security-based swaps.\164\ To address this concern, CCPs have
implemented procedures that provide for the management and oversight of
the liquidation or transfer of the defaulting member's positions by a
default management committee comprising senior CCP staff and
representatives from member institutions.\165\
---------------------------------------------------------------------------

    \162\ Jump-to-default risk refers to the expected change in the
value of a CDS contract if a credit event were to occur with respect
to a reference entity under the terms of the CDS contract,
triggering an obligation for the seller of protection under the
contract to make a lump sum payment to the protection buyer. Jump-
to-default only refers to the incremental information in the
determination that a credit event has occurred because the market
already prices the probability of a credit event. In practice,
credit events are largely anticipated such that jump-to-default
results in small changes in value as opposed to a first order
pricing effect. Jump-to-default risk exists for all CDS, not merely
those on reference entities perceived as risk credits. While the
decline in contract value from a credit event is usually bigger for
creditworthy reference entities (because the initial contract value
is higher and thus has farther to fall), jump-to-default risk can
also be measured for distressed reference entities that are expected
to suffer a credit event in the near future. As a hypothetical
example, market participants might have measured the jump-to-default
risk in ``Hypothetical Risky Corporation'' five-year CDS when the
CDS was trading at 70% upfront (that is, a seller would need to
receive an up-front payment of 70% of notional value to write the
contract) and the expected value in default was 80% upfront
(implying a 20% recovery rate) as being equal to 10% of notional
value; equally, they might have measured the jump-to-default risk of
``Hypothetical Safe Corporation'' five-year CDS when it was trading
at 0.30% per annum and no up-front payment (roughly equivalent to an
up-front payment of 1.5%) with an expected value in default of 60%
upfront (implying a 40% recovery rate) as being equal to
approximately 58.5% of notional value. See generally Darrell Duffie
and Haoxiang Zhu, Does a Central Clearing Counterparty Reduce
Counterparty Risk? (Stanford Univ. 2010), available at http://
www.stanford.edu/~duffie/DuffieZhu.pdf.
    \163\ See, e.g., Stavros Peristiani, Vanessa Savino, ``Are
Credit Default Swaps Associated with Higher Corporate Defaults?'',
Federal Reserve Bank of New York Staff Report No. 494 (May 2011);
Alessandro Fontana and Martin Scheicher, ``An analysis of euro area
sovereign CDS and their relation with government bonds,'' European
Central Bank Working Paper Series, No. 1271 (Dec. 2010).
    \164\ For example, when a participant defaults, the CCP
terminates all of its contracts with the defaulting participant. The
traditional procedures for handling a default, which are used by
CCPs for most exchange-traded derivatives, call for the CCP to
promptly enter the market and replace the contracts, so as to hedge
against further losses on the open positions created by termination
of the defaulter's contracts. However, if the markets for the
contracts cleared by the CCP are illiquid, entering the market may
induce adverse price movements, especially if the defaulting
participant's positions are large relative to the overall market for
the contracts. See Bank for International Settlement's Committee on
Payment and Settlement Systems, New Developments in Clearing and
Settlement Arrangements for OTC Derivatives (Mar. 2007).
    \165\ See id.
---------------------------------------------------------------------------

    The Commission does not believe that changes in the security-based
swap market resulting from the Dodd-Frank Act (e.g., mandatory clearing
requirements, the establishment of the Council, etc.) have eliminated
or will eliminate the additional risk management challenges of
security-based swaps noted above. Therefore, the Commission believes
that it should codify the existing standard for maintenance of
financial resources established by CCPs currently clearing security-
based swaps.
    The Commission notes that current industry participants recognize
the need for more stringent financial resource requirements for CCPs
that clear credit default swaps.\166\ This point is evidenced by the
fact that the ``cover two'' standard has been employed since before the
enactment of the Dodd-Frank Act and prior to the adoption of the
European Market Infrastructure Regulation (``EMIR'') \167\ by the major
CCPs clearing credit default swaps, both in the United States and
internationally. For example, both of the registered CCPs providing
clearing services for credit default swap transactions to customers in
the United States, ICE Clear Credit and ICE Clear Europe, already meet
a ``cover two'' standard as does CME Group (``CME'') with respect to
its clearing service for index credit default swaps, which is
registered with the Commission but does not yet provide CCP services
for security-based swaps.\168\ LCH.Clearnet, a leading CCP

for OTC derivatives in Europe, maintains a ``cover two'' standard for
its credit default swap CCP activities.\169\ These practices are
consistent with the ``cover two'' financial resources requirement for
European CCPs contained in EMIR.\170\
---------------------------------------------------------------------------

    \166\ See, e.g., ISDA Letter at 1; see also Letter to William C.
Dudley from the OTC Derivatives Supervisors Group, dated March 31,
2011, available at http://www.newyorkfed.org/newsevents/news/markets/2011/SCL0331/pdf (generally supporting enhancing the
framework for OTC derivatives risk management).
    \167\ Regulation No. 648/2012 of the European Parliament and of
the Council of 4 July 2012 on OTC derivatives, central
counterparties and trade repositories, 2012 O.J. (L 201).
    \168\ See CFTC-SEC Staff Roundtable on Clearing of Credit
Default Swaps (Oct. 2010), at 123, available at<EMAIL_ADDRESS>(Stan Ivanov, ICE Clear Credit stating ``at ICE
we look at two simultaneous defaults of the two biggest losers upon
extreme conditions * * *.''). See also CDS Clearing Solution ICE
Clear Europe (June 2012), at 6, available at https://www.theice.com/publicdocs/clear_europe/ICE_Clear_Europe_CDS_Clearing_Overview.pdf (``Guaranty Fund covers simultaneous default of 2
largest Clearing Members''); CME Rulebook, Chapter 8H, Rule 8H07,
available at http://www.cmegroup.com/rulebook/CME/I/8H/07.html.
    \169\ See LCH.Clearnet CDS Clearing Rulebook, Chapter 4, Article
<IP_ADDRESS> (May 5, 2012), available at http://www.lchclearnet.com/Images/CDSClear%20Rulebook_tcm6-61343.pdf.
    \170\ See supra note 167, at 43.
---------------------------------------------------------------------------

