.\77\
---------------------------------------------------------------------------

    \77\ See Risk Management Supervision of Designated Clearing
Entities (July 2011), Report by the Commission, Board and CFTC to
the Senate Committees on Banking, Housing, and Urban Affairs and
Agriculture in fulfillment of Section 813 of Title VIII of the Dodd-
Frank Act, at 25.
---------------------------------------------------------------------------

3. Coordinated U.S. Domestic and International Standards
a. Comments Received
    Three commenters strongly encouraged the Commission and the CFTC to
coordinate and cooperate in the development of their parallel
regulation of clearing agencies and derivatives clearing organizations
(``DCOs'') to build a harmonized U.S. framework for OTC derivatives and
to bring appropriate consistency to the two agencies' regulation of
similar products, practices and markets.\78\
---------------------------------------------------------------------------

    \78\ See ICE Letter at 2; MFA (Kaswell) Letter at 8-9; CME
Letter at 4.
---------------------------------------------------------------------------

    One commenter stressed that rules applicable to clearance and
settlement of single name credit default swaps should be comparable to
the final requirements applicable to clearance and settlement of index-
based credit default swaps because clearinghouses will undoubtedly
service both and therefore different sets of compliance standards could
lead to unnecessary operational inefficiencies and may have the
unintended consequence of tilting the market in favor of one class of
instruments.\79\
---------------------------------------------------------------------------

    \79\ See CME Letter at 4.
---------------------------------------------------------------------------

    Three commenters urged the Commission to incorporate specific
requirements for processing, clearing and transfer of customer
positions.\80\ Two of the commenters urged the Commission to adopt
specific rules in these areas that are similar to what the CFTC has
proposed for DCOs--specifically with respect to proposed Rule
39.12(b)(7).\81\
---------------------------------------------------------------------------

    \80\ See MFA (Kaswell) Letter at 8-9; SDMA (June) Letter at 19;
Barnard Letter at 2.
    \81\ See MFA (Kaswell) Letter at 8-9; SDMA (June) Letter at 19
(citing proposed rule 39.12(b)(7) from the CFTC's Requirements for
Processing, Clearing and Transfer of Customer Positions, 76 FR 13101
(Mar. 10, 2011) which would require ``each derivatives clearing
organization to coordinate with each swap execution facility and
designated contract market that lists for trading a product that is
cleared by the derivatives clearing organization, in developing
rules and procedures to facilitate prompt and efficient processing
of all contracts, agreements, and transactions submitted to the
derivatives clearing organization for clearing.''). The CFTC
reserved this rule section in its DCO Release but has not yet
adopted the proposed rule as a final requirement.
---------------------------------------------------------------------------

    Three commenters expressed a preference for principles-based rather
than prescriptive rules.\82\ One commenter expressed its belief that
the CFTC's proposals for DCOs are overly prescriptive and should be
eschewed in favor of case-by-case review of a clearing organizations'
proposed rule changes.\83\ The commenter added that less prescriptive
rules will be easier to reconcile between the two regulatory
agencies.\84\
---------------------------------------------------------------------------

    \82\ See CME Letter at 3; The DTCC (April) Letter at 6; The OCC
Letter at 2.
    \83\ See The OCC Letter at 2.
    \84\ See id.
---------------------------------------------------------------------------

    One commenter strongly encouraged the Commission to avoid final
action on its proposed rules before it has clarity on what
clearinghouse regulations are ultimately adopted by European and United
Kingdom regulators and what approaches to regulation are embraced by
the final FMI Report.\85\ The commenter argued that this approach would
allow the Commission to adopt rules that would not unknowingly force
market activity into other jurisdictions by virtue of associated
regulatory costs.\86\
---------------------------------------------------------------------------

    \85\ See The OCC Letter at 3.
    \86\ See id.
---------------------------------------------------------------------------

b. Commission Response
    We recognize that both domestic and foreign regulators may be
undertaking similar regulatory initiatives with respect to risk
management and operation of clearing agencies. We believe that adopting
Rule 17Ad-22 now, largely in the form proposed, and the phased
implementation schedule set forth above \87\ will ensure that the
Commission's rulemaking for clearing agencies will be coordinated with
equivalent processes being undertaken by the CFTC and the Federal
Reserve in the United States and foreign regulators. As discussed
above, the CPSS-IOSCO Recommendations served as the benchmark for the
operations of the CCPs and CSDs around the world since the publication
of the RSSS in 2001 and the RCCP in 2004, respectively. In addition,
the CFTC and Federal Reserve have also considered the CPSS-IOSCO
Recommendations in their rulemaking efforts with respect to the
clearance and settlement process. Consequently, the final rules that
the CFTC recently adopted to govern the activities of a DCO \88\ and
the rules proposed by the Federal Reserve for certain CCPs and CSDs
\89\ each borrow from the principles in the CPSS-IOSCO Recommendations
and reflect requirements that we believe are consistent with the
minimum requirements for registered clearing agencies that the
Commission is adopting in Rule 17Ad-22. Because Rule 17Ad-22 will
generally codify existing practices that similarly reflect the CPSS-
IOSCO Recommendations, the Commission does not believe it will conflict
with regulatory requirements that are being implemented by other
regulators or in other jurisdictions.
---------------------------------------------------------------------------

    \87\ See supra Section II.B.
    \88\ See Derivatives Clearing Organization General Provisions
and Core Principles, supra note 38.
    \89\ See Financial Market Utilities, supra note 25.
---------------------------------------------------------------------------

4. Appropriate Distinctions Between Clearing Agencies
a. Comments Received
    In the Proposing Release, the Commission identified certain
services in the area of post-trade securities processing that may be
captured by the definition of a clearing agency in the Exchange Act.
Two commenters generally supported the distinctions the Commission
proposed for rules that should apply to all types of clearing agencies
versus those that should apply only to CCPs.\90\ Several commenters
argued that entities that perform certain post-trade processing
services (i.e., comparison of trade data, collateral management and
tear-up/compression) are not performing services that fall within the
definition of a clearing agency under the Exchange Act and consequently
entities that perform these services should not be required to register
as a clearing agency or comply with Rule 17Ad-22.\91\
---------------------------------------------------------------------------

