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

    \711\ Cf. PFMI Report, supra note 1, at 43 (discussing Principle
4, Explanatory Note 3.4.19).
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(4)(vi) and (vii) would also impose
additional costs by requiring additional measures to be taken with
respect to the testing of a covered clearing agency's financial
resources and model validation of a covered clearing agency's credit
risk models. These requirements do not currently exist as part of the
standards applied to registered clearing agencies.\712\ Covered
clearing agencies may incur additional costs under expanded and more
frequent testing of total financial resources if the formal requirement
that results of monthly testing be reported to appropriate decision
makers is a practice not currently used by covered clearing agencies. A
range of costs for these new requirements is discussed in Part
IV.C.3.a.iv(5).
---------------------------------------------------------------------------

    \712\ Rule 17Ad-22(b)(4) requires a registered clearing agency's
policies and procedures be reasonably designed to provide for an
annual validation of its margin models and the related parameters
and assumptions. See 17 CFR 240.17Ad-22(b)(4).
---------------------------------------------------------------------------

    Frequent monitoring and stress testing of total financial
resources, conforming model validations, and reporting of results of
the monitoring and testing to appropriate personnel within the clearing
agency could help rapidly identify any gaps in resources required to
ensure stability, even in scenarios not anticipated on the basis of
historical data. Moreover, the requirement to test and, when necessary,
update the assumptions and parameters supporting models of credit risk
will support the adjustment of covered clearing agency financial
resources to changing financial conditions, and mitigate the risk that
covered clearing agencies will strategically manage updates to their
risk models in support of cost reduction or profit maximization.
(2) Proposed Rule 17Ad-22(e)(5): Collateral
    Proposed Rule 17Ad-22(e)(5) would require a covered clearing agency
to have policies and procedures reasonably designed to limit the assets
it accepts as collateral to those with low credit, liquidity, and
market risks, and to set and enforce appropriately conservative
haircuts and concentration limits. Collateral haircut and concentration
limit models would be subject to a not-less-than-annual review of their
sufficiency.\713\ Rule 17Ad-22(d)(3) currently requires registered
clearing agencies to have policies and procedures reasonably designed
to hold assets in a manner that minimizes risk of loss or risk of delay
in access to them and invest assets in instruments with minimal credit,
market, and liquidity risk.
---------------------------------------------------------------------------

    \713\ See supra Part 0 (discussing the full set of requirements
under proposed Rule 17Ad-22(e)(5)).
---------------------------------------------------------------------------

    By focusing on the nature of assets and not on accounts, the
Commission preliminarily believes the proposed rule may allow covered
clearing agencies the ability to manage collateral more efficiently. In
particular, under the proposed rule, a covered clearing agency would
have the option of accepting collateral that is riskier than cash and
holding this collateral at commercial banks, potentially increasing
default risk exposure. On the other hand, the requirement to regularly
review concentration limits and haircuts mitigates the risk that a
covered clearing agency's collateral policies fail to respond to
changing economic conditions. Based on its supervisory experience, the
Commission understands that all registered clearing agencies that would
meet the definition of a covered clearing agency already conform to the
requirements under the proposed rule related to the nature of assets
they may accept as collateral and the haircuts and concentration limits
they apply to collateral assets, so the associated costs and benefits
that would result from these requirements would apply only if
registered clearing agencies not already in compliance were to become
covered clearing agencies.
    As a result of the proposed rule, these covered clearing agencies
and registered clearing agencies that become covered clearing agencies
may experience additional costs as a result of the proposed annual
review requirements for the sufficiency of collateral haircut and
concentration limit models. Based on its supervisory experience, the
Commission preliminarily believes that many clearing agencies that
require collateral would need to develop policies and procedures to
review haircuts and concentration limits annually. Enforcement of the
proposed haircut requirement would also require additional resources. A
range of costs

for these new requirements is discussed in Part IV.C.3.a.iv(5).
Adherence to the new requirements by these entrants could extend the
benefits of prompt loss coverage, incentive alignment, and systemic
risk mitigation to a larger volume of cleared transactions.
(3) Proposed Rule 17Ad-22(e)(6): Margin
    Proposed Rule 17Ad-22(e)(6) would require a covered clearing agency
that provides CCP services to have policies and procedures reasonably
designed to require it to cover credit exposures using a risk-based
margin system and to establish minimum standards for such a system. It
would require these policies and procedures to cover daily collection
of variation margin. The proposed rule also requires a set of policies
and procedures generally designed to support a reliable margin system.
Among these are policies and procedures to ensure the use of reliable
price data sources and appropriate methods for measuring credit
exposure, which could improve margin system accuracy. Finally, covered
clearing agencies would be required to have policies and procedures
related to the testing and verification of margin models.\714\ Proposed
Rules 17Ad-22(a)(6) and (14) support these requirements by addressing
the means of verification for margin models and the level of coverage
required of a margin system against potential future exposures,
respectively. Based on its supervisory experience, however, the
Commission understands that all current covered clearing agencies have
policies and procedures that conform to the requirements under proposed
Rules 17Ad-22(e)(6)(i) through (v) and (vii), and some will have to
update their policies and procedures to comply with proposed Rule 17Ad-
22(e)(6)(vi).
---------------------------------------------------------------------------

    \714\ See supra Part 0 (discussing the full set of requirements
under proposed Rule 17Ad-22(e)(6)).
---------------------------------------------------------------------------

    Similar to proposed Rules 17Ad-22(e)(4) and (7), covered clearing
agencies that do not already engage in backtesting of margin resources
at least once each day or engage in a monthly analysis of assumptions
and parameters, as well as registered clearing agencies that enter into
the set of covered clearing agencies in the future, may incur
incremental compliance costs as a result of the proposed rule. Since
margin plays a key role in clearing agency risk management, however,
requiring that margin be periodically verified and modified as a result
of changing market conditions may mitigate the risks posed by covered
clearing agencies to financial markets in periods of financial stress.
Further, periodic review of model specification and parameters reduces
the likelihood that covered clearing agencies opportunistically update
margin models in times of low volatility and fail to update margin
models in times of high volatility. A range of costs for verification
and modification of margin models is discussed in Part IV.C.3.a.iv(5).
Further, since risk-based initial margin requirements may cause market
participants to internalize some of the costs borne by the CCP as a
result of large or risky positions,\715\ ensuring that margin models
are well-specified and correctly calibrated with respect to economic
conditions will help ensure that they continue to align the incentives
of clearing members with the goal of financial stability.
---------------------------------------------------------------------------

    \715\ See e.g., Philipp Haene & Andy Sturm, Optimal Central
Counterparty Risk Management (Swiss Nat'l Bank Working Paper, June
2009) (addressing the tradeoff between margin and default fund,
considering collateral costs, clearing member default probability,
and the extent to which margin requirements are associated with risk
mitigating incentives).
---------------------------------------------------------------------------

(4) Proposed Rule 17Ad-22(e)(7): Liquidity Risk
    Proposed Rule 17Ad-22(e)(7) would require a covered clearing agency
to have policies and procedures reasonably designed to effectively
monitor, measure, and manage liquidity risk.\716\ Parties to securities
and derivatives transactions rely on clearing agencies for prompt
clearance and settlement of transactions. Market participants in
centrally cleared and settled markets are often linked to one another
through intermediation chains in which one party may rely on proceeds
from sales of cleared products to meet payment obligations to another
party. If insufficient liquidity causes a clearing agency to fail to
meet settlement or payment obligations to its members, consequences
could include the default of a clearing member who may be depending on
these funds to make a payment to another market participant, with
losses then transmitted to others that carry exposure to this market
participant if the market participant is depending on payments from the
clearing members to make said payments to others. Therefore, the
benefits related to liquidity risk management generally flow from the
reduced risk of systemic risk transmission by covered clearing agencies
as a result of liquidity shortfalls, either in the normal course of
operation or as a result of member default.
---------------------------------------------------------------------------

    \716\ See supra Part 0 (discussing the full set of requirements
under proposed Rule 17Ad-22(e)(7)).
---------------------------------------------------------------------------

    Enhanced liquidity risk management may produce additional benefits.
Clearing members would face less uncertainty over whether a covered
clearing agency has the liquidity resources necessary to make prompt
payments which would reduce any need to hedge the risk of nonpayment.
Potential benefits from enhanced liquidity risk management may also
extend beyond members of covered clearing agencies or markets for
centrally cleared and settled securities. Clearing members are often
members of larger financial networks, and the ability of a covered
clearing agency to meet payment obligations to its members can directly
affect its members' ability to meet payment obligations outside of the
cleared market. Thus, management of liquidity risk may mitigate the
risk of contagion between asset markets.
    Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies would need to create new
policies and procedures, or update existing policies and procedures, to
meet requirements under the various subsections of proposed Rule 17Ad-
22(e)(7). These actions would entail compliance costs, as noted in Part
III.B.2. Further, the Commission preliminarily believes that for some
covered clearing agencies the proposed requirements would require them
to establish new practices. The cost of adherence to the proposed rule
would likely be passed on to market participants in cleared markets, as
discussed in more detail below.
    Under proposed Rule 17Ad-22(e)(7)(i), a covered clearing agency
would be required to have policies and procedures reasonably designed
to require maintaining sufficient resources to achieve ``cover one''
for liquidity risk. This requirement mirrors the ``cover one''
requirement for credit risk in proposed Rule 17Ad-22(e)(4)(iii). Based
on its supervisory experience, the Commission preliminarily believes
that many covered clearing agencies do not currently meet a ``cover
one'' requirement for liquidity and thus will likely incur costs to
comply with this proposed rule. As discussed earlier, whether covered
clearing agencies choose to gather liquidity directly from members or
instead choose to rely on third-party arrangements, the costs of
liquidity may be passed on to other market participants, eventually
increasing transaction costs.\717\ The

requirement may, however, reduce the procyclicality of covered clearing
agencies' liquidity demands, which may reduce costs to market
participants in certain situations. For instance, the requirement would
reduce the likelihood that a covered clearing agency would have to call
on its members to contribute additional liquidity in periods of
financial stress, when liquidity may be most costly.
---------------------------------------------------------------------------

    \717\ See supra Part 0 (discussing the effect of the proposed
rules on concentration in the market for clearing services and among
clearing members).
---------------------------------------------------------------------------

    Under proposed Rule 17Ad-22(e)(7)(ii), a covered clearing agency
would be required to have policies and procedures reasonably designed
to ensure that it meets the minimum liquidity resource requirement in
proposed Rule 17Ad-22(e)(7)(i) with qualifying liquid resources.\718\
Qualifying liquid resources would include cash held at the central bank
or at a creditworthy commercial bank, assets that are readily converted
into cash pursuant to committed lines of credit, committed foreign
exchange swaps, committed repurchase agreements or other highly
reliable prearranged funding agreements, or assets that may be pledged
to a central bank in exchange for cash (if the covered clearing agency
has access to routine credit at a central bank). The Commission notes
that the proposed rules allow covered clearing agencies some measure of
flexibility in managing qualifying liquid resources and that covered
clearing agencies would be able to use creditworthy commercial bank
services where appropriate.
---------------------------------------------------------------------------

    \718\ See proposed Rule 17Ad-22(a)(15), infra Part 0 (defining
``qualifying liquid resources'').
---------------------------------------------------------------------------

    Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies currently do not meet the
proposed liquidity requirements with qualifying liquid resources. As an
alternative to the proposed rules, the Commission could have restricted
the definition of qualifying liquid resources to assets held by covered
clearing agencies. These covered clearing agencies and the markets they
serve would benefit from the proposed minimum requirements for
liquidity resources in terms of the reduced risk of liquidity
shortfalls and associated contagion risks described above. However,
qualifying liquid resources may be costly for covered clearing agencies
to maintain on their own balance sheets. Such resources carry an
opportunity cost. Assets held as cash are, by definition, not available
for investment in less liquid assets that may be more productive uses
of capital. This cost may ultimately be borne by clearing members who
contribute liquid resources to covered clearing agencies to meet
minimum requirements under proposed Rule 17Ad-22(e)(7)(ii) and their
customers.
    The Commission notes that, under the proposed rules, covered
clearing agencies have flexibility to meet their qualifying liquid
resource requirements in a number of ways. In perfect capital markets,
maintaining on-balance-sheet liquidity resources should be no more
costly than entering into committed lines of credit or prearranged
funding agreements backed by less-liquid assets that would allow these
assets to be converted into cash. However, market frictions, such as
search frictions, may enable banks to obtain liquidity at lower cost
than other firms. In the presence of such frictions, obtaining
liquidity using committed and uncommitted funding arrangements provided
by banks may prove a less costly option for some covered clearing
agencies than holding additional liquid resources on their balance
sheets. In particular, the Commission preliminarily believes that
requiring covered clearing agencies to enter into committed or
uncommitted funding arrangements would decrease the costs that would be
experienced by them in the event they sought to liquidate securities
holdings during periods of market disruptions and increase the
likelihood that they meet funding obligations to market participants by
reducing the risk of delay in converting non-cash assets into cash.
    The Commission notes that committed or uncommitted funding
arrangements would only count towards minimum requirements to the
extent that covered clearing agencies had securities available to post
as collateral, so use of these facilities may require covered clearing
agencies to require their members to contribute more securities. If
these securities are costly for clearing members to supply, then
additional required contributions to meet minimum requirements under
proposed Rule proposed Rule 17Ad-22(e)(7)(ii) may impose burdens on
clearing members and their customers. Similarly, prearranged funding
arrangements may entail implicit costs to clearing members. Prearranged
funding arrangements could impose costs on clearing members if they are
obligated to contribute securities towards a collateral pool that the
covered clearing agency would use to back borrowing. Alternatively,
clearing members may be obligated under a covered clearing agency's
rules to act as counterparties to repurchase agreements. Under the
latter scenario, clearing members would bear costs associated with
accepting securities in lieu of cash. Additionally, the Commission
notes certain explicit costs specifically associated with these
arrangements outlined below.
    Counterparties to committed arrangements allowable under proposed
Rule 17Ad-22(a)(15) charge covered clearing agencies a premium to
provide firm liquidity commitments and additional out-of-pocket
expenses will be incurred establishing and maintaining committed
liquidity arrangements. The Commission preliminarily estimates that the
total cost of committed funding arrangements will be approximately 30
basis points per year, including upfront fees, legal fees, commitment
fees, and collateral agent fees.\719\ Furthermore, the Commission is
aware of other potential consequences of these arrangements. In some
instances, they may cause entities outside of a covered clearing agency
to bear risks ordinarily concentrated within the covered clearing
agency, while, in others, these arrangements may result in increased
exposure of covered clearing agencies to certain members.\720\
Financial intermediaries that participate in committed credit
facilities may be those least able to provide liquidity in times of
financial stress, so these commitments may represent a route for risk
transmission.\721\ Finally, the Commission notes that covered clearing
agencies may face constraints in the size of credit facilities
available to them. Recent market statistics have estimated the total
size of the committed credit facility market in the U.S. at $1.2
trillion with only 12 of 1800 facilities exceeding $10 billion in
size.\722\ Given the volume of activity at covered clearing agencies,
it is possible that they may only be able to use committed credit
facilities to meet a portion of their liquidity requirements under
proposed Rule 17Ad-22(e)(7)(ii).
---------------------------------------------------------------------------

    \719\ See Letter from Kim Taylor, President, CME Clearing, to
Melissa Jurgens, Office of the Secretariat, CFTC, Sept. 16, 2013, at
13 & n.48 (noting CME's assumption that the cost of committed
liquidity or committed repurchase facilities is approximately $3
million for every $1 billion of required committed facilities,
including upfront fees, commitment fees, legal fees, and collateral
agent fees).
    \720\ See id. at 11.
    \721\ See Letter from Robert C. Pickel, CEO, ISDA to Secretary,
CFTC, Sept. 16, 2013, at 4 (discussing collateral and liquidity
requirements); see also Craig Pirrong, Clearing and Collateral
Mandates: A New Liquidity Trap?, 24 J. Applied Corp. Fin. 67 (2012).
    \722\ See Bloomberg, Global Syndicated Loans, 1st Half 2013
League Tables (July 1, 2013), available at http://www.bloomberg.com/professional/files/2012/08/Global-Syndicated-Loans-2012.pdf.
---------------------------------------------------------------------------

    A covered clearing agency may alternatively use a prearranged
funding

arrangement determined to be highly reliable in extreme but plausible
market conditions to raise liquid resources backed by non-cash assets
but that does not require firm commitments from liquidity providers.
This strategy would avoid certain of the explicit fees associated with
firm commitments, while incurring costs related to the annual review
and maintenance of such arrangements. Based on its supervisory
experience and discussions with market participants, the Commission
preliminarily believes the cost associated with commitment fees to be
between 5 and 15 basis points per year. Given the 30 basis point cost
associated with committed funding arrangements, mentioned above,
uncommitted facilities could entail costs of between 15 and 25 basis
points.\723\ Prearranged funding arrangements may ultimately prove less
costly than holding cash and may be more widely available than
committed arrangements, while still reducing the likelihood of delay
faced by covered clearing agencies that attempt to market less-liquid
assets. As mentioned above in the context of committed credit
facilities, the Commission acknowledges that financial institutions who
offer to provide liquidity to covered clearing agencies on an
uncommitted basis may be least able to do so in times of financial
stress, when access to liquidity is most needed by the covered clearing
agency. Without a commitment in place, counterparties retain the option
to fail to provide liquidity during stressed conditions, when liquidity
is most valuable to clearing agencies and the markets they serve. To
the extent covered clearing agencies may establish requirements for
clearing members to provide liquidity to ensure compliance with the
Commission's proposed rules, the costs experienced by members
indirectly may exceed those associated with committed credit
facilities.
---------------------------------------------------------------------------

    \723\ Subtracting the lower bound of commitment fees (5 basis
points) from the estimated total cost of a committed facility (30
basis points) yields an estimate of the upper bound of the fees
associated with an uncommitted facility (30-5 = 25 basis points). We
estimate the lower bound of fees associated with an uncommitted
facility analogously (30-15 = 15 basis points).
---------------------------------------------------------------------------

    Finally, covered clearing agencies that have access to routine
credit at a central bank could meet the qualifying liquid resources
requirement with assets that are pledgeable to a central bank. The
Commission notes that this may represent the lowest cost option for
covered clearing agencies, but understands that this latter provision
would represent an advantage only if and when a covered clearing agency
receives the benefit of access to routine central bank borrowing. The
Commission anticipates that at such future time access to routine
credit at a central bank would provide covered clearing agencies with
additional flexibility with respect to resources used to comply with
the liquidity risk management requirements of proposed Rules 17Ad-
22(e)(7)(i) and (ii).
    The total cost of maintaining qualifying liquid resources pursuant
to proposed Rules 17Ad-22(e)(7)(i) and (ii) is composed of the cost of
each liquidity source including assets held by covered clearing
agencies, committed credit facilities and prearranged funding
agreements, multiplied by the quantity of each of these liquidity
sources held by covered clearing agencies. The Commission is unable to
quantify the cost of cash held by clearing agencies and securities
required to back credit facilities since such estimates would require
detailed information about additional required contributions of
clearing members under the proposed rules, as well as clearing members'
best alternative to holding cash and securities.\724\ As mentioned
above, however, the Commission has limited information about the costs
associated with committed and uncommitted credit facilities. Based on
this information, we are able to quantify the costs associated with
committed credit facilities that will result from the requirement to
maintain qualifying liquid resources. The Commission preliminarily
estimates that the cost of compliance with the proposed rules will be
between $133 million and $225 million per year as a result of the
requirement to enter into prearranged funding agreements for non-cash
assets used to meet liquidity requirements under proposed Rules 17Ad-
22(e)(7)(i) and (ii). This analysis assumes that covered clearing
agencies will enter into such agreements at arm's length on an
uncommitted basis. Based on staff discussions with market participants,
the Commission understands that alternative arrangements between
covered clearing agencies and their members may be obtained at lower
cost, though these arrangements may come with increased wrong-way
risk.\725\
---------------------------------------------------------------------------

    \724\ Covered clearing agencies may choose to allocate liquidity
burdens based on a number of factors related to the markets they
serve and their membership. See, e.g., Exchange Act Release No. 34-
70999 (Dec. 5, 2013), 78 FR 75400 (Dec. 11, 2013) (Commission order
approving NSCC rule change to institute supplemental liquidity
deposits to its clearing fund designed to increase liquidity
resources to meet its liquidity needs).
    \725\ To produce this range, the Commission used a combination
of publicly available information from SRO rule filings, comment
letters, and 2012 annual financial statements, and non-public
information gathered as a result of its regulatory role. For each
covered clearing agency, the Commission assumed that the covered
clearing agency's guaranty fund represents the sole source of
liquidity used to satisfy its minimum liquidity requirements under
the proposed rules. To compute the level of qualifying liquid
resources currently held by each covered clearing agency, the
Commission assumed that cash in the covered clearing agency's
guaranty fund remains fixed at current levels and added to this any
amount from credit facilities that could be backed by the value of
securities held in the covered clearing agency's guaranty funds.
    Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
the ``cover one'' guaranty fund requirement over all covered
clearing agencies results in the total shortfall relative to minimum
requirements under proposed Rules 17Ad-22(e)(7)(i) and (ii). The
Commission further assumed that covered clearing agencies would
cover this shortfall using prearranged funding agreements backed by
additional securities posted to guaranty funds by clearing members.
Finally, the Commission multiplied the total prearranged funding
amount by between 0.15% and 0.25% to arrive at a range of ongoing
costs.
---------------------------------------------------------------------------

    U.S. Treasury securities would not fall under the proposed
definition of qualifying liquid resources. The Commission understands
that U.S. Treasury markets represent some of the largest and most
liquid markets in the world, see Part IV.B.3.f.ii, and that, in
``flights to quality'' and ``flights to liquidity'' in times of
financial stress, U.S. Treasuries trade at a premium to other
assets.\726\ If, as an alternative to the proposed rules, the
Commission included U.S. government securities in the definition of
qualifying liquid resources, the Commission preliminarily estimates the
cost of complying with requirements under proposed Rule 17Ad-
22(e)(7)(i) and (ii) would be reduced by between $9 million and $225
million per year.\727\

The Commission preliminarily believes, however, that there are benefits
to including government securities only if prearranged funding
agreements exist. In particular, given the quantity of these securities
financed by the largest individual dealers, fire-sale conditions could
materialize if collateral is liquidated in a disorderly manner, which
could prevent covered clearing agencies from meeting payment
obligations.\728\
---------------------------------------------------------------------------

    \726\ See Alessandro Beber, Michael W. Brandt & Kenneth A.
Kavajecz, Flight-to-Quality or Flight-to-Liquidity? Evidence from
the Euro-Area Bond Market, 22 Rev. Fin. Stud. 925 (2009)
(decomposing sovereign yield spreads into credit and liquidity
components and showing that credit quality matters for bond
valuation but that, in times of market stress, investors chase
liquidity, not quality); Markus K. Brunnermeier & Lasse Heje
Pedersen, Market Liquidity and Funding Liquidity, 22 Rev. Fin. Stud.
2201 (2009) (showing, in a theoretical model, how with low wealth
shocks, demand for illiquid assets falls off more sharply than
demand for liquid assets); Francis A. Longstaff, The Flight-to-
Liquidity Premium in U.S. Treasury Bond Prices, 77 J. Bus 511 (2004)
(estimating the liquidity premium associated with U.S. Treasuries
relative to close substitutes); Dimitri Vayanos Flight to Quality,
Flight to Liquidity, and the Pricing of Risk (NBER Working Paper No.
10327, Feb. 2004) (showing, in a theoretical model, that during
volatile times, assets' liquidity premia increase), available at
http://www.nber.org/papers/w10327.pdf.
    \727\ The Commission re-estimated the level of prearranged
funding agreements required to meet requirements under proposed
Rules 17Ad-22(e)(7)(i) and (ii) using the data and methodology
described in note 725, except in this case the Commission assumed
that all non-defaulting member resources applied to funding
obligations were a mix of cash and U.S. Treasuries for a lower
bound, and assumed that all resources applied to funding obligations
were a mix of cash and U.S. Treasuries for an upper bound.
    Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
cover one guaranty fund requirement over all covered clearing
agencies results in the total shortfall relative to minimum
requirements under proposed Rules 17Ad-22(e)(7)(i) and (ii) if U.S.
government and agency securities were considered qualifying liquid
resources. As above, the Commission further assumed that covered
clearing agencies would cover this shortfall using prearranged
funding agreements backed by additional securities posted to
guaranty funds by clearing members and multiplied this amount by
between 0.15% and 0.25% to arrive at a range of ongoing costs.
    \728\ Brian Begalle et al., The Risk of Fire Sales in the Tri-
Party Repo Market, at 19 & n.37 (FRBNY Staff Report No. 616, May
2013), available at http://www.newyorkfed.org/research/staff_reports/sr616.pdf.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(iii) concerns access to accounts and
services at a central bank, when available and where practical.\729\
The Commission preliminarily believes that it may be beneficial for
covered clearing agencies to use central bank account services because
doing so would reduce exposure to commercial bank default risk.
Moreover, for some covered clearing agencies, central bank services may
represent the lowest-cost admissible funding arrangement under the
proposed rule. The Commission understands, however, that central bank
services are only currently available to a subset of covered clearing
agencies, and the proposed rule only requires policies and procedures
to ensure use of central bank accounts and services when practical and
available.
---------------------------------------------------------------------------