    Given that both of the registered CCPs providing clearing services
for security-based swap transactions already meet the proposed
standard, and that CME, which proposes to provide such services, is
currently following a ``cover two'' standard in index credit default
swap clearing, the Commission believes that Rule 17Ad-22(b)(3) does not
represent a change in existing market practices and would not hinder
the growth of existing security-based swap CCPs.\171\ Furthermore, the
Commission does not believe the rule poses an overly burdensome barrier
to entry for future CCPs wishing to clear security-based swaps, as we
do not intend the rule to require a registered CCP clearing security-
based swaps to cover its two largest participant exposures in the event
of default for all of its products. A CCP can choose to maintain a
separate default fund for security-based swaps, limiting the overall
financial burden.\172\
---------------------------------------------------------------------------

    \171\ See supra note 168.
    \172\ See CME Rulebook, Chapter 8, Rule 802, available at http://www.cmegroup.com/rulebook/CME/I/8/02.html (``The Clearing House
shall establish a guaranty fund (the ``Base Guaranty Fund'') for
products other than CDS Products * * *''); see also CME Rulebook,
Chapter 8H, Rule 8H07, available at http://www.cmegroup.com/rulebook/CME/I/8H/07.html (``The Clearing House shall establish a
financial safeguards package to support CDS clearing, and each CDS
Clearing Member shall make a CDS Guaranty Fund deposit with the
Clearing House.''); see generally discussion infra Section
V.B.1.iii.c.
---------------------------------------------------------------------------

    We are adopting Rule 17Ad-22(b)(3) with modifications intended to
recognize different types of structures currently employed by CCPs
clearing security-based swaps and similar structures that may be
developed in the future. The final rule allows that the policies and
procedures may provide that the additional financial resources required
to be held under the ``cover two'' standard may be maintained for the
entire CCP or in separately maintained funds. This modification from
the proposal recognizes that clearing agencies' practices may be
structured as (i) conducting security-based swap clearing activities in
a separate legal entity or (ii) maintaining within one legal entity
separate rules, membership requirements, risk management practices, and
financial resources specifically designed to cover the CCP's exposures
to a separate pool of instruments that includes security-based swaps.
The Commission also believes that as security-based swap CCPs introduce
new products for clearing on an incremental basis in the future, the
adopted rule will provide them with appropriate flexibility to organize
their operations to obtain additional financial resources to cover
exposures for each new security-based swap product in the manner most
appropriate for their organization.\173\
---------------------------------------------------------------------------

    \173\ The Commission is also aware that clearing agencies that
provide CCP services for security-based swap transactions generally
do not separate their operations and risk management practices
between swap and security-based swap instruments. For example, we
understand that some registered clearing agencies may wish to accept
customer assets used to margin customer positions consisting of
swaps and security-based swaps in commingled customer omnibus
accounts and are already offering clearing services for swaps and
security-based swaps in commingled proprietary accounts.
Accordingly, where a clearing agency's operations and risk
management practices are commingled, the clearing agency will be
subject to the ``cover two'' requirement applicable to security-
based swap CCPs under Rule 17Ad-22(b)(3). See Letter from Winston &
Strawn LLP, dated Nov. 7, 2011 (requesting exemptive relief for ICE
Clear Credit LLC in connection with a program to commingle customer
funds and implement portfolio CDS).
---------------------------------------------------------------------------

    Some commenters argued that the Commission should not adopt a
standard for the level of financial resources that may be inconsistent
with the FMI Report and that there should be industry and regulatory
consensus on the level of financial resources that must be
maintained.\174\ The FMI Report states that CCPs should maintain
financial resources to cover the default of the largest two
participants when the CCP is involved in activities with a more-complex
risk profile.\175\ The FMI Report describes a more-complex risk profile
as ``clearing financial instruments that are characterized by discreet
jump-to-default price changes or that are highly correlated with
potential participant defaults.'' \176\ The vast majority of security-
based swaps by notional value and other measures are credit default
swaps products with such characteristics, and, accordingly, the
Commission believes that the standard being adopted today with regard
to security-based swaps is substantially similar to that in the FMI
Report.\177\ As security-based swap products with different
characteristics are proposed for clearing over time, the Commission
would evaluate risk profiles of such products to consider how they
would be treated under the ``cover two'' standard.
---------------------------------------------------------------------------

    \174\ See supra note 156.
    \175\ See FMI Report, supra note 32, at 36 (Principle 4: Credit
risk ``In addition, a CCP that is involved in activities with a
more-complex risk profile or that is systemically important in
multiple jurisdictions should maintain additional financial
resources sufficient to cover a wide range of potential stress
scenarios that should include, but not be limited to, the default of
the two participants and their affiliates that would potentially
cause the largest aggregate credit exposure to the CCP in extreme
but plausible market conditions. All other CCPs should maintain
additional financial resources sufficient to cover a wide range of
potential stress scenarios that should include, but not be limited
to, the default of the participant and its affiliates that would
potentially cause the largest aggregate credit exposure to the CCP
in extreme but plausible market conditions.'').
    \176\ See id.
    \177\ The Commission has previously estimated that single-name
CDS will constitute roughly 95% of the market, as measured on a
notional basis, for instruments that fall within the definition of
security-based swap. See Securities Exchange Act Release No. 34-
66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012), at 30636, n.476.
---------------------------------------------------------------------------

    The Commission also is not persuaded that the ``cover two''
standard reflects an implausible occurrence that therefore should not
be embedded into the Commission's rules. The financial crisis of 2008
demonstrated the plausibility of the default of two large participants
in a clearing agency over a brief period. One large investment bank was
saved from the brink of default in March 2008.\178\ In September 2008,
two large financial institutions failed and another large financial
institution was rescued from insolvency by the Federal Reserve.\179\
Throughout the course of these events, the U.S. and world financial
markets were affected by a systemic crisis of confidence that stifled
the ability of market participants to obtain financing and avoid
default.\180\ The Commission believes therefore that it is plausible to

assume that a systemic market disruption like that which was
experienced in 2008 could affect the two largest participants of a
security-based swap CCP.
---------------------------------------------------------------------------