    \90\ See TriOptima Letter at 5; ICE Letter at 2.
    \91\ See generally TriOptima Letter; Markit (April) Letter;
Markit (July) Letter; MarkitSERV (April) Letter; MarkitSERV (July)
Letter; Omgeo Letter.
---------------------------------------------------------------------------

b. Commission Response
    We are not persuaded by commenters who suggested that post-trade
processing services should be automatically excluded from the
definition of a clearing agency in the Exchange Act.\92\ We believe
that view is inconsistent with the plain meaning of the clearing agency
definition because the definition of clearing agency in

Section 3(a)(23)(A) of the Exchange Act covers any person who acts as
an intermediary in making payments or deliveries or both in connection
with transactions in securities and provides facilities for the
comparison of data regarding the terms of settlement of securities
transactions, to reduce the number of settlements of securities
transactions, or for the allocation of securities settlement
responsibilities.\93\ That view also is inconsistent with prior
interpretive guidance from the Commission addressing the broader
spectrum of activities that are associated with that term.\94\ The
determination of whether particular activities meet the definition of a
clearing agency depends on the totality of the facts and circumstances
involved.\95\
---------------------------------------------------------------------------

    \92\ See supra note 91 and accompanying text.
    \93\ See supra note 36.
    \94\ See Confirmation and Affirmation of Securities Trades;
Matching, Exchange Act Release No. 34-39829 (Apr. 6, 1998), 63 FR
17943 (Apr. 13, 1998) (noting that ``[t]he Commission is of the view
that matching constitutes a clearing agency function within the
meaning of the clearing agency definition under Section 3(a)(23) of
the Exchange Act. Specifically, matching constitutes `comparison of
data respecting the terms of settlement of securities
transactions.''').
    \95\ See, e.g., supra note 1, at 91 (the Senate Committee on
Banking, Housing and Urban affairs acknowledging that through the
intended breadth of the clearing agency definition the Commission
even retains authority ``to negate, by rule, exclusions in this
category in order to assure the prompt and accurate clearance and
settlement of securities transactions or to prevent evasions of the
Exchange Act'').
---------------------------------------------------------------------------

    On July 1, 2011, the Commission published a conditional, temporary
exemption from clearing agency registration for entities that perform
certain post-trade processing services for security-based swap
transactions.\96\ The order facilitated the Commission's identification
of entities that operate in that area and that accordingly may fall
within the clearing agency definition. Several entities complied with
the conditions of that order and remain exempt from clearing agency
registration under its terms.\97\ By allowing potential clearing agency
registrants to elect temporary, conditional exemption from
registration, the order has given the Commission more time to consider
whether these entities meet the clearing agency definition and, if
registration is required, to consider what form of regulation may be
most appropriate for those services.
---------------------------------------------------------------------------

    \96\ See, e.g., Exchange Act Release No. 34-64796 (July 1,
2011), 76 FR 39963 (July 7, 2011) (providing an exemption from
registration under Section 17A(b) of the Exchange Act, and stating
that ``[t]he Commission is using its authority under section 36 of
the Exchange Act to provide a conditional temporary exemption [from
clearing agency registration], until the compliance date for the
final rules relating to registration of clearing agencies that clear
security-based swaps pursuant to sections 71A(i) and (j) of the
Exchange Act, from the registration requirement in Section 17A(b)(1)
of the Exchange Act to any clearing agency that may be required to
register with the Commission solely as a result of providing
Collateral Management Services, Trade Matching Services, Tear Up and
Compression Services, and/or substantially similar services for
security-based swaps'').
    \97\ The Commission notes further that its adoption of Rule
17Ad-22 does not have any effect on the Commission's order granting
a conditional temporary exemption from clearing agency registration
for entities that perform certain post-trade processing services for
security-based swap transactions. See supra note 96 and accompanying
text. The temporary exemption is conditioned on these entities
providing the Commission with identifying information and a detailed
description of the types of services they provide. Section 17A(g) of
the Exchange Act contains a registration requirement for security-
based swaps clearing agencies. Section 17A(j) of the Exchange Act
requires the Commission to adopt rules governing persons that are
registered as clearing agencies for security-based swaps under the
Exchange Act, and Section 17A(i) requires security-based swaps
clearing agencies to comply with such standards as the Commission
may establish by rule as a condition to being registered or
maintaining registration. As the Commission previously indicated
with respect to the effective date for Section 17A(g), if a Title
VII provision requires a rulemaking, such provision will not go into
effect ``not less than'' 60 days after publication of the final
related rule. 76 FR 36287, 36302 (June 22, 2011). The Commission has
not adopted any rules applicable to clearing agencies that perform
services; therefore, the registration requirement of Section 17A(g)
will not be applicable to such clearing agencies until the date when
rules with respect to such clearing agencies are adopted pursuant to
Section 17A(i).
---------------------------------------------------------------------------

    The Commission preliminarily agrees with commenters that it is
appropriate to consider a tailored framework of regulation for clearing
agencies that perform certain post-trade processing services because
such activities do not involve the same credit, market and operational
risk concerns that are presented by clearing agencies that perform CCP
or CSD services.\98\ Accordingly, the Commission intends to separately
address clearing agencies that perform only post-trade processing
services. The Commission has previously distinguished entities that
provide certain post-trade services and fall within the definition of
clearing agency from those entities that provide services more commonly
associated with the functions of a clearing agency (e.g., CCP and CSD
services).\99\ As part of its future rulemaking regarding these types
of clearing agencies, the Commission may consider whether to apply the
future rules to clearing agencies engaged in activities that were
separately identified by Congress as PCS Activities in the Clearing
Supervision Act. In particular, the Clearing Supervision Act identifies
the following as PCS Activities:
---------------------------------------------------------------------------

    \98\ See supra notes 90-91 and accompanying text.
    \99\ See, e.g., Exchange Act Order No. 34-44188 (Apr. 17, 2001)
(providing an exemption from registration as a clearing agency to a
subsidiary of Omgeo conducting electronic trade confirmation and
matching services).
---------------------------------------------------------------------------