    \729\ See proposed Rule 17Ad-22(e)(7)(iii), infra Part 0.
---------------------------------------------------------------------------

    Proposed Rules 17Ad-22(e)(7)(iv) and (v) address relations between
covered clearing agencies and their liquidity providers. The Commission
preliminarily believes that a key benefit of these proposed rules would
be an increased level of assurance that liquidity providers would be
able to supply liquidity to covered clearing agencies on demand. Such
assurance is especially important because of the possibility that
covered clearing agencies may rely on outside liquidity providers to
convert non-cash assets into cash using prearranged funding
arrangements or committed facilities, pursuant to proposed Rule 17Ad-
22(e)(7)(ii) and the definition of qualifying liquid resources in
proposed Rule 17Ad-22(a)(15). The required policies and procedures
would ensure the covered clearing agency undertakes due diligence to
confirm that it has a reasonable basis to believe each of its liquidity
providers understand the liquidity risk borne by the liquidity
provider, and that the liquidity provider would have the capacity to
provide liquidity under commitments to the covered clearing agency.
Finally, covered clearing agencies would be required, under the
proposed rule, to maintain and test the covered clearing agency's
procedures and operational capacity for accessing liquidity under their
agreements. The Commission preliminarily believes that, besides the
costs associated with new or updated policies and procedures discussed
in Part III.B.2, covered clearing agencies and liquidity providers may
experience costs associated with the proposed rules as a result of the
requirement to test liquidity resources, such as, for example, fees
associated with conducting test draws on a covered clearing agency's
credit lines. Costs associated with ongoing monitoring and compliance
related to testing are included in the Commission's estimate of
quantifiable costs presented in Part IV.C.3.d.
    Proposed Rules 17Ad-22(e)(7)(vi) and (vii) may impose costs on
covered clearing agencies as a result of requirements for testing the
sufficiency of liquidity resources and validating models used to
measure liquidity risk. The testing and model validation requirements
of these proposed rules are similar to requirements for testing and
model validation for credit risk in proposed Rules 17Ad-22(e)(4)(vi)
and (vii), and the Commission preliminarily believes that these
proposed rules would yield similar benefits. Frequent monitoring and
testing liquidity resources could help rapidly identify any gaps in
resources required to meet payment obligations. Moreover, the
requirement to test and, when necessary, update the assumptions and
parameters supporting models of liquidity risk will support the
adjustment of covered clearing agency liquidity resources to changing
financial conditions and mitigate the risk that covered clearing
agencies will strategically manage updates to their liquidity risk
models in support of cost-reduction or profit-maximization.
    Proposed Rule 17Ad-22(e)(7)(viii) addresses liquidity shortfalls at
a covered clearing agency, and the Commission preliminarily believes
the proposed rule would reduce ambiguity related to settlement delays
in the event of liquidity shocks. Among other things, by requiring
procedures that seek to avoid delay of settlement payments, this
proposed rule would require covered clearing agencies to address
liquidity concerns in advance rather than relying on strategies of
delaying accounts payable in the event of liquidity shocks. As
discussed previously, effective liquidity risk management by covered
clearing agencies that serves to eliminate uncertainty on the part of
clearing members that payments by the covered clearing agency will be
made on time may allow these clearing members to allocate their
liquidity resources to more efficient uses than holding precautionary
reserves.\730\ The Commission preliminarily believes the proposed rule
may reduce some of the flexibility covered clearing agencies have in
the absence of the proposed rule, which could impose additional burdens
on these clearing agencies as discussed in Part IV.C.1.b.
---------------------------------------------------------------------------

    \730\ See supra Part 0.
---------------------------------------------------------------------------

    Proposed Rule 17Ad-22(e)(7)(ix) would require a covered clearing
agency to have policies and procedures reasonably designed to describe
its process for replenishing any liquid resources that it may employ
during a stress event.\731\ The ability to replenish liquidity
resources is critical to ensure that covered clearing agencies are able
to continue operations after a stress event. Beyond the general
benefits associated with liquidity risk management noted earlier, this
proposed rule would yield particular benefits insofar as it would
reduce uncertainty about covered clearing agency liquidity resources at
precisely those times when information about liquidity may be most
important to market participants.
---------------------------------------------------------------------------

    \731\ See proposed Rule 17Ad-22(e)(7)(ix), infra Part 0.
---------------------------------------------------------------------------

    Finally, proposed Rule 17Ad-22(e)(7)(x) would require a covered
clearing agency that provides CCP services and is either systemically
important in multiple jurisdictions or is a clearing agency involved in
activities with a more complex risk profile to conduct a feasibility
analysis for ``cover two.'' \732\ The primary cost associated with this
rule will be an annual analysis by the affected covered clearing
agencies. Costs associated with a

feasibility study would likely include the cost of staffing and
consulting, which will depend on the scope of products cleared and the
particular approach taken by each covered clearing agencies. The costs
associated with this requirement are included in Part IV.C.3.d.
---------------------------------------------------------------------------

    \732\ See proposed Rule 17Ad-22(e)(7)(x), infra Part 0.
---------------------------------------------------------------------------

(5) Testing and Validation of Risk Models
    Proposed Rules 17Ad-22(e)(4) through (7) include requirements for
covered clearing agencies to have policies and procedures reasonably
designed to test and validate models related to financial risks.
Covered clearing agencies may incur additional costs under expanded and
more frequent testing of financial resources if the proposed
requirements for testing and validation do not conform to practices
currently used by covered clearing agencies.\733\ These costs are
composed of two portions. The first encompasses startup costs related
to collection and storage of data elements necessary to implement
testing and validation, along with investments in software tools and
human capital to support these functions. The second portion of costs
includes the ongoing, annual costs of conducting testing and validation
under the proposed rules.
---------------------------------------------------------------------------

    \733\ The Commission notes that while the stress testing
provisions in proposed Rules 17Ad-22(e)(4) through (7) include new
requirements for covered clearing agencies, Rule 17Ad-22(b)(4)
requires registered clearing agencies that provide CCP services for
security-based swaps to have policies and procedures for a general
margin model validation requirement. See supra note 712.
---------------------------------------------------------------------------

    Based on its supervisory experience and discussions with industry
participants, the Commission preliminarily believes that startup costs
to support testing and validation of credit risk, margin, and liquidity
risk models at covered clearing agencies could fall in the range of $5
million to $25 million for each covered clearing agency. This range
primarily reflects investments in information technology to process
data already available to covered clearing agencies for stress testing
and validation purposes. The range's width reflects differences in
markets served by, as well as the scope of operations of, each covered
clearing agency. Based on its supervisory experience and discussions
with industry participants, the Commission estimates a lower bound of
$1 million per year for ongoing costs related to testing of risk
models.
    Should each covered clearing agency choose to hire external
consultants for the purposes of performing model validation required
under proposed Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) through written
policies and procedures, the Commission preliminarily estimates the
ongoing cost associated with hiring such consultants would be
approximately $4,388,160 in the aggregate.\734\
---------------------------------------------------------------------------

    \734\ This figure was calculated as follows: 2 Consultants for
40 hours per week at $653 per hour = $52,240 x 12 weeks = $626,880
per clearing agency x 7 covered clearing agencies = $4,388,160. The
$653 per hour figure for a consultant was calculated using
www.payscale.com, modified by Commission staff to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits, and overhead.
     The Commission previously estimated that ongoing costs
associated with hiring external consultants to fulfill the
requirements of Rule 17Ad-22(b)(4) would be approximately $3.9
million per year. See Clearing Agency Standards Release, supra note
5, at 66261.
---------------------------------------------------------------------------

    The Commission acknowledges that it could have, as an alternative,
proposed rules that would require testing and validation of financial
risk models at covered clearing agencies at different frequencies. For
example, the Commission could have required backtesting of margin
resources less frequently than daily. Such a policy could imply less
frequent adjustments in margin levels that may result in over- or
under-margining. The Commission preliminarily believes that the
frequencies of testing and validation of financial risk models that it
has proposed are appropriate given the risks faced by covered clearing
agencies and current market practices related to frequency of meetings
of risk management committees and boards of directors at covered
clearing agencies.
v. Proposed Rules 17Ad-22(e)(8) Through (10): Settlement and Physical
Delivery
    Proposed Rules 17Ad-22(e)(8) through (10) require covered clearing
agencies to have policies and procedures reasonably designed to address
settlement risk. Many of the issues raised by settlement are similar to
those raised by liquidity. Uncertainty in settlement may make it
difficult for clearing members to fulfill their obligations to other
market participants within their respective financial networks if they
hold back precautionary reserves, as discussed above. Based on its
supervisory experience, the Commission preliminarily believes that the
benefits and costs for the majority of covered clearing agencies will
likely be limited. Registered clearing agencies that enter into the set
of covered clearing agencies in the future, by contrast, may bear more
significant costs as a result of the enhanced standards.
    Settlement finality is important to market participants for a
number of reasons. Reversal of transactions can be costly to
participants. For example, if transactions are reversed, buyers and
sellers of securities may be exposed to additional market risk as they
attempt to reestablish desired positions in cleared products.
Similarly, reversal of transactions may render participants expecting
to receive payment from the covered clearing agency unable to fulfill
payment obligations to their counterparties, exposing these additional
parties to the transmitted credit risk. Finally, settlement finality
can help facilitate default management procedures by covered clearing
agencies since they improve transparency of members' positions. Unless
settlement finality is established by covered clearing agencies, market
participants may attempt to hedge reversal risk for themselves. This
could come at the cost of efficiency if it means that, on the margin,
participants are less likely to use cleared products as collateral in
other financial transactions.
    In addition, settlement in central bank money, where available and
determined to be practical by the board of directors of the covered
clearing agency, as the proposed rules would require, greatly reduces
settlement risk related to payment agents. Using central bank accounts
to effect settlement rather than settlement banks removes a link from
the intermediation chain associated with clearance and settlement. As a
result, a covered clearing agency would be less exposed to the default
risk of its settlement banks. In cases where settlement banks maintain
links to other covered clearing agencies, for example as liquidity
providers or as members, reducing exposure to settlement bank default
risk may be particularly valuable.
    As in the case of proposed Rule 17Ad-22(e)(7)(iii), the Commission
acknowledges there may be circumstances in which covered clearing
agencies either do not have access to central bank account services or
the use of such services is impractical. Accordingly, the Commission
preliminarily believes it is appropriate to allow covered clearing
agencies the flexibility to also use commercial bank account services
to effect settlement, subject to a requirement that covered clearing
agencies monitor and manage the risks associated with such
arrangements.
vi. Proposed Rule 17Ad-22(e)(11): CSDs
    CSDs play a key role in modern financial markets. For many issuers,
many transactions in their securities

involve no transfer of physical certificates.
    Paperless trade generally improves transactional efficiency. Book-
entry transfer of securities may facilitate conditional settlement
systems required by proposed Rule 17Ad-22(e)(12). For example, book-
entry transfer in a delivery versus payment system allows securities to
be credited to an account immediately upon debiting the account for the
payment amount. Institutions and individuals may elect to no longer
hold and exchange certificates that represent their ownership of
securities. An early study showed that the creation of DTC resulted in
a 30-35% reduction in the physical movement of certificates.\735\ Among
other benefits, to the extent that delays in exchanging paper
certificates result in settlement failures, immobilization and
dematerialization of shares reduces the frequency of these
failures.\736\
---------------------------------------------------------------------------