    \178\ See Board of Governors of the Federal Reserve System, Bear
Stearns, JPMorgan Chase, and Maiden Lane LLC, http://www.federalreserve.gov/newsevents/reform_bearstearns.htm (last
visited June 25, 2012).
    \179\ LaBonte and Norden Berg, Dodd-Frank Act, Congressional
Research Services, Title VIII: Supervision of Payment, Clearing and
Settlement Activities (Dec. 10, 2010), at 1, available at http://www.llsdc.org/attachments/files/279/CRS-R41529.pdf (noting the
failures of Lehman Brothers Holdings, Inc. and Washington Mutual,
Inc. in 2008 and the subsequent rescue of American International
Group, Inc.).
    \180\ See, e.g., Trustee's Preliminary Investigation Report and
Recommendations of the Attorneys for James W. Giddens for the SIPA
Liquidation of Lehman Brothers, Inc. (Aug. 25, 2010), available at
http://dm.epiq11.com/LBI/Project/default.aspx.
---------------------------------------------------------------------------

    One clearing agency commented that since its modeling assumptions
for simultaneous default of two participants assume significant market
volatility but its modeling assumptions for the default of the largest
participant assume low volatility, it is possible that a requirement
for financial resources to cover the default of the largest two
participants may result in only a slightly higher or even a lower
requirement than one for financial resources to cover the default of
the largest participant.\181\ However, the Commission is not persuaded
by this comment and the assumption regarding low volatility. All
registered clearing agencies are expected to ensure that the
assumptions underlying their models are reasonably designed to meet the
requirements of the Exchange Act and related regulations at all times,
and the Commission staff reviews the practices of clearing agencies in
this area through its established supervisory process. To the extent
Commission staff identifies shortcomings in an individual registered
clearing agency's practices relevant to its maintenance of the ``cover
one'' or ``cover two'' requirements, further action may be taken to
address such concerns, as may be necessary or appropriate. For example,
in connection with an examination, the Commission can request
corrective action as part of its examination findings. Where there are
shortcomings that violate the clearing agency's rules or Rule 17Ad-
22(b)(3), the Commission may take enforcement action.\182\
---------------------------------------------------------------------------

    \181\ See supra note 150.
    \182\ See Section 17A discussion supra Section I.A.2 and
accompanying text.
---------------------------------------------------------------------------

    Finally, the Commission does not believe that Rule 17Ad-22(b)(3)
will require major changes to the practices that have been developed to
measure the sufficiency of financial resources at registered CCPs. The
Commission understands that all CCPs currently registered with the
Commission maintain enough financial resources to withstand the default
of their largest participant under extreme but plausible market
conditions.\183\ All of the security-based swap transactions that are
centrally cleared in the United States are handled by a security-based
swap CCP that maintains enough financial resources to be able to
withstand the default of its two largest participants.\184\
---------------------------------------------------------------------------

    \183\ See, e.g., International Monetary Fund, Publication of
Financial Sector Assessment Program Documentation--Detailed
Assessment of Observance of the National Securities Clearing
Corporation's Observance of the CPSS-IOSCO Recommendations for
Central Counterparties (2010), at 10, available at http://www.imf.org/external/pubs/ft/scr/2010/cr10129.pdf (assessing NSCC's
observance of Recommendation 5 from the RCCP that a CCP should
maintain sufficient financial resources to withstand, at a minimum,
the default of a participant to which it has the largest exposure in
extreme but plausible market conditions and noting that NSCC began
evaluating itself against this standard in 2009 and has back-testing
results to support that during the period from January through April
2009 there was sufficient liquidity to cover the needs of the
failure of the largest affiliated family 99.98% of the time);
International Monetary Fund, Publication of Financial Sector
Assessment Program Documentation--Detailed Assessment of Observance
of the Fixed Income Clearing Corporation--Government Securities
Division's Observance of the CPSS-IOSCO Recommendations for Central
Counterparties (2010), at 9-10, available at http://www.imf.org/external/pubs/ft/scr/2010/cr10130.pdf (finding that Fixed Income
Clearing Corporation's Government Securities Division ``observed''
the requirement to maintain enough financial resources to meet the
default of its largest participant in extreme but plausible market
conditions).
    \184\ See supra note 168 (reflecting that ICE Clear Credit
``looks at two simultaneous defaults of the two biggest losers upon
extreme conditions * * *.''). Most centrally cleared CDS
transactions have cleared at ICE Clear Credit or ICE Clear Europe
Limited. As of April 19, 2012, ICE Clear Credit had cleared
approximately $15.6 trillion notional amount of CDS contracts based
on indices of securities and approximately $1.5 trillion notional
amount of CDS contracts based on individual reference entities or
securities. As of April 19, 2012, ICE Clear Europe had cleared
approximately [euro]7.2 trillion notional amount of CDS contracts
based on indices of securities and approximately [euro]1.2 trillion
notional amount of CDS contracts based on individual reference
entities or securities. See https://www.theice.com/marketdata/reports/ReportCenter.shtml. As of April 19, 2012, CME had cleared
approximately $522 billion notional amount of CDS contracts based on
indices of securities.
---------------------------------------------------------------------------