    (1) Calculation and communication of unsettled financial
transactions between counterparties;
    (2) netting of transactions;
    (3) provision and maintenance of trade, contract, or instrument
information;
    (4) management of risks and activities associated with continuing
financial transactions;
    (5) transmittal and storage of payment instructions;
    (6) movement of funds;
    (7) final settlement of financial transactions; and
    (8) other similar functions that the Council may determine.\100\
---------------------------------------------------------------------------

    \100\ 12 U.S.C. 5462(7).
---------------------------------------------------------------------------

    Accordingly, at this time, the Commission does not intend for Rule
17Ad-22 to apply to clearing agencies that perform post-trade
processing services. The scope of Rule 17Ad-22 will be limited to
clearing agencies that are registered with the Commission and the rule
will not apply to any clearing agencies operating pursuant to an
exemption from registration as a clearing agency granted by the
Commission, unless the terms of future exemptions specifically
contemplate its application, in whole or in part. The Commission has
clarified this as part of the final Rule 17Ad-22 adopted today by
adding the word ``registered'' before the term ``clearing agency''
appearing in the first instance in paragraphs (b), (c)(1), (c)(2), and
(d). For this reason, references to the term ``clearing agency'' in
this release are generally intended to capture only registered clearing
agencies, unless the context suggests otherwise. The Commission may
consider at a later time whether rules tailored to clearing agencies
that provide post-trade processing services would be appropriate.

III. Description of Rule 17Ad-22

A. Overview and Scope

    The Commission is adopting Rule 17Ad-22 with minor modifications
from the proposal to implement the statutory provisions for clearing
agencies under the Exchange Act. Rule 17Ad-22 requires registered
clearing agencies to establish, implement, maintain and enforce written
policies and procedures that are reasonably designed to meet certain
minimum requirements for their operations and risk management practices
on an ongoing basis. These minimum requirements will work in tandem
with the requirements in

Section 17A that the Commission must make certain determinations
regarding a clearing agency's rules.
    The Commission anticipates that the clearing agency's rules and
procedures will likely continue to evolve so that the clearing agency
can adequately respond to changes in technology, legal requirements,
trading volume, trading practices, linkages between financial markets
and the financial instruments traded in the markets that a clearing
agency serves. Accordingly, registered clearing agencies must evaluate
continually and make appropriate updates and improvements to their
operations and risk management practices to facilitate the prompt and
accurate clearance and settlement of securities transactions and to
safeguard securities and funds in their custody or control.
    Rule 17Ad-22 consists of the following parts: (1) Rule 17Ad-22(a)
provides definitions for certain terms; (2) Rule 17Ad-22(b) contains
risk management and participation requirements for registered CCPs; (3)
Rule 17Ad-22(c) establishes a reporting requirement for registered
clearing agencies with respect to certain matters including financial
resources and methodologies used to calculate financial requirements;
and (4) Rule 17Ad-22(d) requires registered clearing agencies, as
applicable, to meet certain minimum standards.
    As noted above, at this time, the Commission intends for Rule 17Ad-
22 to apply only to registered clearing agencies. The Commission may
consider at a later time whether any additional rules tailored to
clearing agencies that perform post-trade processing services would be
appropriate. In addition, Rule 17Ad-22 will not apply to any clearing
agencies operating pursuant to an exemption from registration as a
clearing agency granted by the Commission unless the terms of future
exemptions specifically contemplate its application, in whole or in
part.

B. Definitions--Rule 17Ad-22(a)

1. Proposed Rule
    Proposed Rule 17Ad-22(a) contains five definitions. Proposed Rule
17Ad-22(a)(1) would define ``central counterparty'' as a clearing
agency that interposes itself between counterparties to securities
transactions to act functionally as the buyer to every seller and as
the seller to every buyer. Proposed Rule 17Ad-22(a)(2) would define
``central securities depository services'' to mean services of a
clearing agency that is a securities depository as described in Section
3(a)(23) of the Exchange Act.\101\ Proposed Rule 17Ad-22(a)(3) would
define ``participant,'' for the limited purposes of Rules 17Ad-22(b)(3)
and 17Ad-22(d)(14), to mean that if a participant controls another
participant, or is under common control with another participant, then
the affiliated participants shall be collectively deemed to be a single
participant. Proposed Rule 17Ad-22(a)(4) would define ``normal market
conditions,'' for the limited purposes of Rules 17Ad-22(b)(1) and (2),
to mean conditions in which the expected movement of the price of
cleared securities would produce changes in a clearing agency's
exposures to its participants that would be expected to breach margin
requirements or other risk control mechanisms only one percent of the
time.\102\ Proposed Rule 17Ad-22(a)(5) would define ``net capital,''
for the limited purpose of Rule 17Ad-22(b)(7), to have the same meaning
as set forth in Rule 15c3-1 under the Exchange Act for broker-dealers
or any similar risk adjusted capital calculation for all other
prospective clearing members.\103\
---------------------------------------------------------------------------

    \101\ See supra note 36 and accompanying text.
    \102\ The definition of normal market conditions in Rule 17Ad-
22(a)(4) is consistent with the corresponding explanation
established in the CPSS-IOSCO Recommendations. See RCCP, supra note
33, at 21 (explanatory note number 1).
    \103\ As appropriate, the clearing agency may develop risk-
adjusted capital calculations for prospective clearing members that
are not broker-dealers.
---------------------------------------------------------------------------

2. Comments Received
    Commenters generally supported proposed Rule 17Ad-22(a)(3) because
it would require a clearing agency to take account of an entire group
of affiliated entities when complying with the financial resources
requirements of proposed Rule 17Ad-22(b)(3), as well as the
requirements in proposed Rule 17Ad-22(d)(14) for risk controls to
address participants' failures to settle.\104\ However, one commenter
recommended that the rule employ the phrase ``participant family''
because ``participant'' on its own may be easily confused with other
uses of that term in the Exchange Act and in the rules and regulations
thereunder.\105\ Accordingly, the commenter suggested that
``participant family'' should be defined to mean each participant that
controls, is controlled by or is under common control with another
participant.\106\ The commenter recommended that the standard of
control for this purpose should be defined as the disclosed ownership
of 50% or more of the voting securities or other interests in a
participant and that it should be based on information available to the
clearing agency.\107\
---------------------------------------------------------------------------