    \735\ See Neal L. Wolkoff & Jason B. Werner, The History of
Regulation of Clearing in the Securities and Futures Markets, and
Its Impact on Competition, 30 Rev. Banking & Fin. L. 313, 323
(2010).
    \736\ See Commission, Study of Unsafe and Unsound Practices of
Brokers and Dealers, H.R. Doc. No. 231, 92nd Cong., 1st Sess. 13, at
168 (1971) (suggesting that the delivery and transfer process for
paper certificates were a principal cause of failures to deliver and
receive during the ``paperwork crisis'' of the late 1960s).
---------------------------------------------------------------------------

    For markets to realize the transactional benefits of paperless
trade, however, requires confidence that CSDs can correctly account for
the number of securities in their custody and for the book entries that
allocate these securities across participant accounts. In order to
realize these benefits, the proposed rules also require covered CSDs to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to ensure the integrity of securities
issues, minimize the risks associated with transfer of securities, and
protect assets against custody risk. Based on its supervisory
experience, the Commission preliminarily believes that registered CSDs
already have infrastructure in place to meet these requirements.
However, CSDs may face incremental compliance costs in instances where
they must modify their rules in order to implement appropriate
controls. Compliance costs may be higher for potential new CSDs that
are determined to be covered clearing agencies in the future.
vii. Proposed Rule 17Ad-22(e)(12): Exchange-of-Value Settlement Systems
    Clearance and settlement of transactions between two parties to a
trade involves an exchange of one obligation for another. Regarding
transactions in securities, these claims can be securities or payments
for securities. A particular risk associated with transactions is
principal risk, which is the risk that only one obligation is
successfully transferred between counterparties. For example, in a
purchase of common stock, a party faces principal risk if, despite
successfully paying the counterparty for the purchase, the counterparty
may fail to deliver the shares.
    The proposed requirements under Rule 17Ad-22(e)(12) are
substantially the same as those in Rule 17Ad-22(d)(13).\737\ As a
result, covered clearing agencies that have been in compliance with
Rule 17Ad-22(d)(13) face no substantially new requirements under
Proposed Rule 17Ad-22(e)(12). The Commission preliminary expects the
proposed rule would likely impose limited material additional costs on
covered clearing agencies. It would also produce benefits in line with
the general economic considerations discussed in Part IV.C.1. The
economic effects may differ for registered clearing agencies that enter
into the set of covered clearing agencies in the future.
---------------------------------------------------------------------------

    \737\ See supra note 274; supra Part 0 (discussing the full set
of requirements under proposed Rule 17Ad-22(e)(13)); supra Part 0
(discussing current practices among registered clearing agencies
regarding exchange-of-value settlement systems); see also 17 CFR
240.17Ad-22(d)(13).
---------------------------------------------------------------------------

viii. Proposed Rule 17Ad-22(e)(13): Participant-Default Rules and
Procedures
    Proposed Rule 17Ad-22(e)(13) would require covered clearing
agencies to have policies and procedures for participant default with
additional specificity relative to current requirements for registered
clearing agencies under Rule 17Ad-22(d)(11). In particular, proposed
Rule 17Ad-22(e)(13) requires policies and procedures that address the
allocation of credit losses that exceed default resources, repayment of
liquidity providers, replenishment of financial resources, and testing
and review of default procedures.
    Based on its supervisory experience, the Commission preliminarily
believes all covered clearing agencies currently test and review
default procedures at least annually, so the costs of this requirement
would apply only to registered clearing agencies that may enter into
the set of covered clearing agencies in the future. Most covered
clearing agencies, however, will be required to update their policies
and procedures as a result of proposed Rules 17Ad-22(e)(13)(i) and
(ii). Clearing members may experience benefits from proposed Rule 17Ad-
22(e)(13)(i), which requires covered clearing agencies to provide
disclosure to members regarding the allocation of default losses when
these losses exceed the level of financial resource it has available.
As a result of this additional transparency, clearing members may
experience an improved ability to manage their expectations of
potential obligations against the covered clearing agency, which may
increase the likelihood of orderly wind-downs in the event of member
default. Crafting such allocation plans by covered clearing agencies
may entail certain compliance costs, as previously discussed in Part
III.D.5.a and as discussed further in Part IV.C.3.d. Further, covered
clearing agencies may allocate default losses in a number of ways that
may themselves have implications for participation, competition, and
systemic risk.\738\ For example, if, as a part of a default resolution
plan, selective tear-up is contemplated after a failed position
auction, then clearing members who expect low loss exposure in the
tear-up may not have adequate incentives to participate in the position
auction, even if they are better able to absorb losses than clearing
members who expect high exposure in the tear-up plan. This would
increase the chances of a failed auction and the chances of a
protracted and more disruptive wind-down. Thus, the total costs of any
loss allocation plan may depend largely on the particular choices
embedded in covered clearing agencies' plans.
---------------------------------------------------------------------------

    \738\ See, e.g., Elliot, supra note 617 (discussing various
loss-allocation rules and CCP recovery and wind-down).
---------------------------------------------------------------------------

    As an alternative to the proposed rules, the Commission could have
proposed more prescriptive requirements for default procedures at
covered clearing agencies. The Commission preliminarily believes that
differences in cleared assets and in the characteristics of clearing
members supports allowing each covered clearing agency flexibility in
choosing its own default procedures pursuant to proposed Rule 17Ad-
22(e)(13).
    In addition to loss allocation plans, proposed Rule 17Ad-22(e)(13)
contains new provisions related to the replenishment of financial
resources and testing and review of default procedures that do not
appear in Rule 17Ad-22(d)(11). The Commission preliminarily believes
that proposed rules related to replenishment of financial resources may
reduce the potential for systemic risk and contagion in cleared
markets, as they

facilitate covered clearing agencies' prompt access to these resources
in times of financial stress. The Commission also preliminarily
believes that broad-based participation in the testing of default
procedures could reduce disruption to cleared markets in the event of
default. However, to the extent that testing of these procedures
requires participation by members of covered clearing agencies,
members' customers, and other stakeholders, these parties may bear
costs under the proposed rules. The Commission is unable to quantify
the economic effects of participation in these tests at this time.
ix. Proposed Rule 17Ad-22(e)(14): Segregation and Portability
    Segregation and portability of customer positions serves a number
of useful purposes in cleared markets. In the normal course of
business, the ability to efficiently identify and move an individual
customer's positions and collateral between clearing members enables
customers to easily terminate a relationship with one clearing member
and initiate a relationship with another. This may facilitate
competition between clearing members by ensuring customers are free to
move their accounts from one clearing member to another based on their
preferences, without being unduly limited by operational barriers.\739\
---------------------------------------------------------------------------

    \739\ See, e.g., Paul Klemperer, Competition When Consumers Have
Switching Costs: An Overview with Applications to Industrial
Organization, Macroeconomics, and International Trade, 62 Rev. Econ.
Stud. 515 (1995) (presenting an overview of switching costs and
their effects on competition).
---------------------------------------------------------------------------

    Segregation and portability may be especially important in the
event of participant default. By requiring that customer collateral and
positions remain segregated, covered clearing agencies can facilitate,
in the event of a clearing member's insolvency, the recovery of
customer collateral and the movement of customer positions to one or
more other clearing members. Further, portability of customer positions
may facilitate the orderly wind down of a defaulting member if customer
positions may be moved to a non-defaulting member. Porting of positions
in a default scenario may yield benefits for customers if the
alternative is closing-out positions at one clearing member and
reestablishing them at another clearing member. The latter strategy
would cause customers to bear transactions costs, which might be
especially high in times of financial stress.
    The Commission notes that, in its preliminary view, these proposed
rules are flexible in their approach to implementing segregation and
portability requirements. The most efficient means of implementing
these requirements may depend on the products that a covered clearing
agency clears as well as other business practices at a covered clearing
agency. For example, a clearing agency's decision whether or not to
collect margin on a gross or net basis may bear on its decision to port
customer positions and collateral on an individual or omnibus basis,
and while an individual account structure may provide a higher degree
of protection from a default by another customer, it may be
operationally and resource intensive for a covered clearing to
implement and may reduce the efficiency of its operations.
    As a result, the costs and benefits of proposed Rule 17Ad-22(e)(14)
will depend on specific rules implemented by covered clearing agencies
as well as how much these rules differ from current practice. Based on
its supervisory experience, the Commission preliminarily believes that
the current practices at covered clearing agencies to which the
proposed rule would apply already meets segregation requirements under
the proposed rule, so any costs and benefits for covered clearing
agencies would flow from implementing portability requirements, though
it potentially raises a barrier to entry for security-based swap
clearing agencies or clearing agencies involved in activities with a
more complex risk profile that seek to become covered clearing
agencies.
x. Proposed Rule 17Ad-22(e)(15): General Business Risk
    While proposed Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) require that
covered clearing agencies have policies and procedures reasonably
designed to address credit risk and liquidity risk, proposed Rule 17Ad-
22(e)(15) requires that covered clearing agencies have policies and
procedures reasonably designed to address general business risk. The
Commission preliminarily believes that general business losses
experienced by covered clearing agencies represent a distinct risk to
cleared markets, given limited competition and specialization of
clearing agencies. In this regard, the loss of clearing services due to
general business losses would likely result in major market disruption.
The proposed rule requires a covered clearing agency to have policies
and procedures reasonably designed to mitigate the risk that business
losses result in the disruption of clearing services. Under these
policies and procedures covered clearing agencies would hold sufficient
liquid resources funded by equity to cover potential general business
losses, which at a minimum would constitute six months of operating
expenses. The Commission preliminarily believes that the benefits of
such policies and procedures would flow primarily from covered clearing
agencies that would be required to increase their holdings of liquid
net assets funded by equity, enabling them to sustain their operations
for sufficient time and achieve orderly wind-down if such action is
eventually necessary.
    The Commission could have proposed a higher or lower minimum level
of resources, for example, corresponding to one quarter of operating
expenses or one year of operating expenses. The Commission
preliminarily believes, however, that the rules, as proposed, afford
covered clearing agencies sufficient flexibility in determining the
level of resources to hold while maintaining a minimum standard that
supports continued operations in the event of general business losses.
As another alternative, the Commission could have allowed covered
clearing agencies additional flexibility in determine the nature of the
financial resources held to mitigate the effects of general business
risk or the means by which these resources are funded. The Commission
preliminarily believes, however, that by specifying that these
resources be liquid in nature, the proposed rule would limit any delays
by covered clearing agencies that suffer business losses from paying
expenses required for continued operations. Additionally, by
specifically requiring that a covered clearing agency draw liquid net
resources from members as equity capital, the proposed rules may also
encourage members to more closely monitor the business operations of a
covered clearing agency, which may reduce the likelihood of losses.
    Based on its supervisory experience Commission preliminarily
believes that certain covered clearing agencies would be required to
establish and maintain policies and procedures providing for specified
levels of equity capital and higher levels of liquid net assets than
they would in the absence of proposed Rule 17Ad-22(e)(15).\740\ Table 2
contains summary information from five registered clearing agencies and
estimates, solely for purposes of evaluating the costs and benefits of
proposed Rule 17Ad-22(e)(15), the amount of additional capital these
entities would be required to establish

and maintain to comply with the proposed rule. As the Commission has
not previously had such a capital requirement, the estimate is based on
one half of the average annual operating expenses for each covered
clearing agency as reflected in their annual financial statements over
the five-year period ending December 31, 2012.\741\
---------------------------------------------------------------------------

    \740\ Additional equity capital may be raised through share
issuance or by retaining earnings.
    \741\ In the case of DTCC, to obtain an estimate of annual
operating expense, the Commission made minor adjustments to the
total expense by excluding expenses not related to DTCC's core
operations, since its annual income statement does not explicitly
show the operating expense.
---------------------------------------------------------------------------

    Table 2 identifies cash and cash equivalents as liquid assets and
averages this over the same five-year period. A key shortcoming of
using publicly available financial data is the difficulty in
determining how much of a firm's cash and cash equivalents are funded
by either equity or liabilities, or both. To this end, the Commission
considered two different cases.\742\ In Case 1, the Commission assumed
that cash on each clearing agency's balance sheet was funded by
liabilities first, with the residual funded by equity. In Case 2, the
Commission assumed that cash on each clearing agency's balance sheet
was funded pro-rata by equity and liabilities.\743\ This procedure
likely yields an upper bound for estimates of additional equity
necessary to meet the minimum reserve requirements.
---------------------------------------------------------------------------

    \742\ The Commission notes that these two cases are provided as
estimates of cash and cash equivalents funded by equity for existing
covered clearing agencies for limited purposes of the economic
analysis but are not methods the Commission would necessarily accept
if used by a covered clearing agency to comply with proposed Rule
17Ad-22(e)(15). Nor should the two cases presented be viewed as
interpretive guidance regarding proposed Rule 17Ad-22(e)(15).
    \743\ For example, in Case 2, for DTC we arrive at a pro-rata
allocation of cash by computing the ratio of Average Equity to the
sum of Average Equity and Average Liabilities (282/3646 = 7.73%,)
and applying this to Average Cash and Cash Equivalents (7.73% x 3151
= 243.71) to arrive at a proxy of the level of liquid net assets
funded by equity.
    \744\ The figures in Table 2 are based on financial data taken
from the 2008-2012 annual reports of DTC, FICC, ICEEU, NSCC, and
OCC. The Commission notes that these figures are presented for the
limited purposes of conducting this economic analysis and do not
represent methods the Commission would necessarily accept if used by
a covered clearing agency to comply with proposed Rule 17Ad-
22(e)(15).