    The Commission agrees with the commenter who suggested that it is
important for the Commission to provide concrete guidance regarding the
meaning of ``extreme but plausible market conditions'' to assure
consistent treatment of that term across clearing CCPs. In general,
``extreme but plausible market conditions'' are tail event conditions
in which the price movement of a cleared security results in losses
exceeding expectations at a 99% confidence interval, causing a clearing
agency's exposures to its participants to breach margin requirements or
other risk controls (i.e., a one out of 100 days scenario). For
example, ``extreme but plausible market conditions'' may include or
exceed the worst historical price movement for a particular financial
instrument over a specified time horizon. However, the Commission also
agrees with commenters that argued that industry professionals,
including but not limited to personnel at the clearing agencies
themselves, are likely to be equipped with the relevant expertise that
can contribute to developing a well-informed standard of ``extreme but
plausible market conditions.'' To ensure that the standard is
consistently applied across CCPs and that it accurately captures the
market understanding of the terminology, the Commission expects to
review and publish for public comment rule proposals from clearing
agencies adopting a definition for ``extreme but plausible market
conditions'' that is appropriate for the market they serve.
4. Rule 17Ad-22(b)(4): Model Validation
a. Proposed Rule
    Rule 17Ad-22(b)(4), as proposed, would require a CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide for an annual model validation process
consisting of evaluating the performance of the CCP's margin models and
the related parameters and assumptions associated with such models by a
qualified person who does not perform functions associated with the
clearing agency's margin models (except as part of the annual model
validation) and does not report to a person who performs these
functions.\185\ The Commission is adopting Rule 17Ad-22(b)(4) to ensure
that a registered CCP's models are validated by qualified persons free
from influence from the persons responsible for development or
operation of the systems and models being validated, with sufficient
frequency to assure that the models perform in a manner that
facilitates prompt and accurate clearance and settlement of
transactions.
---------------------------------------------------------------------------

    \185\ Any person responsible for supervising the operation of
the clearing agency's margin model would be viewed as performing the
functions associated with the clearing agency's margin model and
could not therefore have supervisory authority over the person
conducting the model validation.
---------------------------------------------------------------------------

b. Comments Received
    Commenters generally supported proposed Rule 17Ad-22(b)(4) \186\
but

they also provided several suggested modifications regarding the
required frequency of the model validation and how best to achieve the
proper level of scrutiny and testing of the model's adequacy. One
commenter stated that the rule should not require the model to be
validated on an annual basis. Instead, the commenter suggested that the
frequency should be left to the discretion of the clearing agency
because it is in the best position to determine the appropriate
timing,\187\ and in the absence of a material change (either to the
model itself or in the market environment that affects the model),
requiring an annual validation may be unnecessary and overly
burdensome.\188\
---------------------------------------------------------------------------

    \186\ See The DTCC (April) Letter at 13 (supporting Rule 17Ad-
22(b)(4) and recommending certain clarifications); see also Barnard
Letter at 1 (supporting generally the thrust of the Commission's
proposals in the Proposing Release, particularly proposed Rule 17Ad-
22 concerning standards for clearing agencies); BlackRock Letter at
2 (supporting Rules 17Ad-22(b)(1)-(7) because these rules will
benefit the markets by reducing concentration risk, increasing the
diversity of market participants involved in governance, enhancing
competition and lowering costs for customers of clearing members);
LCH Letter at 3 (generally supporting the Commission's proposed
rules under 17Ad-22(b)); MFA (Kaswell) Letter at 2 (generally
supporting the Commission's proposed rules under 17Ad-22(b)).
    \187\ See The DTCC (April) Letter at 13.
    \188\ See id.
---------------------------------------------------------------------------

    Commenters also argued that the CCP is in the best position to
determine how to conduct a candid assessment free from outside
influence concerning its margin models and that qualified internal
personnel at the CCP are capable of validating the models if reasonable
steps are taken to ensure objectivity (i.e., the reviewers are not the
same individuals who are or who were involved in designing the models
or who are otherwise biased due to their involvement in implementation
of the models).\189\ Commenters argued that Rule 17Ad-22(b)(4) should
not prescribe a particular method for a clearing agency to achieve that
outcome.\190\
---------------------------------------------------------------------------

    \189\ See The DTCC (April) Letter at 13; The OCC Letter at 11.
    \190\ See The DTCC (April) Letter at 13.
---------------------------------------------------------------------------

    One commenter recommended that the Commission should replace the
text in proposed Rule 17Ad-22(b)(4) that addresses independence with
language from the Proposing Release that ``the person validating the
clearing agency's model should be sufficiently free from outside
influences so that he or she can be completely candid in their [sic]
assessment of the model.'' \191\ The commenter stated that this
construction is more consistent with RCCP 4: Financial Resources \192\
and with Principle 6: Margin from the Consultative version of the FMI
Report \193\ because it does not prescribe a model validation frequency
or a specific way to achieve integrity in the validation process.\194\
Another commenter stated that proposed Rule 17Ad-22(b)(4) should be
strengthened to require the model validation to be performed by an
outside, independent expert and that the CCP must adjust and revalidate
the model at any time it has reason to believe the model is no longer
adequate.\195\
---------------------------------------------------------------------------

    \191\ See The DTCC (April) Letter at 14.
    \192\ See RCCP, supra note 33, at 19.
    \193\ See Principles for Financial Market Infrastructures
Consultative Report (Mar. 2011), at 40, http://www.iosco.org/library/pubdocs/pdf/IOSCOPD350.pdf; but see supra note 32, at 56
(stating in the finalized FMI Report that a CCP should have its
margin model validated at least annually).
    \194\ See The DTCC (April) Letter at 15.
    \195\ See Better Markets Letter at 6.
---------------------------------------------------------------------------

    Another commenter stated that requiring a CCP to bring independence
to the model review process by detaching it from the model development
process would effectively require maintenance of two quantitative
teams.\196\ According to this commenter, that result would impose costs
on the CCP to staff both teams as well as create potential staffing
problems because talented personnel with the requisite quantitative
skills often view the review process as non-creative.\197\ That
structure, the commenter argued, may create adversarial relationships
within the CCP and could require senior management to resolve highly-
technical disputes between the model development team and model review
team.\198\
---------------------------------------------------------------------------

    \196\ See The OCC Letter at 11.
    \197\ See id.
    \198\ See id.
---------------------------------------------------------------------------

    The same commenter suggested that proposed Rule 17Ad-22(b)(4)
should be revised to require a CCP to do the following: (1) Maintain a
culture of commitment to quality where correcting and improving models
is career-enhancing; (2) adopt sound policies and procedures that
create a transparent and auditable model review process; and (3)
require that reporting lines must come together at a person who is
well-versed in technical quantitative matters.\199\ Commenters also
cited to the recently released Supervisory Guidance on Model Risk
Management, in which the Federal Reserve and the Office of the
Comptroller of the Currency stated that ``corporate culture plays a
role [in providing appropriate incentives for proper model review] if
it establishes support for objective thinking and encourages
questioning and challenging of decisions'' and that ``independence may
be supported by separation of reporting lines, [but] it should be
judged by actions and outcomes because there may be additional ways to
ensure objectivity and prevent bias.'' \200\
---------------------------------------------------------------------------