    \104\ See The DTCC (April) Letter at 9-10.
    \105\ See id.
    \106\ See The DTCC (April) Letter at 10.
    \107\ See id.
---------------------------------------------------------------------------

    One commenter expressed concern about the definition of ``normal
market conditions'' as conditions in which the expected movement of the
price of cleared securities would produce changes in a clearing
agency's exposures to its participants that would be expected to breach
margin requirements or other risk control mechanisms only one percent
of the time.\108\ The commenter argued that it would be unusual to
define normal market conditions this way (i.e., using margin
requirements as a standard of measure) because margin models are
designed to adjust during periods of market turbulence.\109\
---------------------------------------------------------------------------

    \108\ See The OCC Letter at 7.
    \109\ See id.
---------------------------------------------------------------------------

    The Commission received no comments on proposed Rules 17Ad-
22(a)(1), (2) and (5).
3. Final Rule
    As described more fully below, the Commission is adopting Rules
17Ad-22(a)(1), (2), (4) and (5) as proposed. We are also adopting Rule
17Ad-22(a)(3) with certain modifications to address concerns of
commenters.
    We agree with commenters who suggested that in the interest of
clarity and to avoid confusion with use of the term ``participant''
elsewhere in Exchange Act regulations, Rule 17Ad-22(a)(3) should be
modified so that the term defined by the rule is ``participant family''
instead of ``participant.'' We are also modifying Rule 17Ad-22(a)(3)
with respect to the language that describes the test for determining
when a sufficient relationship of control exists between participants
to qualify them as a ``participant family.'' The definition has been
expanded to include entities controlled by a participant and to cover
direct and indirect relationships. Accordingly, Rule 17Ad-22(a)(3) now
provides that participants will be deemed to be a ``participant
family'' for purposes of Rules 17Ad-22(b)(3) and 17Ad-22(d)(14) when
``a participant directly, or indirectly through one or more
intermediaries, controls, is controlled by, or is under common control
with, another participant.'' This modification is intended to respond
to the recommendation of commenters and more closely conform the text
of Rule 17Ad-22(a)(3) to the language in which this standard appears in
other contexts within the U.S. federal securities

laws.\110\ At the same time, we are not narrowing the definition of
control in this context to mean ownership of 50% or more of the voting
securities or other interests in a participant.\111\ We believe the
more appropriate evaluation of control is based on the relationship
between the entities and the power, directly or indirectly, to direct
the management or policies of a company, whether through ownership of
securities, by contract, or otherwise. In conducting this evaluation,
clearing agencies should also be guided by the definition of
``control'' set forth in Rule 405 under the Securities Act of 1933,
using the information available to them.
---------------------------------------------------------------------------

    \110\ See, e.g., 17 CFR 230.405 (using ``controls or is
controlled by, or is under common control with'' in the definition
of affiliate found in Rule 405 under the Securities Act of 1933).
    \111\ See supra note 107 and accompanying text.
---------------------------------------------------------------------------

    The Commission agrees with the commenter that well-designed margin
models include factors that adjust to periods of market turbulence. The
Commission, however, is not persuaded by the argument that the
definition of normal market conditions in Rule 17Ad-22(a)(4) is at odds
with the concept of certain periods of market turbulence.\112\ The rule
defines ``normal market conditions'' as those that prevail 99 trading
days out of 100. Margin models and other risk control mechanisms
designed to adjust during periods of market turbulence are consistent
with the definitional standard to the extent they help to reduce the
number of trading days during which a clearing agency's exposure to
participants are not fully covered by such measures.
---------------------------------------------------------------------------

    \112\ The Commission notes that the definition of normal market
conditions found in Rule 17Ad-22(a) is modeled on the current
international standard for determining normal market conditions in
the CPSS-IOSCO Recommendations.
---------------------------------------------------------------------------

    The definition of ``normal market conditions'' in Rule 17Ad-
22(a)(4) is also modeled on relevant and analogous international
standards. The RCCP stipulates that a CCP should limit its exposures to
potential losses from defaults by its participants in normal market
conditions and defines ``normal market conditions'' as price movements
that produce changes in exposures that are expected to breach margin
requirements or other risk controls only 1% of the time.\113\ The
standard also comports with the international standard for bank capital
requirements established by the Bank for International Settlements,
which requires banks to measure market risks at a 99% confidence
interval when determining regulatory capital requirements.\114\
---------------------------------------------------------------------------

    \113\ See Bank for International Settlements' Committee on
Payment and Settlement Systems and Technical Committee of the
International Organization of Securities Commissions,
Recommendations for Central Counterparties (Nov. 2004), at 18-21,
available at http://www.bis.org/publ/cpss64.pdf.
    \114\ See infra Section V.B.2 (discussion on current industry
practices).
---------------------------------------------------------------------------

C. Risk Management Requirements for Central Counterparties: Rules 17Ad-
22(b)(1)-(4)

    Rules 17Ad-22(b)(1)-(4) contain several requirements that address
risk management practices by registered CCPs. Specifically, the
proposed rules would create standards with respect to: (1) Measurement
and management of credit exposures; (2) margin requirements; (3)
financial resources; and (4) annual evaluations of the performance of
the clearing agency's margin models.
    During the comment period, commenters pointed out that to properly
frame these requirements requires a great deal of technical expertise
and that a failure to properly allow that expertise to influence final
rules adopted by the Commission could result in inefficient
requirements that lack the proper degree of flexibility to achieve
prudent risk management practices without being overly burdensome. In
some cases, commenters argued that personnel at the clearing agencies
possess the requisite levels of experience and expertise to help the
Commission shape CCP risk management standards.\115\
---------------------------------------------------------------------------