  Table 2--Hypothetical Additional Equity Necessary To Meet Requirements Under Proposed Rule 17Ad-22(e)(15), in
                               Millions of Dollars, Based on Years 2008-2012 \744\
----------------------------------------------------------------------------------------------------------------
                                        DTC            FICC            ICEEU           NSCC             OCC
----------------------------------------------------------------------------------------------------------------
Average Six Months Operating                 166              62              41              94              68
 Expense........................
Average Cash and Cash                      3,151           8,259             129           3,838              64
 Equivalents....................
Average Liabilities.............           3,364           8,471              84           3,833             155
Cash Funded by Equity...........               0               0              45               5               0
Average Total Equity............             282              97             192             125              15
Average Net Income..............              21              16             119              26               2
Case 1, Additional Equity Needed             166              62               0              89              68
Case 2, Additional Equity Needed               0               0               0               0              63
----------------------------------------------------------------------------------------------------------------

    Absent market frictions, a change in capital structure should have
no effect on the value of a covered clearing agency.\745\ The
Commission acknowledges that market imperfections such as asymmetric
information, moral hazard, and regulation may imply that covered
clearing agencies that would need to raise additional equity capital
incur opportunity costs for holding this additional capital rather than
investing it in projects or distributing it back to equity holders who
might, in turn, invest in projects.
---------------------------------------------------------------------------

    \745\ See Franco Modigliani & Merton H. Miller, The Cost of
Capital, Corporation Finance and the Theory of Investment, 48 Am.
Econ. Rev. 261 (1958) (showing the irrelevance of capital structure
in perfect markets).
---------------------------------------------------------------------------

    To estimate these costs, the Commission applied the capital asset
pricing model to observed returns for CME and ICE, two clearing
agencies that have publicly-traded equity outstanding.\746\ This
methodology yielded an estimate of the cost of equity for these two
clearing agencies of approximately 10%. Applying estimated cost of
equity to the lower bound of additional equity required under the
proposed rule suggests an annual cost of $16 million, while applying
this cost to the upper bound of additional equity needed suggests an
annual cost of $50 million.\747\ These estimates are subject to a
number of caveats. In particular, this exercise does not take into
account the possibility that equity finance may reduce the cost of
equity due to the resulting decrease in leverage,\748\ or that clearing
agencies might simultaneously raise equity while reducing liabilities.
Both of these possibilities would likely reduce the cost to covered
clearing agencies of increased equity capital. Finally, this analysis
presumes that covered clearing agencies will choose to comply with the
requirements in proposed Rule 17Ad-22(e)(15)(iii) at the lower bound of
six months' operating expenses.
---------------------------------------------------------------------------

    \746\ See Eugene F. Fama & Kenneth R. French, The Cross-Section
of Expected Stock Returns, 47 J. Fin. 427 (1992). For CME, the
Commission used monthly return data from January 2003 to December
2012, and for ICE, from December 2005 to December 2012.
    The Commission calculated this data using Daily/Monthly U.S.
Stock Files (copyright) 2012 Center for Research in Security Prices
(CRSP), The University of Chicago Booth School of Business, and
Thomson Reuters Datastream.
    \747\ The Commission based this estimate on the 2012 financial
statements for DTC, CME, FICC, ICE, NSCC, and OCC. To ensure
comparability, the Commission estimated leverage ratios for each of
these clearing agencies by adjusting assets for clearing and
guaranty funds and dividing by shareholders' equity. While DTC,
NSCC, FICC, ICE, and CME all have estimated leverage ratios of
between 1 and 2, the Commission computed a higher leverage ratio of
5 for OCC. As a result, the Commission computed OCC's cost of
capital by first ``unlevering'' CME's estimated beta of 1.14 using
2012 financial statement information to arrive at an unlevered beta
of 0.87 and levering this using OCC's 2012 financial statement
information to arrive at a levered beta of 3.36. Finally, the
Commission applied the current Fama-French monthly risk premium at a
10-year horizon, annualized, and added the current 10 year risk-free
rate to arrive at a levered cost of equity of approximately 26% for
OCC.
    \748\ See e.g., Anat R. Admati, Peter M. DeMarzo, Martin F.
Hellwig & Paul Pfleiderer, Fallacies, Irrelevant Facts, and Myths in
the Discussion of Capital Regulation: Why Bank Equity is Not
Expensive (Working Paper, Mar. 23, 2011), available at http://www.coll.mpg.de/pdf_dat/2010_42online.pdf (addressing the
statement that ``[i]ncreased bank equity requirements increase the
funding costs for banks because they must use more equity, which has
a higher required return'').
---------------------------------------------------------------------------

    Clearing agencies that issue equity in order to satisfy the new
requirements would additionally face costs related to issuance. The
Commission preliminarily recognizes that the cost of maintaining
additional equity resembles an insurance premium against the losses
associated by market disruption in the absence of clearing services.

xi. Proposed Rule 17Ad-22(e)(16): Custody and Investment Risks
    Proposed Rule 17Ad-22(e)(16) requires a covered clearing agency to
have policies and procedures reasonably designed to safeguard both
their own assets as well as the assets of participants, broadening the
requirement applicable to registered clearing agencies in Rule 17Ad-
22(d)(3) to the protection of participants' assets.
    The Commission preliminarily believes that this may have benefits
in terms of protecting against systemic risk, to the extent that
covered clearing agencies to this point have treated their own assets
differently by applying greater safeguards to those assets than with
respect to assets of their members and members' clients. Protection of
member assets is important to cleared markets because, for example, the
assets of a member in default serve as margin and represent liquidity
supplies that a covered clearing agency may access to cover losses. If
covered clearing agencies can quickly access these liquidity sources,
they may be able to limit losses to non-defaulting members.
    Participants may benefit from proposed Rule 17Ad-22(e)(16) in other
ways. Requiring a covered clearing agency's policies and procedures to
safeguard its assets and participant assets and to invest in assets
with minimal credit, liquidity, and market risk may reduce uncertainty
in the value of participant assets and participants' exposure to
mutualized losses. This may allow participants to deploy their own
capital more efficiently. Furthermore, easy access to their own capital
enables members to more freely terminate their participation in covered
clearing agencies.
    Based on its supervisory experience, the Commission preliminarily
believes that current practices at covered clearing agencies meet the
requirements under proposed Rule 17Ad-22(e)(16) in most cases, so the
additional costs and benefits flowing from these requirements would be
generally limited to registered clearing agencies that may enter the
set of covered clearing agencies in the future.
xii. Proposed Rule 17Ad-22(e)(17): Operational Risk Management
    Because, as noted above, proposed Rule 17Ad-22(e)(17) would require
substantially the same set of policies and procedures as Rule 17Ad-
22(d)(4),\749\ the Commission preliminarily believes that proposed Rule
17Ad-22(e)(17) would likely impose limited material additional costs on
covered clearing agencies and produce limited benefits, in line with
the general economic considerations discussed in Part IV.C.1.
---------------------------------------------------------------------------

    \749\ See supra Part 0 (discussing the full set of requirements
under proposed Rule 17Ad-22(e)(17)); see also 17 CFR 240.17Ad-
22(d)(4).
---------------------------------------------------------------------------

xiii. Proposed Rules 17Ad-22(e)(18) Through (20): Membership
Requirements, Tiered Participation, and Linkages
    As discussed earlier, covered clearing agencies play an important
role in the markets they serve. They often enjoy a central place in
financial networks that enables risk sharing, but may also enable them
to serve as conduits for the transmission of risk throughout the
financial system. Proposed Rules (18) through (20) require covered
clearing agencies to have policies and procedures reasonably designed
to explicitly consider and manage the risks associated with the
particular characteristics of their network of direct members, the
broader community of customers, and other parties that rely on the
services provided by the covered clearing agencies or other partners
that the covered clearing agency is connected to through relevant
linkages. The Commission preliminarily believes that these efforts
carry benefits insofar as they reduce the extent to which covered
clearing agencies may impose negative externalities on financial
markets.
    As economies of scale contribute to the business dynamics of
clearing and settlement, there is often only one clearing agency or a
small number of clearing agencies for a particular class of security.
Consequently, membership in a clearing agency may influence competitive
dynamics between members and indirect participants, such as
intermediaries, in cleared markets. Members and indirect participants
may compete for the same set of customers, but indirect participants
must have relationships with members to access clearing services.
Members, therefore, may have incentives in place to extract economic
rents from indirect participants by imposing higher fees or restricting
access to clearing services.
    Permitting fair and open access to clearing agencies and their
services may promote competition among market participants and may
result in lower costs and efficient clearing and settlement services.
Open access to clearing agencies may reduce the likelihood that credit
and liquidity risk become concentrated among a small number of clearing
members, each of which retain a large number of indirect participants
through tiered arrangements. Further, links between clearing agencies
may facilitate risk management across multiple security classes and
improve the efficiency of collateral arrangements.
(1) Proposed Rule 17Ad-22(e)(18): Member Requirements
    While fair and open access to clearing agencies may promote
competition and enhance the efficiency of clearing and settlement
services, these improvements should not come at the expense of prudent
risk management. The soundness of clearing members contributes directly
to the soundness of a clearing agency and mutualization of losses
within clearing agencies expose each clearing member to the default
risk of every other clearing member. Accordingly, it is important for
clearing agencies to control and effectively manage the risks to which
they are exposed by their direct and indirect participants by
establishing risk-related requirements for participation.
    Based on its supervisory experience, the Commission preliminarily
believes that current practices among most covered clearing agencies
involve a mix of objective financial and business requirements
stipulated in publicly-available rulebooks and discretion exercised by
the covered clearing agency. As a result and based on its supervisory
experience, the Commission preliminarily believes that some changes to
policies and procedures at covered clearing agencies may be required
under the proposed rule.
(2) Proposed Rule 17Ad-22(e)(19): Tiered Participation Arrangements
    The Commission preliminarily believes that proposed Rule 17Ad-
22(e)(19) may improve covered clearing agencies' ability to manage its
exposure to market participants that are not clearing members, but
access payment, clearing, or settlement facilities through their
relationships with clearing members. A covered clearing agency that is
able to effectively manage its exposure to its members but fails to
identify, monitor, and manage its exposures to non-member firms may
overlook dependencies that are critical to the stability of cleared
markets. This is particularly true if indirect participants in the
covered clearing agency are large and might potentially precipitate the
default of one or more direct members.
    The data necessary to compute summary statistics that would be
helpful in quantifying the costs and benefits of the proposed rule,
including those that would indicate the size of indirect participants
and the volume of transactions in which they are involved,