    \199\ See id.
    \200\ See id.; see also The DTCC (April) Letter at 14 (citing
Supervisory Guidance on Model Risk Management (Apr. 4, 2011)),
available at http://www.occ.treas.gov/news-issuances/bulletins/2011/bulletin-2011-12a.pdf.
---------------------------------------------------------------------------

c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(4) with certain
modifications to address concerns raised by commenters, including the
clarification discussed in Sections II.B.4 and III.A regarding the
application of the rule only to registered clearing agencies. In light
of comments asking the Commission to clarify the standard of
independence of the qualified person who performs the model validation,
the Commission is revising the text of Rule 17Ad-22(b)(4) so that the
annual model validation must be performed by a qualified person who is
free from influence from the persons responsible for development or
operation of the systems and models being validated. Generally, the
Commission would consider that a person was free from influence when
that person does not, including but not limited to, perform functions
associated with the clearing agency's margin models (except as part of
the annual model validation) and does not report to a person who
performs these functions. The Commission believes that the change from
the proposal addresses the concerns raised by commenters.\201\
Specifically, the Commission agrees that who will be the reviewer of
the model is best left to the discretion of the CCP, so long as the
goals of the model validation process are achieved.\202\
---------------------------------------------------------------------------

    \201\ See, e.g., The OCC Letter at 11-12 (stating that ``[w]e
think that a clearing agency is capable of validating its own models
through the use of qualified internal personnel, provided that
appropriate steps are taken to ensure objectivity, such as ensuring
that the reviewers are not the same individuals as those who are or
were involved in designing such models or are otherwise biased due
to their involvement in implementation of the models. Many employees
who perform functions associated with margin models may have no
particular conflict or bias that would prevent them from conducting
objective model validations and, in fact, many such employees may
have a strong interest in ensuring that margin models are as well-
designed as possible.'').
    \202\ See The DTCC (April) Letter at 14 (``The DTCC model risk
policy provides that all models must be certified as valid by a
qualified independent reviewer, defined as `a qualified reviewer
that did not develop and does not currently own the model.' The
reviewer may be an individual or unit within the organization or an
outside consultant.'').
---------------------------------------------------------------------------

    As proposed, Rule 17Ad-22(b)(4) would not have permitted the model
validation to be performed by a person performing functions associated
with the CCP's margin models (except as part of the annual model
validation), or who reports to a person who performs those
functions.\203\ The Commission reasoned in the Proposing Release that a
person involved with the functions related to the model's operation, or
someone who reports to such a person, may be less

likely to evaluate critically the margin models.\204\ After considering
the comments, the Commission agrees that instead of requiring a
particular method or reporting structure, the less-prescriptive
language from the Proposing Release, namely, that a person may perform
the model validation as long as that person is free from influence from
the persons responsible for development or operation of the systems and
models being validated so that he or she can be candid in his or her
assessment of the model, would be appropriate to achieve the intended
purpose.
---------------------------------------------------------------------------

    \203\ See supra note 185 and accompanying text.
    \204\ See supra note 35.
---------------------------------------------------------------------------

    The Commission also notes that the ``sufficiently free from
influence'' standard is consistent with the FMI Report, which does not
prescribe a specific method to assure the effectiveness of the
validation process,\205\ and is consistent with the recent guidance
from the Federal Reserve and the Office of the Comptroller of the
Currency in Supervisory Guidance on Model Risk Management.\206\ The
revised standard adopted by the Commission herein would not require the
clearing agency to detach model review from model development or to
maintain two separate quantitative teams and thus would not lead to
potential increased costs.
---------------------------------------------------------------------------

    \205\ See FMI Report, supra note 32.
    \206\ Board of Governors of the Federal Reserve System and the
Office of the Comptroller of the Currency, Supervisory Guidance on
Model Risk Management (Apr. 4, 2011), at 9, available at http://occ.gov/news-issuances/bulletins/2011/bulletin-2011-12a.pdf (stating
that independence for model review ``should be judged by actions and
outcomes, since there may be [many] ways to ensure objectivity and
prevent bias'').
---------------------------------------------------------------------------

    The Commission is not persuaded that the model validation must be
performed by an outside independent expert.\207\ As noted above, the
Commission believes that objectivity can be preserved where the person
performing the model validation is an employee of the CCP as long as
the clearing agency strictly adheres to the standard the Commission is
adopting herein. Because the Commission has not previously required
CCPs to perform an annual model validation, we understand that the
implementation of this requirement may require the exercise of
substantial judgment by such clearing agencies in the adoption and
implementation of written policies and procedures. The Commission
intends to review the development of compliance practices and to issue
interpretive guidance as appropriate.
---------------------------------------------------------------------------

    \207\ See supra note 195.
---------------------------------------------------------------------------