    \115\ See The DTCC (April) Letter at 18-20; The OCC Letter at
12; LCH Letter at 3-4.
---------------------------------------------------------------------------

    As an initial matter, the Commission believes that Rules 17Ad-
22(b)(1)-(4) are appropriate minimum standards for registered CCPs and
that they are consistent with existing international standards of
practice. However, we agree that the process of evaluating, testing and
refining CCP risk management standards will be ongoing and necessarily
include an open dialogue among the CCPs, investors, the Commission and
various other interested parties. In particular, the Commission will
carefully consider further input from interested parties obtained
through outreach to various constituencies and in response to any rules
or rule amendments that may be proposed by the Commission upon
considering the international standards developed by CPSS-IOSCO in the
FMI Report.
    Further, Rules 17Ad-22(b)(1), (2), and (3) establish targets for
clearing agencies to meet without prescribing a particular method.
Accordingly, the rules provide clearing agencies with the flexibility
to establish risk management procedures (e.g., back testing, stress
testing, model validation procedures and the composition of financial
resources) that are appropriately tailored to current market conditions
and can be revised over time to address changes in market conditions.
Given the existing use and general understanding by U.S. CCPs and CCPs
and regulatory authorities around the world of the RCCP and the
principles that form the basis of Rules 17Ad-22(b)(1), (2) and (3), the
Commission is adopting these rules largely as proposed.
1. Rule 17Ad-22(b)(1): Measurement and Management of Credit Exposures
a. Proposed Rule
    Proposed Rule 17Ad-22(b)(1), as proposed, would require a CCP to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to measure its credit exposures to its
participants at least once each day, and limit its exposures to
potential losses from defaults by its participants under normal market
conditions \116\ so that the operations of the CCP will not be
disrupted and non-defaulting participants will not be exposed to losses
that they cannot anticipate or control.
---------------------------------------------------------------------------

    \116\ See supra note 102 and accompanying text.
---------------------------------------------------------------------------

b. Comments Received
    Three commenters urged the Commission to consider adopting a more
prescriptive version of the rule.\117\ Of this group, one suggested
that the rule should permit a CCP to use correlated positions to reduce
initial margin requirements only if the CCP can demonstrate a robust
correlation between those positions under stressed market conditions
and the CCP publicly discloses its methodology periodically for
determining the correlation and the CCP's resulting margin
requirements.\118\ Another commenter suggested that a CCP should be
required to measure credit exposures several times each business day
and to recalculate initial and variation margin for each clearing
member and the clearing member's clients more than once each day.\119\
The third commenter stated that Rule 17Ad-22(b)(1) should also require
the CCP to perform intraday calculations of credit risk exposure when
circumstances warrant, including situations where the security-based
swap is illiquid, difficult to price, or highly volatile.\120\
---------------------------------------------------------------------------

    \117\ See ISDA Letter at 7; LCH Letter at 2; Better Markets
Letter at 5.
    \118\ See ISDA Letter at 7.
    \119\ See LCH Letter at 2.
    \120\ See Better Markets Letter at 5.

---------------------------------------------------------------------------

c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(1) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies. We
agree with commenters that the risks CCPs face are subject to change
over time due to the potential for significant changes in the risk
profiles of participants and if those risks are not appropriately
measured and managed by the CCP, they can result in the accrual of
significant liabilities.\121\ The Commission believes that measuring
credit exposures once each day is the minimum frequency of measurement
that will permit a clearing agency to consider effectively the credit
exposures it faces.
---------------------------------------------------------------------------

    \121\ See supra notes 119-120 (citing the Better Markets Letter
and LCH Letter).
---------------------------------------------------------------------------

    The Commission agrees with commenters that clearing agencies may
need to measure credit exposures more frequently than once each day in
order to ensure that the CCP can facilitate the prompt and accurate
clearance and settlement of securities transactions and ensure that
they operate safely and efficiently. That point of view is reflected in
the rule requirement that the measurement must be performed at least
once each day. However, the Commission believes that a less
prescriptive and more flexible rule sets a more appropriate baseline
standard. Each CCP is exposed to participants in different markets
characterized by different trading patterns, volumes, liquidity,
transparency and other unique market characteristics. Rather than
prescribing a specific frequency for risk exposure measurements (other
than the once daily minimum), the Commission believes that CCPs should
monitor exposure and margin coverage on an intraday basis depending on
the individual risk characteristics of their members and businesses,
and adjust their risk management processes as needed. This stance is
also consistent with our understanding that the practice at many CCPs
is to measure credit exposures more than once daily.\122\
---------------------------------------------------------------------------

    \122\ See id.
---------------------------------------------------------------------------

    While the Commission also agrees with commenters who expressed the
view that a CCP should provide reductions in initial margin
requirements based on offsetting or inversely correlated positions only
if the CCP can demonstrate a robust correlation between those
positions--including under stressed market conditions,\123\ the rule is
being adopted as proposed. The Commission believes that the
determination of whether positions are sufficiently correlated to
warrant offsets or whether reductions should be provided at all, is a
matter that should be determined by the CCP as it implements its risk
management procedures, and submitted to the Commission for review and
public comment, as part of the Section 19b-4 rule filing process. The
Commission believes that the rule should allow each CCP the flexibility
to set margin requirements based on the unique products and markets
that it serves. Margin requirements will vary based on a number of
factors, including, but not limited to, the type, volume, and
volatility of the instruments cleared. It is difficult to make
determinations at the rule level regarding the suitability of margin
reductions based on adequate position correlations; therefore, the
Commission believes it is more appropriate to conduct such
methodological evaluations during the supervisory process.
---------------------------------------------------------------------------

    \123\ See supra note 118 and accompanying text.
---------------------------------------------------------------------------