are not available. Nevertheless, the Commission is sensitive to the
fact that costs associated with the proposed rules may result in
concentration of clearing services among fewer clearing members. Part
of this process of consolidation may mean an increase in the volume of
trading activity that involves indirect members, making identification
of risks associated with indirect members even more critical. Based on
its supervisory experience, however, the Commission preliminarily
believes that certain covered clearing agencies already have policies
and procedures in place that would satisfy the requirements of the
proposed rule even in the absence of such explicit requirements under
existing rules. Costs and benefits from the proposed rule would come
from those other registered clearing agencies that require updates to
their policies and procedures to come into compliance with the proposed
rule.
    The Commission is sensitive to the fact that indirect participants
play a key role in maintaining competition in markets for
intermediation of trading in securities insofar as they offer investors
a broader choice of intermediaries to deal with in centrally cleared
and settled securities markets. If elements of policies and procedures
under this rule make indirect participation marginally more costly,
then transactions costs for investors may increase.
(3) Proposed Rule 17Ad-22(e)(20): Links
    Links between clearing agencies and their members are only one way
that clearing agencies interface with the financial system. A clearing
agency may also establish links with other clearing agencies and FMUs
through a set of contractual and operational arrangements. For a
clearing agency, the primary purpose of establishing a link would be to
expand its clearing and settlement services to additional financial
instruments, markets, and institutions. Established links among
clearing agencies and FMUs may enable direct and indirect market
participants to have access to a broader spectrum of clearing and
settlement services.
    Sound linkages between clearing agencies that provide CCP services
may also provide their customers with more efficient collateral
arrangements and cross-margining benefits. Cross-margining potentially
relaxes liquidity constraints in the financial system by reducing total
required margin collateral. Resources that would otherwise be posted as
margin may be allocated to more productive investment opportunities.
    A clearing agency that establishes a link or multiple links may
also impose costs on participants in markets it clears by indirectly
exposing them to systemic risk from linked entities. The Commission
acknowledges that clearing agencies that form linkages may be exposed
to additional risks, including credit and liquidity risks, as a
consequence of these links. Links may, however, produce benefits for
members to the extent that diversification and hedging across their
combined portfolio reduces their margin requirements. At the same time,
because such an agreement requires the linked clearing agencies to each
guarantee cross-margining participants' obligations to the other
clearing agency, cross-margining potentially exposes members of one
clearing agency to default risk from members of the other.
    By requiring that covered clearing agencies have policies and
procedures reasonably designed to identify, monitor, and manage risks
related to any link, proposed Rule 17Ad-22(e)(20), like Rule 17Ad-
22(d)(7), reduces the likelihood that such links serve as channels for
systemic risk transmission. Because proposed Rule 17Ad-22(e)(20)
differs only marginally from Rule 17Ad-22(d)(7), the Commission
preliminarily believes that the costs and benefits flowing from the
proposed rule will be incremental, to the extent that the additional
specificity in proposed Rule 17Ad-22(e)(20) causes covered clearing
agencies to modify current practices. The Commission has aggregated
these costs below.
xiv. Proposed Rule 17Ad-22(e)(21): Efficiency and Effectiveness
    Proposed Rule 17Ad-22(e)(21) would impose on covered clearing
agencies requirements in addition to those currently applied to
registered clearing agencies under Rule 17Ad-22(d)(6) by also requiring
covered clearing agencies to have policies and procedures that ensure
that a covered clearing agency's management review efficiency and
effectiveness in four key areas:
     Efficiency and effectiveness in clearing and settlement
arrangements may reduce participants' transaction costs and enhance
liquidity by reducing the amount of collateral that customers must
provide for transactions and the opportunity cost associated with
providing such collateral. Where appropriate, net settlement
arrangements can reduce collateral requirements. Similarly, clearing
arrangements that include a broad scope of products enable clearing
members to take advantage of netting efficiencies across positions.
     Efficient and effective operating structures, including
risk management policies, procedures, and systems, may reduce the
likelihood of failures that may lead to impairment of a clearing
agency's capacity to complete settlement and interfering with its
ability to monitor and manage credit exposures.
     An efficient scope of products that a clearing agency
clears, settles, or records may provide its participants and customers
with more efficient collateral arrangements and cross-margining
benefits that ultimately reduce transaction costs and improve liquidity
in cleared markets.
     Efficient and effective use of technology and
communication procedures facilitates effective payment, clearing and
settlement, and recordkeeping.
    The Commission preliminarily believes that requirements related to
efficient operation of covered clearing agencies are appropriate given
the market power enjoyed by these entities, as discussed in Part
IV.C.1.d. Limited competition in the market for clearing services may
blunt incentives for covered clearing agencies to cost effectively
provide high quality services to market participants in the absence of
regulation.
    Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies would be required to make
updates to their policies and procedures as a result of the proposed
rule. As a result, the Commission expects incremental costs and
benefits to flow from the proposed rule only to the extent that this
additional specificity causes covered clearing agencies to modify
current practices.
xv. Proposed Rule 17Ad-22(e)(22): Communication Procedures and
Standards
    Based on its supervisory experience, the Commission preliminarily
believes that some changes to policies and procedures would be
necessary to meet requirements under proposed Rule 17Ad-22(e)(22).\750\
These costs are included as a part of implementation costs, as
discussed below. However, the Commission understands that covered
clearing agencies already accommodate internationally accepted
communication procedures and standards and preliminarily anticipates
only incremental costs resulting from the proposed rule, in addition to
the above discussed benefits. Registered clearing

agencies that may enter into the set of covered clearing agencies in
the future may need to conform their practices to internationally
accepted communication procedures and standards, as well as adopt new
policies and procedures as a result of the proposed rule, resulting in
more substantial costs.
---------------------------------------------------------------------------

    \750\ See supra Parts 0 and 0(discussing the requirements for
communication procedures and standards under Rule 17Ad-22(e)(22) and
providing the rule text, respectively).
---------------------------------------------------------------------------

xvi. Proposed Rule 17Ad-22(e)(23): Disclosure of Rules, Key Procedures,
and Market Data
    Enhanced disclosure may also improve the efficiency of transactions
in cleared products and improve financial stability more generally by
improving the ability of members of covered clearing agencies to manage
risks and assess costs. Additional information would reduce the
potential for uncertainty on the part of clearing members regarding
their obligations to covered clearing agencies. Proposed Rule 17Ad-
22(e)(23) requires a covered clearing agency to establish, implement,
maintain, and enforce written policies and procedures reasonably
designed to require specific disclosures. As in Rules 17Ad-22(d)(9) and
(11), covered clearing agencies would be required under proposed Rule
17Ad-22(e)(23) to disclose default procedures to the public and
disclose sufficient information to participants to allow them to manage
the risks, fees, and other material costs associated with membership.
    Under proposed Rule 17Ad-22(e)(23), a covered clearing agency must
establish, implement, maintain and enforce written policies and
procedures reasonably designed to update, on a biannual basis, public
disclosures that describe the covered clearing agency's market and
activities, along with information about the agency's legal,
governance, risk management, and operating frameworks, including
specifically covering material changes since the last disclosure, a
general background on the covered clearing agency, a rule-by-rule
summary of compliance with proposed Rules 17Ad-22(e)(1) through (22),
and an executive summary. The proposed rule adds a new requirement,
relative to existing requirements for registered clearing agencies
under Rule 17Ad-22(d)(9), to update the disclosure biannually and to
include, among other things, specific data elements, including details
about system design and operations, transaction values and volumes,
average intraday exposure to participants, and statistics on
operational reliability.
    Additional transparency may have benefits for participants and
cleared markets more generally. For example, if information about the
systems that support a covered clearing agency is public, investors may
be more certain that the market served by this agency is less prone to
disruption and more accommodating of trade. Furthermore, public
disclosure of detailed operating data may facilitate evaluation of each
covered clearing agency's operating record by market participants.
Further, under proposed Rule 17Ad-22(e)(23)(iv), these disclosures
would be made about specific categories that potentially facilitate
comparisons between covered clearing agencies. Additional availability
of information on operations may increase the likelihood that clearing
agencies compete to win market share from participants that value
operational stability. This additional market discipline may provide
additional incentives for covered clearing agencies to maintain
reliability. Finally, updating the public disclosure every two years or
more frequently following certain changes as required pursuant to
proposed Rule 17Ad-22(e)(23)(v) would support the benefits of enhanced
public disclosures by ensuring that information provided to the public
remains up-to-date. The Commission preliminarily believes this would
reduce the likelihood that market participants are forced to evaluate
covered clearing agencies on the basis of stale data.
    Clearing members, in particular, may benefit from additional
disclosure of risk management and governance arrangements. These
details potentially have significant bearing on clearing members' risk
management because they may remove uncertainty surrounding members'
potential obligations to a covered clearing agency. In certain
circumstances, additional disclosures may reveal to members that the
expected costs of membership exceed the expected benefits of
membership, and that exit from the clearing agency may be privately
optimal. In addition to the costs of concentration among members
discussed in earlier sections, the Commission also recognizes the
potential for systemic benefits from termination. Member exit on the
basis of more precise information may reduce the risk posed to other
financial market participants by members who, given additional
information, might prefer to terminate their membership, due to an
inability to manage the risks to which a covered clearing agency
exposes them. While exit from clearing agencies may have consequences
for competition among clearing members, the Commission preliminarily
believes that encouraging the participation of firms that are not able
to bear the risks of membership is not an appropriate means of
mitigating the effects of market power on participants in cleared
markets.
    Based on its supervisory experience, the Commission preliminarily
believes that some covered clearing agencies will require changes to
policies and procedures as a result of the proposed rules. Compliance
costs associated with changes to policies and procedures, biannual
review and disclosure of additional data are included in implementation
costs, below.
b. Proposed Rule 17Ab2-2
    Proposed Rule 17Ad-22(e) would subject covered clearing agencies to
requirements that are in many instances more specific than requirements
under Rule 17Ad-22(d) and in some cases produce new obligations to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to test, report, and disclose key
elements of a covered clearing agency's performance, risk management,
and operations.
    Proposed Rule 17Ab2-2 provides procedures for the Commission to
determine on its own initiative, or upon voluntary application by a
registered clearing agency, whether a registered clearing agency is a
covered clearing agency and therefore is subject to proposed Rule 17Ad-
22(e). It also provides procedures for the Commission to determine
whether a covered clearing agency is systemically important in multiple
jurisdictions or has a complex risk profile and therefore should be
subject to stricter risk management standards under proposed Rule 17Ad-
22(e).
    Proposed Rule 17Ab2-2(a) provides procedures for the Commission to
determine whether a registered clearing agency that is otherwise not a
designated clearing agency or a complex risk profile clearing agency is
a covered clearing agency on the basis of the products it clears or
other characteristics the Commission may deem appropriate under the
circumstances. While the Commission preliminarily believes the current
scope of proposed Rule 17Ad-22(e) is appropriate,\751\ proposed Rule
17Ab2-2(a) would provide the Commission with latitude in adjusting the
scope of proposed Rule 17Ad-22(e) in response to financial innovation
and changing economic circumstances. Proposed Rule 17Ab2-2(a)
contemplates voluntary

application of registered clearing agencies to become covered clearing
agencies.
---------------------------------------------------------------------------

    \751\ See supra Part 0 (discussing the appropriateness of the
proposed scope of Rule 17Ad-22(e)).
---------------------------------------------------------------------------

    Proposed Rule 17Ab2-2(b) includes criteria the Commission may
consider in determining whether a covered clearing agency is
systemically important in multiple jurisdictions. Two of these criteria
are based on input from a set of other bodies comprised of FSOC and
regulators in other jurisdictions. As a result, it is possible that the
flow of costs and benefits from proposed Rule 17Ad-22(e) may be
partially determined by the decisions of other regulatory bodies.
    Proposed Rule 17Ab2-2(c), by contrast, suggests characteristics of
the financial products that a clearing agency clears as a basis upon
which the Commission may determine that a clearing agency's activity
has a complex risk profile.
    The impact of proposed rules that determine the application of
enhanced requirements could have direct costs on registered clearing
agencies in the form of legal or consulting costs incurred as a result
of seeking a determination from the Commission. In instances where
these clearing agencies choose to apply to the Commission for status as
a covered clearing agency under proposed Rule 17Ab2-2(a), the
Commission preliminarily believes that a registered clearing agency's
voluntary application would suggest that the applicant's private
benefits from regulation under proposed Rule 17Ad-22(e) justify its
costs.
    Quantifiable costs related to determinations under proposed Rule
a17Ab2-2 are noted in Part IV.C.3.d.
    Indirect effects of the determination process may have important
economic effects on the ultimate volume of clearing activity, beyond
the economic effects of the proposed requirements themselves. An
important feature of proposed Rule 17Ab2-2 is providing transparency
for the determinations process. On one hand, transparency may allow
clearing agencies to plan for new obligations under proposed Rule 17Ad-
22(e); on the other, transparency may allow clearing agencies to
restructure their business to avoid falling within the scope of
proposed Rule 17Ad-22(e).
    To the extent that proposed Rule 17Ad-22(e), if adopted as
proposed, may increase costs relative to their peers for covered
clearing agencies, clearing agencies whose activities have a more
complex risk profile, and clearing agencies systemically important in
multiple jurisdictions, clearing agencies may have incentives to
restructure their businesses strategically to avoid these Commission
determinations or otherwise exit any services made prohibitively
expensive by such determinations. Such potential consequential effects
would be among the considerations for the Commission to review in
connection with any specific decision under proposed Rule 17Ab2-2.
Restructuring may involve spinning off business lines into separate
entities, limiting the scope of clearing activities to certain markets,
or limiting the scale of clearing activities within a single
market.\752\
---------------------------------------------------------------------------