    The Commission is not persuaded that the frequency of the model
validation should be left to the discretion of the CCP. Current model
validation practices vary among CCPs. Some CCPs conduct annual
validations, while other conduct them on an ad hoc basis. Because of
the role margin plays in a default, a CCP needs assurance of its value
in the event of liquidation, as well as the capacity to draw upon its
margin promptly. The Commission believes, especially considering its
statutory responsibilities and the importance of model validation in
limiting systemic risk, that it is important to create a consistent and
uniformly applied minimum standard across all clearing CCPs. The
Commission believes that requiring model validation at least annually
is appropriate because model performance is not ordinarily expected to
vary significantly over short periods but should be reevaluated as
market conditions change. Furthermore, the Commission does not think
the standard of an annual model validation is too burdensome,
particularly given the fact that the Commission is not prescribing any
specific qualifications or credentials of the person performing the
model validation and is not requiring the person performing the model
validation to be independent of the clearing agency and given how
important understanding of the margin methodology is to the risk
management framework.
    The requirement for an annual model validation does not preclude
the CCP from adjusting its model any time it has reason to believe that
the model is no longer adequate. In fact, as noted above, Rule 17Ad-
22(b)(2) requires a CCP to review its risk-based models to set margin
requirements at least monthly.
    The Commission continues to believe that clearing agencies that
provide CCP services must have a qualified person conduct a review of
models that are used to set margin levels, along with related
parameters and assumptions, to assure that the models perform in a
manner that facilitates prompt and accurate clearance and settlement of
transactions. In determining whether a person is qualified to conduct
the model validation, registered CCPs may consider several factors,
including the person's experience in validating margin models,
expertise in risk management generally, and understanding of the
clearing agency's particular operations and procedures.
    While the Commission agrees with the commenter who suggested that
CCPs should strive to create a culture of commitment to quality where
improving models is career-enhancing and to adopt sound policies and
procedures to create a transparent and auditable model review
process,\208\ the Commission believes that this result can be achieved
by requiring that a model validation review occur annually and that the
reviewer be qualified and free from influence from the persons
responsible for development or operation of the systems and models
being validated.
---------------------------------------------------------------------------

    \208\ See supra note 199 and accompanying text.
---------------------------------------------------------------------------

D. Participant Access Standards for Central Counterparties: Rules 17Ad-
22(b)(5)-(7)

    Section 17A of the Exchange Act requires that a clearing agency
shall not be registered unless the Commission determines, among other
things, that the clearing agency's rules do not impose burdens on
competition that are unnecessary or inappropriate to promote the
purposes of the Exchange Act \209\ and that the rules are not designed
to permit unfair discrimination in the admission of participants or
among participants in the use of the CCP.\210\ Therefore, when
evaluating the participation standards at a CCP, the Commission must
strike an appropriate balance between affording CCPs the necessary
discretion to select clearing members that do not jeopardize the CCP's
ability to facilitate prompt and accurate clearance and settlement
while also not impeding access to central clearing among a range of
market participants.
---------------------------------------------------------------------------

    \209\ 15 U.S.C. 78q-1(b)(3)(F).
    \210\ 15 U.S.C. 78q-1(b)(3)(G).
---------------------------------------------------------------------------

    Rules 17Ad-22(b)(5), (6) and (7) introduce certain requirements
regarding access to registered CCPs. Respectively, the rules would
require a registered CCP to do the following: (1) Provide the
opportunity for a person who does not perform any dealer or security-
based swap Dealer services to obtain membership; (2) refrain from using
minimum portfolio size and minimum volume transaction thresholds as
conditions to membership; and (3) provide the ability to obtain
membership to persons who maintain net capital equal to or greater than
$50 million.
    Rules 17Ad-22(b)(5), (6) and (7) each address the common topic of
access to and participation in CCPs. Several commenters provided
general comments on that shared focus. Those comments represent a wide
range of views and are reflected immediately below.
    Some commenters expressed their general support for the ways that
Rules 17Ad-22(b)(5), (6), and (7) would promote fair and open access to
CCP services through CCP participation

requirements that are risk appropriate without being unnecessarily
restrictive.\211\ One of these commenters expressed support for the
design of the rules but also made a request for the rules to offer more
flexibility and latitude for CCPs to establish participation
requirements that ensure integrity of operation and risk management.''
\212\
---------------------------------------------------------------------------

    \211\ See LCH Letter at 3 (upholding the Commission's intent of
``ensuring broad participation in and open access to clearing
agencies''); MFA (Kaswell) Letter at 2, 3 (generally supporting the
Commission's proposed rules under 17Ad-22(b)); CME Letter at 3
(generally supporting ``the regulatory objective of participation
requirements that are risk appropriate without being unnecessarily
restrictive, in order to promote fair and open access to clearing
services.'').
    \212\ See LCH Letter at 3.
---------------------------------------------------------------------------

    Two commenters urged the Commission not to adopt proposed Rules
17Ad-22(b)(5), (6) and (7).\213\ The first commenter concluded that the
proposed rules, while well-intentioned, ``are unnecessary and
counterproductive to the goal of fair and open access within a
framework of the safe and sound operation of clearing agencies.'' \214\
In particular, this commenter stated its belief that proposed Rules
17Ad-22(b)(5), (6) and (7) are overly prescriptive and that the
Commission already has ample and alternative authority under which to
monitor membership practices.\215\ Specifically, the commenter pointed
to the existing requirement in Section 17A(b)(3)(F) of the Exchange Act
that a clearing agency shall not be registered unless the Commission
determines that the clearing agency's rules are not designed to permit
unfair discrimination in the admission of participants or among
participants in the use of the clearing agency. The commenter also
stated that if proposed Rule 17Ad-22(d)(2) is adopted, that rule would
already require clearing agencies to establish, implement, maintain and
enforce written policies and procedures reasonably designed to have
participation requirements that are objective, publicly disclosed, and
that permit fair and open access.\216\ Finally, this commenter argued
that proposed Rules 17Ad-22(b)(5), (6) and (7) do not conform to
current or proposed global standards related to participation in CCPs.
In contrast, the commenter stated its belief that Section 17A(b)(3) of
the Exchange Act and proposed Rule 17Ad-22(d)(2) are consistent with
RCCP Recommendation 2: Participation requirements \217\ as well as FMI
Principle 18: Access and participation requirements.\218\
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    \213\ See The DTCC (April) Letter at 9; The OCC Letter at 12.
    \214\ See The DTCC (April) Letter at 18.
    \215\ See id.
    \216\ See id.
    \217\ RCCP Recommendation 2 provides that ``[a] CCP's
participation requirements should be objective, publicly disclosed,
and permit fair and open access.''
    \218\ Principle 18 from the FMI Report provides that ``[a]n FMI
should have objective, risk-based, and publicly disclosed criteria
for participation, which permit fair and open access.''
---------------------------------------------------------------------------