    As adopted, Rule 17Ad-22(b)(1) does not require that a registered
CCP publicly disclose its correlation methodology and related margin
requirements.\124\ Correlation methodology is generally considered
confidential by clearing agencies because it is a critical element in
determining their margin requirements. While CCPs generally provide
this type of information to their participants, it typically is not
made public. In this connection, we are adopting Rule 17Ad-22(d)(9),
discussed below, which requires each registered CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide market participants with sufficient
information to enable them to identify and evaluate the risks and costs
associated with using its services. Rule 17Ad-22(d)(9) is intended in
part to promote appropriate levels of transparency concerning a CCP's
margin practices while allowing registered clearing agencies to tailor
disclosure in a way that preserves incentives for business model
innovations and responsible competition among clearing agencies.
---------------------------------------------------------------------------

    \124\ See The OCC Letter at 17; The DTCC (April) Letter at 7.
---------------------------------------------------------------------------

    We are also adopting Rule 17Ad-22(b)(1), as it was proposed, to
require registered CCPs to establish, implement, maintain, and enforce
written policies and procedures reasonably designed to limit their
exposures to potential losses from participant defaults. By collecting
sufficient margin and having other liquid resources at its disposal,
the Commission expects that a clearing agency will be able to limit its
exposures to potential losses from defaults by clearing members in
normal market conditions.\125\
---------------------------------------------------------------------------

    \125\ See supra note 102 and accompanying text.
---------------------------------------------------------------------------

2. Rule 17Ad-22(b)(2): Margin Requirements
a. Proposed Rule
    Proposed Rule 17Ad-22(b)(2) would require a CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to: (i) Use margin requirements to limit its credit
exposures to participants under normal market conditions; \126\ (ii)
use risk-based models to set margin requirements; and (iii) review the
models at least monthly.
---------------------------------------------------------------------------

    \126\ See id.
---------------------------------------------------------------------------

b. Comments Received
    One commenter recommended that the rule be amended to require that
the CCP's margin requirements must be sufficient to limit credit
exposures to both the CCP's participants and the clients of the CCP's
participants.\127\ Another commenter supported standardization of the
way CCPs set margin requirements and stated that the final rule should
require those clearing agencies to make their margin-setting
methodology available to customers.\128\ The commenter argued that this
disclosure would enable market participants to reasonably anticipate
when additional margin may be required and would consequently promote
stable liquidity in the marketplace.\129\
---------------------------------------------------------------------------

    \127\ See LCH Letter at 2.
    \128\ See MFA (Kaswell) Letter at 2.
    \129\ See id. (noting that if the Commission requires the
creation of these transparent conditions with respect to margin in
its final rules, then the commenter would fully support the ability
of clearing agencies to have flexibility to modify margin
requirements as necessary, including by imposing special margin
requirements or requiring intraday posting of margin).
---------------------------------------------------------------------------

    In response to a question asked by the Commission in the Proposing
Release, one commenter stated that adopting Rule 17Ad-22(b)(2) as
proposed is unlikely to create the risk that CCPs will lower margin
standards to compete for business.\130\ The commenter asserted that
integrity in risk management is the primary focus of CCPs, and that a
CCP would suffer severe reputational harm if it risked using guaranty
fund resources to cover margin deficiencies of clearing members.\131\
In addition, according to the commenter, CCPs do not alter margin
requirements based on the

identity of the individual counterparty.\132\
---------------------------------------------------------------------------

    \130\ See id.
    \131\ See id.
    \132\ See MFA (Kaswell) Letter at 2-3.
---------------------------------------------------------------------------

    One commenter contended that certain aspects of a CCP's margin
methodology, such as choice of confidence levels (used to estimate
expected shortfall), the number of days' data relied on, and the
various weights used to determine stress test charges do not need to be
reviewed on a monthly basis.\133\ If the final rule does require a
monthly review, the commenter suggested that the Commission should make
clear that CCPs have substantial discretion to determine which aspects
of the model are appropriate for the monthly review.\134\ In contrast,
another commenter asked the Commission to consider a more prescriptive
approach to the rule. It suggested that Rule 17Ad-22(b)(2) should be
modified to require a clearing agency to use two to three years of
historical price data when establishing normal market conditions,
consider liquidity and the amount of time necessary to replace a
position once a default occurs, and make a showing of significant and
reliable correlation of price risks before it is allowed to net initial
margin using long and short positions.\135\
---------------------------------------------------------------------------

    \133\ See The OCC Letter at 7.
    \134\ See id.
    \135\ See Better Markets Letter at 3-4.
---------------------------------------------------------------------------