    \752\ See Exchange Act Release No. 34-63107 (Oct. 14, 2010), 75
FR 65881, 65919 & n.206 (Oct. 26, 2010).
---------------------------------------------------------------------------

    Any one of these responses could result in inefficiencies. As
suggested in Part IV.C.2.b, registered clearing agencies may incur
costs as a result of attempts to restructure. Clearing agencies that
break up along product lines or fail to consolidate when consolidation
is efficient may fail to take advantage of economies of scope and
result in inefficient use of collateral.\753\ Similarly, clearing
agencies that limit their scale may provide lower levels of clearing
services to the markets that they serve.
---------------------------------------------------------------------------

    \753\ See, e.g., Darrell Duffie & Haoxiang Zhu, Does a Central
Clearing Counterparty Reduce Counterparty Risk?, 1 Rev. Asset
Pricing Stud. 74 (2011) (addressing potential inefficiencies
resulting from fragmented clearing along product lines).
---------------------------------------------------------------------------

c. Proposed Rule 17Ad-22(f)
    Proposed Rule 17Ad-22(f) includes a provision that specifies
Commission authority over designated clearing agencies for which it is
the supervisory agency. Since this provision codifies existing
statutory authority, the Commission does not anticipate any economic
effects from this proposed rule.
d. Quantifiable Costs and Benefits
    As discussed above, the proposed amendments to Rule 17Ad-22 and
proposed Rule 17Ab2-2 would impose certain costs on covered clearing
agencies. As discussed in Part IV.C.3.a.ii, if a covered clearing
agency is required to recruit new directors, the Commission
preliminarily estimates a cost per director of $73,000.\754\ As
discussed in Part IV.C.3.a.iv(4), the Commission preliminarily
estimates costs associated with liquidity resources under proposed
Rules 17Ad-22(e)(7) and (a)(15) would likely fall between $133 million
and $225 million per year across all covered clearing agencies. As
discussed in Part IV.C.3.a.iv(5), the Commission preliminarily believes
that startup costs related to financial risk management systems for
existing covered clearing agencies, related to new testing and model
validation requirements to be between $5 million to $25 million. The
Commission also estimates a lower bound on ongoing costs related to
these requirements of $1 million per year. If covered clearing agencies
were to hire external consultants for the purposes of performing model
validation required under proposed Rules 17Ad-22(e)(4) and (7) through
policies and procedures, the Commission preliminarily estimates the
ongoing cost associated with hiring such consultants would be about
$4,388,160 in the aggregate.\755\ As discussed in Part IV.C.3.a.x, the
Commission expects quantifiable economic costs as a result of proposed
Rule 17Ad-22(e)(15) to be between $16 million and $50 million per year
across covered clearing agencies.
---------------------------------------------------------------------------

    \754\ See supra note 705.
    \755\ See supra Part 0, in particular note 734.
---------------------------------------------------------------------------

    In addition, proposed Rules 17Ad-22(e)(3), (4), (6), (7), (15) and
(21) all include elements of review by either a covered clearing
agency's board or its management on an ongoing basis. The Commission
preliminarily estimates the cost of ongoing review for these proposed
rules at approximately $39,312 per year.\756\ The proposed rules would
also impose certain implementation burdens and related costs on covered
clearing agencies.\757\ These costs generally include assessment costs
to determine compliance with the proposed rules and

costs related to new policies and procedures and updates to existing
policies and procedures required by the proposed rules. In Part III,
the Commission estimated the burdens of these implementation
requirements for covered clearing agencies.
---------------------------------------------------------------------------

    \756\ To monetize the cost of board review, the Commission used
a recent report by Bloomberg stating that the average director works
250 hours and earns $251,000, resulting in an estimated $1000 per
hour for board review. As a proxy for the cost of management review,
the Commission is estimating $457 per hour, based upon the Director
of Compliance cost data from the SIFMA table, see infra note 778.
The Commission estimates the total cost of review for each clearing
agency as follows: ((Board Review for 32 hours at $1000 per hour) +
(Management Review for 16 hours at $457 per hour)) = $39,312. The
Commission requests comment on this estimate.
    \757\ To monetize the internal costs the Commission staff used
data from the SIFMA publications, Management and Professional
Earnings in the Security Industry--2012, and Office Salaries in the
Securities Industry--2012, modified by the Commission staff to
account for an 1800 hour work-year and multiplied by 5.35
(professionals) or 2.93 (office) to account for bonuses, firm size,
employee benefits and overhead. Commission staff also estimated an
hourly rate for a Chief Financial Officer. The Web site
www.salary.com reports that median CFO annual salaries in 2012 were
$307,554. A Grant Thornton LLP survey estimated that in 2012 public
company CFOs received an average annual salary of $286,500. Using an
approximate midpoint of these two estimates of $300,000 per year,
and dividing by an 1800-hour work year and multiplying by the 5.35
factor which normally is used to include benefits but here is used
as an approximation to offset the fact that New York salaries are
typically higher than the rest of the country, the result is $892
per hour. The Commission requests comment on this estimate.
---------------------------------------------------------------------------

    For a new entrant into the set of covered clearing agencies from
the set of registered clearing agencies, the Commission preliminarily
estimates the startup compliance costs associated with policies and
procedures to be $592,215,\758\ and compliance costs associated with
the determinations process under proposed Rule 17Ab2-2 to be
$9,148.\759\ Based on its supervisory experience, the Commission
preliminarily believes that in many cases registered clearing agencies
are already in compliance with many of the requirements included in the
proposed rules, so this cost represents an upper bound on upfront
costs. Conditioned on its current understanding of current market
practice at covered clearing agencies, the Commission preliminarily
estimates that the total costs across all existing covered clearing
agencies will be $4,032,720.\760\ The Commission preliminarily
estimates that in the aggregate existing covered clearing agencies
would be subject to ongoing costs associated with the proposed rule in
the amount of approximately $801,980 per year.\761\
---------------------------------------------------------------------------

    \758\ The total initial cost for an entrant that is not a CSD
and does engage in activities with a more complex risk profile was
calculated as follows: ((Assistant General Counsel for 428 hours at
$467 per hour) + (Compliance Attorney for 365 hours at $310 per
hour) + (Administrative Assistant for 2 hours at $72 per hour) +
(Computer Operations Department Manager for 300 hours at $361 per
hour) + (Senior Business Analyst for 85 hours at $245 per hour) +
(Senior Risk Management Specialist for 114 hours at $249 per hour) +
(Chief Compliance Office for 102 hours at $441 per hour) + (Senior
Programmer for 53 hours at $282 per hour) + (Chief Financial Officer
for 50 hours at $892 per hour) + (Financial Analyst for 70 hours at
$245 per hour)) = $592,215.
    \759\ The total cost associated with determinations under
proposed Rule 17Ab2-2 was calculated as follows: ((Assistant General
Counsel for 2 hours at $467 per hour) + (Compliance Attorney for 4
hours at $310 per hour) + (Outside Counsel for 6 hours at $400 per
hour)) x 2 registered clearing agencies = $9,148.
    \760\ The total initial cost was calculated as follows:
((Assistant General Counsel for 2,906 hours at $467 per hour) +
(Compliance Attorney for 2,475 hours at $310 per hour) +
(Administrative Assistant for 14 hours at $72 per hour) + (Computer
Operations Department Manager for 2,030 hours at $361 per hour) +
(Senior Business Analyst for 565 hours at $245 per hour) + (Senior
Risk Management Specialist for 773 hours at $249 per hour) + (Chief
Compliance Office for 699 hours at $441 per hour) + (Senior
Programmer for 361 hours at $282 per hour) + (Chief Financial
Officer for 350 hours at $892 per hour) + (Financial Analyst for 490
hours at $245 per hour) + (Intermediate Accountant for 15 hours at
$155 per hour)) = $4,032,720.
    \761\ The total ongoing cost was calculated as follows:
((Compliance Attorney for 1,851 hours at $310 per hour) +
(Administrative Assistant for 137 hours at $72 per hour) + (Senior
Business Analyst for 151 hours at $245 per hour) + (Senior Risk
Management Specialist for 70 hours at $249 per hour) + (Risk
Management Specialist for 1,251 hours at $131 per hour)) = $801,980.
---------------------------------------------------------------------------

    A benefit of the proposed rules that the Commission is able to
quantify is the impact of QCCP status of OCC to non-U.S. bank clearing
members at OCC. This benefit comes as a result of lower capital
requirements against exposures to QCCPs relative to non-qualifying
CCPs. In Part IV.C.1.e, the Commission provided an estimate of the
upper bound of this benefit, $600 million per year, or 0.60% of the
aggregate 2012 net income reported by bank clearing members at OCC. The
Commission preliminarily believes that the actual benefits flowing from
QCCP status would likely be higher due to benefits for foreign bank
members of FICC and ICEEU, in addition to the benefits with respect to
OCC discussed above.\762\
---------------------------------------------------------------------------

    \762\ See supra note 686 and accompanying text.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed rules will
result in an increase in financial stability insofar as they result in
minimum standards at covered clearing agencies that are higher than
those standards implied by current practices at covered clearing
agencies. Some of this increased stability may come as a result of
lower activity as the proposed rules cause participants to internalize
a greater proportion of the costs that their activity imposes on the
financial system, reducing the costs of default, conditional on a
default event occurring. Increased stability may also come as a result
of higher risk management standards at covered clearing agencies that
effectively lower the probability that either covered clearing agencies
or their members default.
    The Commission preliminarily believes that clearance and settlement
of securities and security-based swaps is fundamental to the stability
of financial markets. As discussed above, clearing agencies may not
fully consider the costs they could impose on financial market
participants.\763\ As a result of the potential negative externalities
associated with their activities, enhanced risk management standards
are particularly important for those clearing agencies that pose the
greatest risk to financial markets and the U.S. financial system.
---------------------------------------------------------------------------

    \763\ See Duffie, Li & Lubke, supra note 563 (noting that the
failure of a CCP could suddenly expose many major market
participants to losses); see also Cecchetti, Gyntelberg &
Hollanders, supra note 19 (``[A] CCP concentrates counterparty and
operational risks and the responsibilities for risk management.
Therefore it is critical that CCPs have both effective risk control
and adequate financial resources.''); supra note 278 and
accompanying text (asserting that delays and breakdowns in the
payments and clearance process and the perception that the clearing
system might not be able to meet obligations may have contributed to
price declines during the October 20, 1987 market crash).
---------------------------------------------------------------------------

D. Request for Comments

    The Commission generally requests comment about its preliminary
analysis of the economic effects of the proposed rules and any
qualitative and quantitative data that would facilitate an evaluation
and assessment of the economic effects of this proposal. In addition,
the Commission requests comment on the following specific issues:
     Has the Commission appropriately identified the relevant
costs and benefits associated with each requirement under proposed Rule
17Ad-22(e)? Why or why not?
     Are there any provisions of proposed Rule 17Ad-22(e) for
which the costs of enhanced risk management standards appear
inappropriate relative to the benefits of such standards, particularly
given existing requirements under Rule 17Ad-22(d)? Please explain.
     Would particular provisions of proposed Rule 17Ad-22(e)
improve or diminish competition between covered clearing agencies?
Which provisions are likely to have such effects and through what
transmission channels?
     Would the scope of proposed Rule 17Ad-22(e) have
implications for competition between covered clearing agencies and
registered clearing agencies that are not covered clearing agencies?
     Would particular provisions of proposed Rule 17Ad-22(e)
improve or diminish competition between members of covered clearing
agencies? Are there any provisions that would allow a subset of members
to compete on better terms than other members?
     How would the effects of QCCP status will be allocated
across members? Can market participants provide any qualitative or
quantitative data to help the Commission evaluate the effects of QCCP
status on clearing members and any heterogeneity in trade exposures and
default fund exposures to covered clearing agencies across bank and
non-bank clearing members?
     Would bank clearing members to be constrained by the Basel
III capital requirements? Do bank clearing members typically target
tier one or total capital ratios as a business practice?
     In areas where existing requirements under Rule 17Ad-22(d)
could be viewed as being consistent with the PFMI, and so could
potentially earn QCCP status for covered clearing

agencies, do the costs of additional requirements under proposed Rule
17Ad-22(e) appear appropriate relative to benefits of these
requirements, aside from QCCP status? Please explain.
     Does the Commission's proposed definition of qualifying
liquid resources adequately reflect the ability with which covered
clearing agency assets may be used to meet funding obligations? Has the
Commission adequately assessed the costs and benefits of requiring
funding arrangements before considering non-cash resources
``qualifying''?
     What would be the potential costs and benefits of
requiring covered clearing agencies to hold liquid net assets in
accordance with proposed Rule 17Ad-22(e)(15)? Can you provide
qualitative and quantitative data to aid the Commission in evaluating
these potential costs and benefits?
     Has the Commission adequately assessed the risks posed by
indirect participation at covered clearing agencies? Can you provide
qualitative and quantitative data to aid the Commission in evaluating
the level of indirect participation in cleared markets, the
heterogeneity of indirect participation across clearing members and the
implications for networks of exposures in cleared markets?

V. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') requires the Commission,
in promulgating rules, to consider the impact of those rules on small
entities.\764\ Section 603(a) of the Administrative Procedure Act,\765\
as amended by the RFA, generally requires the Commission to undertake a
regulatory flexibility analysis of all proposed rules to determine the
impact of such rulemaking on ``small entities.'' \766\ Section 605(b)
of the RFA states that this requirement shall not apply to any proposed
rule which, if adopted, would not have a significant economic impact on
a substantial number of small entities.\767\
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    \764\ See 5 U.S.C. 601 et seq.
    \765\ 5 U.S.C. 603(a).
    \766\ Section 601(b) of the RFA permits agencies to formulate
their own definitions of ``small entities.'' See 5 U.S.C. 601(b).
The Commission has adopted definitions for the term ``small entity''
for the purposes of rulemaking in accordance with the RFA. These
definitions, as relevant to this proposed rulemaking, are set forth
in Rule 0-10, 17 CFR 240.0-10.
    \767\ See 5 U.S.C. 605(b).
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A. Registered Clearing Agencies

    The proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2
would apply to covered clearing agencies, which would include
registered clearing agencies that are designated clearing agencies,
complex risk profile clearing agencies, or clearing agencies that
otherwise have been determined to be covered clearing agencies by the
Commission. For the purposes of Commission rulemaking and as applicable
to the proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2, a
small entity includes, when used with reference to a clearing agency, a
clearing agency that (i) compared, cleared, and settled less than $500
million in securities transactions during the preceding fiscal year,
(ii) had less than $200 million of funds and securities in its custody
or control at all times during the preceding fiscal year (or at any
time that it has been in business, if shorter), and (iii) is not
affiliated with any person (other than a natural person) that is not a
small business or small organization.\768\
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    \768\ See 17 CFR 240.0-10(d).
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    Based on the Commission's existing information about the clearing
agencies currently registered with the Commission,\769\ the Commission
preliminarily believes that such entities exceed the thresholds
defining ``small entities'' set out above. While other clearing
agencies may emerge and seek to register as clearing agencies, the
Commission preliminarily does not believe that any such entities would
be ``small entities'' as defined in Exchange Act Rule 0-10.\770\ In any
case, clearing agencies can only become subject to the new requirements
under proposed Rule 17Ad-22(e) should they meet the definition of a
covered clearing agency, as described above. Accordingly, the
Commission preliminarily believes that any such registered clearing
agencies will exceed the thresholds for ``small entities'' set forth in
Exchange Act Rule 0-10.
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    \769\ In 2012, DTCC processed $1.6 quadrillion in financial
transactions, subsidiary DTC settled $110.3 trillion of securities
and held securities valued at $37.2 trillion, subsidiary NSCC
processed an average daily value of $742.7 billion in equity
securities, subsidiary FICC cleared $1.116 quadrillion in government
securities, and FICC's Mortgage-Backed Securities Division cleared
$104 trillion of transactions in agency mortgage-backed securities.
See DTCC, 2012 Annual Report, available at http://www.dtcc.com/about/annual-report.aspx and http://www.dtcc.com/annuals/2012/br-settlement-and-asset-services.html; FSOC, 2013 Annual Report, supra
note 39, at 99.
    In addition, OCC cleared more than 4 billion contracts and held
margin of $78.8 billion at the end of 2012. See OCC, 2012 Annual
Report, available at http://www.optionsclearing.com/components/docs/about/annual-reports/occ_2012_annual_report.pdf. CME Group had
total contract volume of 2.89 billion contracts (in round turn
trades) with a total notional value of $806 trillion. See CME Group,
2012 Annual Report, available at http://files.shareholder.com/downloads/CME/2635449816x0x653543/02DB7C7F-ACF0-4D73-9AD7-1ACCEF68559A/CME_Group_2012_Annual_Report.pdf. ICE and ICEEU
together cleared CDS with a total notional value of $10.24 trillion.
See Intercontinental Exchange, Inc., 2012 Annual Report, available
at http://files.shareholder.com/downloads/ICE/2623237906x0x649669/DFB49A9C-152C-4287-848C-7CCDDA42D61E/ICE_2012_Annual_Report_FINAL.pdf.
    \770\ See 17 CFR 240.0-10(d). The Commission based this
determination on its review of public sources of financial
information about registered clearing agencies and lifecycle event
service providers for OTC derivatives.
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B. Certification

    For the reasons described above, the Commission certifies that the
proposed amendments to Rule 17Ad-22 and proposed Rule 17Ab2-2 would not
have a significant economic impact on a substantial number of small
entities for purposes of the RFA. The Commission requests comment
regarding this certification. The Commission requests that commenters
describe the nature of any impact on small entities, including clearing
agencies and counterparties to security and security-based swap
transactions, and provide empirical data to support the extent of the
impact.

VI. Small Business Regulatory Enforcement Fairness Act

    Under the Small Business Regulatory Enforcement Fairness Act of
1996,\771\ a rule is considered ``major'' where, if adopted, it results
or is likely to result in (i) an annual effect on the economy of $100
million or more (either in the form of an increase or a decrease); (ii)
a major increase in costs or prices for consumers or individual
industries; or (iii) significant adverse effect on competition,
investment, or innovation. The Commission requests comment on the
potential impact of the proposed amendments to Rule 17Ad-22 and
proposed Rule 17Ab2-2 on the economy on an annual basis, any potential
increase in costs or prices for consumers or individual industries, and
any potential effect on competition, investment, or innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
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    \771\ Public Law 104-121, 110 Stat. 857 (1996) (codified in
various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
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VII. Statutory Authority and Text of Amended Rule 17Ad-22 and Proposed
Rule 17Ab2-2

    Pursuant to the Exchange Act, particularly Section 17A thereof, 15
U.S.C. 78q-1, and Section 805 of the Clearing Supervision Act, 12
U.S.C. 5464, the Commission proposes to amend Rule 17Ad-22 and proposes
new Rule 17Ab2-2.

List of Subjects in 17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

Text of Amendment

    In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE

0
1. The general authority citation for Part 240 continues to read, and
the sectional authority for Sec.  240.17Ad-22 is revised to read, as
follows:

    Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78d, 78e, 78f, 78g, 78i, 78j,
78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 78p, 78q, 78q-
1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37,
80b-3, 80b-4, 80b-11, and 7201 et. seq.; 18 U.S.C. 1350; and 12
U.S.C. 5221(e)(3), unless otherwise noted.
* * * * *
    Section 240.17Ad-22 is also issued under 12 U.S.C. 5461 et seq.
* * * * *
0
2. Section 240.17Ab2-2 is added to read as follows:

Sec.  240.17Ab2-2  Determinations affecting covered clearing agencies.

    (a) The Commission may, if it deems appropriate, upon application
by any clearing agency or member of a clearing agency, or on its own
initiative, determine whether a registered clearing agency should be
considered a covered clearing agency. In determining whether a clearing
agency should be considered a covered clearing agency, the Commission
may consider:
    (1) Characteristics such as the clearing of financial instruments
that are characterized by discrete jump-to-default price changes or
that are highly correlated with potential participant defaults; or
    (2) Such other characteristics as it deems appropriate in the
circumstances.
    (b) The Commission may, if it deems appropriate, upon application
by any clearing agency or member of a clearing agency, or on its own
initiative, determine whether a covered clearing agency is systemically
important in multiple jurisdictions. In determining whether a covered
clearing agency is systemically important in multiple jurisdictions,
the Commission may consider:
    (1) Whether the covered clearing agency is a designated clearing
agency;
    (2) Whether the clearing agency has been determined to be
systemically important by one or more jurisdictions other than the
United States through a process that includes consideration of whether
the foreseeable effects of a failure or disruption of the designated
clearing agency could threaten the stability of each relevant
jurisdiction's financial system; or
    (3) Such other factors as it may deem appropriate in the
circumstances.
    (c) The Commission may, if it deems appropriate, determine whether
any of the activities of a clearing agency providing central
counterparty services, in addition to clearing agencies registered with
the Commission for the purpose of clearing security-based swaps, have a
more complex risk profile. In determining whether a clearing agency's
activity has a more complex risk profile, the Commission may consider:
    (1) Characteristics such as the clearing of financial instruments
that are characterized by discrete jump-to-default price changes or
that are highly correlated with potential participant defaults; or
    (2) Such other characteristics as it deems appropriate in the
circumstances, as factors supporting a finding of a more complex risk
profile.
    (d) The Commission shall publish notice of its intention to
consider making a determination under paragraph (a), (b), or (c) of
this section, together with a brief statement of the grounds under
consideration therefor, and provide at least a 30-day public comment
period prior to any such determination, giving all interested persons
an opportunity to submit written data, views, and arguments concerning
such proposed determination. The Commission may provide the clearing
agency subject to the proposed determination opportunity for hearing
regarding the proposed determination.
    (e) Notice of determinations under paragraph (a), (b), or (c) of
this section shall be given by prompt publication thereof, together
with a statement of written reasons therefor.
    (f) For purposes of this rule, the terms central counterparty,
covered clearing agency, designated clearing agency, and systemically
important in multiple jurisdictions shall have the meanings set forth
in Sec.  240.17Ad-22(a).
0
3. Amend Sec.  240.17Ad-22 by:
0
a. Revising paragraph (a) and the introductory text of paragraph (d);
and
0
b. Adding paragraphs (e) and (f).
    The revisions and additions read as follows:

Sec.  240.17Ad-22  Standards for clearing agencies.

    (a) Definitions. For purposes of this section:
    (1) Backtesting means an ex-post comparison of actual outcomes with
expected outcomes derived from the use of margin models.
    (2) Central counterparty means a clearing agency that interposes
itself between the counterparties to securities transactions, acting
functionally as the buyer to every seller and the seller to every
buyer.
    (3) Central securities depository services means services of a
clearing agency that is a securities depository as described in Section
3(a)(23)(A) of the Exchange Act (15 U.S.C. 78c(a)(23)(A)).
    (4) Clearing agency involved in activities with a more complex risk
profile means a clearing agency registered with the Commission under
Section 17A of the Exchange Act (15 U.S.C. 78q-1) and that:
    (i) Provides central counterparty services for security-based
swaps;
    (ii) Has been determined by the Commission to be involved in
activities with a more complex risk profile at the time of its initial
registration; or
    (iii) Is subsequently determined by the Commission to be involved
in activities with a more complex risk profile pursuant to Sec.
240.17Ab2-2(c).
    (5) Conforming model validation means an evaluation of the
performance of each material risk management model used by a covered