    The second commenter, while not opposed to the substance of
proposed Rules 17Ad-22(b)(5), (6) and (7), generally questioned the
need to hard wire these requirements into the Commission's rules.\219\
Specifically, this commenter argued that the Commission already has
authority under Section 17A(b)(3)(F) of the Securities Exchange Act to
deny registration to a clearing agency if the clearing agency's rules
are designed to permit unfair discrimination in the admission of
participants or among participants in the use of the clearing
agency.\220\ In addition, this commenter stated that under proposed
Rule 17Ad-22(d)(2) the Commission would gain less prescriptive but
broader and coextensive rule-based authority without imposing ``one
size fits all'' access requirements.\221\
---------------------------------------------------------------------------

    \219\ See The OCC Letter at 12.
    \220\ See id.
    \221\ See id.
---------------------------------------------------------------------------

    In the ``Final Rule and Guidance'' sections for Rules 17Ad-
22(b)(5), (6) and (7) below, we address these more general comments in
the context of a discussion of the more specific comments the
Commission received on the proposed rules.
1. Rule 17Ad-22(b)(5): Non-Dealer Member Access
a. Proposed Rule
    Rule 17Ad-22(b)(5), as proposed, would require a registered CCP to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide the opportunity for a person
that does not perform any dealer \222\ or security-based swap dealer
\223\ services to obtain membership on fair and reasonable terms at the
CCP in order to clear securities for itself or on behalf of other
persons.
---------------------------------------------------------------------------

    \222\ The term ``dealer'' is defined in Section 3(a)(5) of the
Exchange Act and means any person engaged in the business of buying
and selling securities for such person's own account through a
broker or otherwise. The definition contains an exception for a
person that buys or sells securities for such person's own account,
either individually or in a fiduciary capacity, but not as a part of
a regular business. There is also an exception for banks engaging in
certain specified activities. See 15 U.S.C. 78c(a)(5) for the
complete definition.
    \223\ Pursuant to Section 761 of the Dodd-Frank Act, the term
``security-based swap dealer'' is added as Section 3(a)(71) of the
Exchange Act, 15 U.S.C. 78c(a), and generally means any person who
(A) Holds itself out as a dealer in security-based swaps; (B) makes
a market in security-based swaps; (C) regularly enters into
security-based swaps with counterparties as an ordinary course of
business for its own account; or (D) engages in any activity causing
it to be commonly known in the trade as a dealer or market maker in
security-based swaps. The Commission and the CFTC jointly adopted
rules to further define the terms ``swap dealer,'' ``security-based
swap dealer,'' ``major swap participant,'' ``major security-based
swap participant,'' and eligible contract participant.'' See supra
note 12 (Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant'', Securities
Exchange Act Release No. 34-66868 (Apr. 27, 2012), 77 FR 30596 (May
23, 2012)).
---------------------------------------------------------------------------

b. Comments Received
    Some commenters generally supported the goals of Rule 17Ad-
22(b)(5),\224\ while other commenters expressed several concerns.\225\
Specifically, one commenter stated that ``any regulatory mandate to
admit specific entities as members of a CCP could undermine the
impartial development and application of risk-based standards for
membership.'' \226\ This commenter acknowledged the discussion in the
Proposing Release explaining that proposed Rule 17Ad-22(b)(5) would not
prohibit a clearing agency from using factors aside from a potential
clearing member's dealer or security-based swap dealer status to make
an admissions decision, but nevertheless urged the Commission to forgo
adoption of the rule altogether because it believes clearing agencies
should be permitted, under Commission oversight, to determine how best
to promote correspondent clearing \227\ and to design membership
standards.\228\ The

commenter suggested that if the rule is adopted, it should be modified
to reflect the more permissive process for evaluation described in the
body of the Proposing Release, namely by clarifying that the clearing
agency may take other factors into account in making membership
decisions.\229\
---------------------------------------------------------------------------

    \224\ See supra note 211 (citing LCH Letter, MFA (Kaswell)
Letter, and CME Letter); see also Barnard Letter at 1 (supporting
generally the thrust of the Commission's proposals in the Proposing
Release, particularly proposed Rule 17Ad-22 concerning standards for
clearing agencies); BlackRock Letter at 2 (supporting Rules 17Ad-
22(b)(1)-(7) because these rules will benefit the markets by
reducing concentration risk, increasing the diversity of market
participants involved in governance, enhancing competition and
lowering costs for customers of clearing members).
    \225\ See The DTCC (April) Letter at 18-19; The OCC Letter at
12.
    \226\ See The DTCC (April) Letter at 18.
    \227\ Correspondent clearing is an arrangement between a current
participant of a clearing agency and a non-participant that desires
to use the clearing agency for clearance and settlement services.
    \228\ See The DTCC (April) Letter at 18-19. The commenter also
stated its belief that ``financial resources'' and
``creditworthiness'' should be expressly added to the factors that
may be considered. Moreover, the commenter suggested that the term
``otherwise qualified'' be clarified as it was not precise enough
standard to meaningfully inform clearing agencies of what criteria
may be considered when evaluating potential members.
    \229\ See The DTCC (April) Letter at 19.
---------------------------------------------------------------------------

c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(5) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies.
    While the Commission understands concerns raised by commenters, the
Commission ultimately believes that the benefits of Rule 17Ad-22(b)(5)
are critical to maintaining fairness and open access to central
clearing for all market participants, including security-based swaps
participants. The Commission believes that no registered CCP should
deny membership solely because a person does not perform any dealer or
security-based swap dealer services and that such a requirement
unfairly discriminates against certain market participants and should
be prohibited. The Commission does not believe that performing dealer
or security-based swap dealer services is, by itself, a sufficient
indicator of whether an applicant should be admitted to a clearing
agency.
    Dealer and security-based swap dealer services generally involve
services designed to facilitate securities transactions by buying and
selling securities for a person's own account.\230\ The Commission
continues to believe that requiring registered CCPs to allow persons
who are not dealers or security-based swap dealers to become members of
the clearing agency will promote more competition by allowing more
firms to clear, thereby increasing competition among clearing members
on both price and service which should, in turn, reduce costs to market
participants. The enhanced access to central clearing should engender
more correspondent clearing in the security-based swap market. Because
of the relationship between security-based swaps and traditional
securities (e.g., market participants using security-based swaps to
hedge positions in traditional securities), the Commission believes
that applying these rules to all CCPs will help ensure that market
participants have access to central clearing in all instruments that
are centrally cleared.
---------------------------------------------------------------------------