    One commenter focused more narrowly on the appropriate confidence
level that should be applied to initial margin collected by a clearing
agency.\136\ The commenter argued that setting the appropriate
confidence level is directly tied to the degree of mutualization
performed by a clearing agency (i.e., the lesser the degree of
mutualization the higher the appropriate confidence level because the
amount of funds available to manage a default will be reduced).\137\
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    \136\ See ISDA Letter at 7.
    \137\ See id. (stating, for example, that if the clearing agency
performs mutualization in its default fund and for clients in
omnibus client accounts then a 99% confidence level is completely
appropriate. By contrast, if the clearing agency imposes a
requirement for individualized client accounts instead of an omnibus
account, then the commenter believes that a confidence level greater
than 99% is likely appropriate).
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c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(2) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies. This
requirement recognizes that the collection of assets (e.g., cash or
securities) from participants provides the clearing agency with assets
to limit its exposure to a participant in the event of a participant
default. By limiting its credit exposure in this manner, a CCP is less
likely to be subject to disruptions in its operations as a result of a
participant default, thereby facilitating the prompt and accurate
clearance and settlement of securities transactions.
    The Commission does not believe it is necessary to amend the rule
to state that a registered CCP's margin requirements must limit credit
exposures to customers of participants as well as participants.\138\
Margin requirements applicable to a customer's securities positions are
established in accordance with regulations specifically governing
customer margin practices \139\ and in some cases through additional
margin requirements imposed by the participant to address its credit
risk to the customer. As a result, even when a participant is
transacting on the behalf of a customer, the CCP enters into a
transaction only with the participant, and therefore it is the
participant's creditworthiness that the clearing agency's margin
requirements must adequately address.
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    \138\ See supra note 127 and accompanying text.
    \139\ See, e.g., 17 CFR 240.15c3-3 (Customer protection--
reserves and custody of securities and Regulation T, 12 CFR 220).
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    The Commission is aware that some CCPs may already have the ability
to measure credit exposures to customers of participants as well as to
participants. To the extent that such margin practices are already in
place or develop over time to help ensure prompt and accurate clearance
and settlement in the market the clearing agency serves, we believe
those practices can be effective in limiting aggregate credit exposures
of clearing agencies. We agree that the ability to limit credit
exposures to customers of participants using margin may help inform and
shape appropriate credit risk management practices in certain cases--
for example, where (i) direct access to a clearing agency by some
participants may be relatively more constrained by the operational or
financial demands commensurate with participation; (ii) open interest
periods associated with the instruments cleared by the clearing agency
are relatively significant; or (iii) customer margin requirements are
established independently from the CCP (e.g., pursuant to regulation or
by agreement with a participant). However, we believe that, at this
time, individual CCPs should develop rules and procedures to address
these specific circumstances consistent with their general
responsibilities as clearing agencies under the Exchange Act and that
rules of this kind would be subject to the rule filing procedures of
Section 19b-4.
    The Commission is not amending Rule 17Ad-22(b)(2) to specify which
aspects or components of the CCP's risk-based models must be reviewed
in the context of the CCP's monthly review.\140\ The Commission
recognizes that some assumptions that underlie model parameters may be
widely accepted by current convention, and those components therefore
may be less likely to become outdated from month to month. On the other
hand, the Commission notes that market conditions and risks are
constantly changing and CCPs will need to exercise discretion in how
they administer their review of those components.
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    \140\ See supra note 134 and accompanying text.
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    The Commission notes that, to the extent a CCP believes that an
assumption in a model or parameter does not lend itself to empirical
testing, a review of that assumption can in some cases be accomplished
by the CCP performing a theoretical assessment of that assumption
compared to alternative assumptions. For example, a CCP may evaluate
the appropriateness of the number of days of market data used in its
margin model or the expected amount of time needed to liquidate a
security in an event of default by comparing the performance of the
margin model when a range of representative values is input.
    Also consistent with the intent of preserving appropriate
flexibility for clearing agencies to tailor their methods of achieving
compliance, the Commission is not prescribing a particular confidence
level for initial margin in Rule 17Ad-22(b)(2).\141\ Rather, subject to
Commission oversight, Rule 17Ad-22(b)(2) allows a confidence level
determination to be made by the clearing agency as part of the
development of its margin parameters and risk-based models. In arriving
at an appropriate confidence level, we agree with commenters that the
extent of mutualization of financial resources performed by a CCP in
its risk management practices and the particular use of individualized
client accounts or an omnibus account structure are appropriate factors
to consider.\142\ The Commission also chose not to stipulate specific
requirements pertaining to the scope of historical price data,
liquidity and replacement considerations, and the correlation of price
risks used in calculating margin requirements, again opting for a more
flexible standard. While a clearing

agency may take such factors into consideration when determining margin
requirements, each registered CCP should be free to develop the best
margin methodology to accommodate its unique products and markets.
Accordingly, the Commission believes that it should not attempt to
prescribe the appropriate margin methodologies for each CCP or
financial instrument.\143\
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    \141\ See supra note 136 and accompanying text.
    \142\ See supra note 137 and accompanying text.
    \143\ See Section 17A discussion supra Section I.A.2 and
accompanying text.
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    We agree with commenters who asserted that a CCP's disclosure of
its margin-setting methodology to customers facilitates prompt and
accurate clearance and settlement by enabling market participants to
better plan for margin costs associated with the use of the clearing
agency.\144\ As noted above, registered CCPs must submit their risk
management procedures, including margin methodology, to the Commission
for review and public comment as a proposed rule change under Rule 19b-
4. The Rule 19b-4 process provides for public disclosure, as well as an
opportunity for interested parties to comment on the proposed rule
change. In addition, the Commission believes that any reasonable
process for implementing risk management practices will involve
further, more detailed communication with clearing members and their
customers regarding the particular expected results of the practices in
identified circumstances. Such communication may involve both direct
contacts with members and their customers or indirect contacts through
general information published by the CCP on its Web site or in other
generally available resources.
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    \144\ See supra note 59.
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3. Rule 17Ad-22(b)(3): Financial Resources
a. Proposed Rule
    Proposed Rule 17Ad-22(b)(3) would require a CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to maintain sufficient financial resources to
withstand, at a minimum, a default by the participant to which it has
the largest exposure in extreme but plausible market conditions,
provided that a security-based swap clearing agency would be required
to maintain sufficient financial resources to withstand, at a minimum,
a default by the two participants (also referred to as the ``cover
two'' standard) to which it has the largest exposures in extreme but
plausible market conditions.\145\
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    \145\ See proposed Rule 17Ad-22(a)(3), supra Section III.B.1
(defining ``participant'' for purposes of proposed Rule 17Ad-
22(b)(3)).
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b. Comments Received
    Commenters expressed a wide range of views concerning proposed Rule
17Ad-22(b)(3). Some commenters generally supported the proposed
rule.\146\ Others expressed concern that the introduction of two
different financial resources standards may discourage CCPs from
extending their services to security-based swaps or may discourage
prospective participants from seeking membership in CCPs for security-
based swaps, which would disrupt the goal of the Dodd-Frank Act to
promote central clearing.\147\ One commenter stated its opinion that no
historical or empirical case has been made for changing the way that
CCPs currently measure the sufficiency of their financial resources and
that no cost-benefit analysis has been done on the impact of any such
change on the operations and economics of CCPs.\148\
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    \146\ See Better Markets Letter at 5 (supporting the rule and
stating that it appropriately differentiates between security-based
swap and non security-based swap clearing agencies due to unique
features of the security-based swap markets, such as jump-to-default
risk); see also Barnard Letter at 1 (supporting generally the thrust
of the Commission's proposals in the Proposing Release, particularly
proposed Rule 17Ad-22 concerning standards for clearing agencies);
BlackRock Letter at 2 (supporting Rules 17Ad-22(b)(1)-(7) because
these rules will benefit the markets by reducing concentration risk,
increasing the diversity of market participants involved in
governance, enhancing competition and lowering costs for customers
of clearing members); MFA (Kaswell) Letter at 2 (generally
supporting the rules proposed under 17Ad-22(b) because they would
establish reasonable, objective, risk-based criteria for fair and
open access).
    \147\ See LCH Letter at 2; The OCC Letter at 9.
    \148\ See The DTCC (April) Letter at 12.
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    A commenter also suggested that CCPs should consider the
simultaneous default of multiple clearing members when sizing their
financial resources but that a simultaneous default of the two largest
clearing members is an extremely implausible occurrence, and
accordingly it is not a scenario that should be embedded as a fixed
requirement in the Commission's rules.\149\ That commenter stated that
it is reasonable to assume a default by the two largest participants
would take place in conditions of heightened market volatility, which
would cause a CCP to collect more financial resources because of the
risk-based nature of margin requirements.\150\
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    \149\ See The OCC Letter at 8.
    \150\ See The OCC Letter at 9.
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    One commenter disagreed with assertions in the Proposing Release
that the performance of CCP services for security-based swaps entails
risks that are unique to those products and that those unique risks
support the proposed ``cover two'' requirement.\151\ The commenter also
stated that accounting for the jump-to-default risk of certain
security-based swap instruments (i.e., credit-default swaps) should be
addressed through calculation of financial resource requirements using
more extreme market scenarios instead of adjusting the number of
participant defaults.\152\ The commenter urged the Commission to
consider how changes taking place to the infrastructure and risk
management practices in the securities markets due to the Dodd-Frank
Act may render irrelevant certain risks that are associated with
security-based swaps today.\153\
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    \151\ See The OCC Letter at 8 (expressing by way of example that
a total return security-based swap on a single underlying security
of a company that has a large market capitalization is a lower risk
management challenge for a clearing agency that performs CCP
services than a put or a call option on the same underlying
security. It expressed a belief that the risk is much the same as a
security future on the same underlying).
    \152\ See id.
    \153\ See id.
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    Commenters supported the position that the Commission's regulatory
standards for CCPs should be modified where appropriate to account for
the relevant work of international standard setters such as the CPSS
and IOSCO.\154\ However, commenters pointed out that a ``cover two''
standard would be inconsistent with the existing CPSS-IOSCO
Recommendations for financial resources.\155\ They also urged the
Commission not to require any CCP to increase its liquidity resources
or otherwise re-engineer its risk management controls unless and until
there is industry and regulatory consensus on the changes that should
be made.\156\ These commenters encouraged the Commission to ensure that
its final rulemakings are aligned with the existing CPSS-IOSCO
Recommendations to the closest extent possible.\157\
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    \154\ See The OCC Letter at 9 (citing CPSS-IOSCO Recommendation
for Central Counterparties, Recommendation 3).
    \155\ See id.
    \156\ See The DTCC (April) Letter at 12.
    \157\ See LCH Letter at 2-3; The OCC Letter at 9.
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    Commenters disagreed over what role the Commission should play in
defining the term ``extreme but plausible market conditions'' as that
term appears in proposed Rule 17Ad-22(b)(3).\158\ One commenter favored
a significant role for

the Commission.\159\ Other commenters agreed that CCPs should be
primarily responsible for determining the parameters of the standard
because of their unique access to market data and understanding of the
range of applicable market conditions.\160\ Those commenters stated
that Rule 17Ad-22(b)(3) should clarify that a CCP is responsible for
determining what constitutes ``extreme but plausible market
conditions.''
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    \158\ See Better Markets Letter at 5-6; The DTCC (April) Letter
at 10.
    \159\ See Better Markets Letter at 5-6 (stressing that the
Commission should provide concrete guidance on the meaning of
``extreme but plausible market conditions'' to prevent lax or self-
serving interpretation of that standard and to promote consistent
practices among clearing agencies that will prevent the adoption of
lower standards designed to reduce costs and attract business volume
at the expense of stability and risk mitigation. The commenter also
expressed that the Commission's definition of the standard should
focus on unprecedented periods of illiquidity, volatility and
interconnectedness that lead to multiple defaults).
    \160\ See The DTCC (April) Letter at 10; The OCC Letter at 10.
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c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(3) with certain
modifications to address concerns raised by commenters, including but
not limited to the clarification discussed in Sections II.B.4 and III.A
regarding the application of the rule only to registered clearing
agencies and clarifications relating to the term ``participant family''
as discussed above.\161\ The Commission believes that requiring a
registered CCP, other than a security-based swap CCP, to maintain
sufficient financial resources to withstand, at a minimum, a default by
the participant family to which it has the largest exposure in extreme
but plausible market conditions, reduces the likelihood that a default
would create losses that disrupt the operations of the CCP and
adversely affect the clearing agency's non-defaulting participants.
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    \161\ See supra note 146 (supporting the rule as proposed); see
also supra section III.B.3 (discussing the term ``participant
family'').
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    While the Commission is sensitive to the consequences of
establishing a different standard for CCPs that clear security-based
swaps, the Commission believes that the financial resources of the
entity must be robust enough to accommodate the risks that are
particular to each market served--irrespective of whether such analysis
results in different standards. The Commission believes that requiring
a security-based swap CCP to cover its two largest potential exposures
is the appropriate standard due to the nature of these products.
Security-based swaps pose unique risk management issues. In particular,
credit default swaps, a subset of security-based swaps, are non-linear
financial instruments subject to additional risk factors such as jump-
to-default risk \162\ and asymmetrical risk allocation between short
and long counterparties. Unlike other products that also exhibit these
characteristics (e.g., Long-Term Equity Anticipation Securities
(LEAPS)), credit default swaps are unique in their size relative to
their underlying markets. Recent research shows that notional
outstandings in credit default swaps are often close to or greater than
the outstanding value of the underlying instruments.\163\ The
traditional procedures for a clearing agency to handle a default may
not be effective and may entail significant risk to a CCP clearing