    \230\ See supra note 222.
---------------------------------------------------------------------------

    In situations where direct access to clearing agencies is limited
by reasonable participation standards, firms that do not meet these
standards may still be able to access clearing agencies through
correspondent clearing arrangements with direct participants.\231\ Such
a process involves the non-participant entering a correspondent
clearing arrangement with a participant so that the transaction may be
submitted by the participant to the clearing agency. Thus, the success
of correspondent clearing arrangements depends on the willingness of
participants to enter such arrangements with non-participant firms that
may act as direct competitors to the participants in the participants'
capacity as dealers or security-based swap dealers in the market for
the relevant securities. Given that the existing CCP participants that
are dealers or security-based swap dealers may therefore have
incentives to restrict competitors in the securities execution markets
from accessing a CCP, correspondent clearing arrangements may be
inhibited unless participants that do not provide dealer or security-
based swap dealer services are provided with the ability to become
direct members of a clearing agency.
---------------------------------------------------------------------------

    \231\ See Exchange Act Release Nos. 63107 (Oct. 14, 2010), 75 FR
65882 (Oct. 26, 2010) and 64018 (Mar. 3, 2011), 76 FR 12645 (Mar. 8,
2011) (Ownership Limitations and Governance Requirements for
Security-Based Swap Clearing Agencies, Security-Based Swap Execution
Facilities, and National Securities Exchanges with Respect to
Security-Based Swaps under Regulation MC).
---------------------------------------------------------------------------

    Also, the Commission is not persuaded by the comment that Rule
17Ad-22(b)(5) is likely to undermine the impartial development and
application of risk-based standards for membership.\232\ Simply stated,
Rule 17Ad-22(b)(5) is designed to prohibit registered CCPs from denying
membership on fair and reasonable terms to otherwise qualified persons
solely by virtue of the fact that they do not perform any dealer or
security-based swap dealer services.\233\ The Commission fully
recognizes that persons who are not dealers or security-based swap
dealers may fail to meet other standards for membership at a clearing
agency, such as the operational capabilities required for direct
participation. While non-dealer status cannot serve as the sole reason
for denying membership, Rule 17Ad-22(b)(5) does not prohibit a
registered CCP from taking other standards of membership into account
when establishing membership criteria for non-dealers.
---------------------------------------------------------------------------

    \232\ See supra note 228.
    \233\ See Proposing Release, supra note 35, at Section II.A.
---------------------------------------------------------------------------

    Because the factors that each CCP considers when establishing
membership criteria differ based on the particular characteristics of
the relevant clearing agency and the markets it serves, the Commission
believes that it would be counterproductive to modify Rule 17Ad-
22(b)(5) to make it more specific and therefore more constraining. One
commenter, however, requested that the Commission provide additional
clarity in terms of what is required to be considered ``otherwise
qualified'' for membership at a CCP.\234\ In response to this comment,
the Commission notes that, for purposes of Rule 17Ad-22(b)(5), the term
``otherwise qualified'' means that the clearing agency's sole reason
for denying membership to a prospective participant would be the
prospective participant's status as a non-dealer or non security-based
swap dealer and that it otherwise maintains the financial resources,
creditworthiness, operational capacity, and any other additional
characteristics necessary to meet the obligations of participation. As
CCPs shape practices to come into compliance with Rule 17Ad-22(b)(3),
the Commission will consider whether further guidance is appropriate.
---------------------------------------------------------------------------

    \234\ See supra note 229.
---------------------------------------------------------------------------

    The Commission believes that the incentives of persons who do not
perform dealer or security-based swap dealer services to promote access
at a CCP in general would tend to be consistent with increased
competition in the market for the relevant securities. These persons do
not execute securities trades for their own account. Instead, they
provide correspondent clearing services for market participants.\235\
As a result, their ability to provide correspondent clearing services
would tend to increase as competition and transaction volumes
increased. Accordingly, the Commission believes that Rule 17Ad-22(b)(5)
will foster the development of correspondent clearing arrangements that
will allow market participants who are not dealers or security-based
swap dealers to obtain access to a registered CCP and that such access
will have the beneficial result of greater competition in and access to
central clearing. Moreover, because entities must meet all of the
standards for membership, the Commission does not believe that it will
undermine the

development or application of risk management standards.
---------------------------------------------------------------------------

    \235\ For a description of correspondent clearing activity, see
generally The Role and Regulation of Clearing Brokers, 48 Bus. Law
841 (May 1993).
---------------------------------------------------------------------------

2. Rule 17Ad-22(b)(6): Portfolio Size and Transaction Volume Thresholds
Restrictions
a. Proposed Rule
    Rule 17Ad-22(b)(6), as proposed, would prohibit a CCP from having
membership standards that require participants to maintain a portfolio
of any minimum size or to maintain a minimum transaction volume.
b. Comments Received
    Some commenters expressed general support for the goals of proposed
Rule 17Ad-22(b)(6).\236\ At the same time, one commenter opposed
adoption of the rule because of concern that ``any regulatory mandate
on portfolio size and transaction volume thresholds could undermine the
impartial development and application of risk-based standards for
membership'' in a CCP.\237\ This commenter also questioned why certain
language in the discussion section of the Proposing Release (explaining
that the proposed rule ``would not prohibit a central counterparty from
considering portfolio size and transaction volume as one of several
factors when reviewing a potential participant's operations'') was not
included in the text of the proposed rule.\238\ In addition, the
commenter stated that even if a CCP has the discretion to consider
portfolio size and transaction volume when making a membership
decision, it is unclear how much weight the clearing agency actually
may give to this factor without running afoul of Rule 17Ad-
22(b)(6).\239\ Finally, this commenter noted that it ultimately would
prefer to see the Commission not adopt Rule 17Ad-22(b)(6) and instead
continue to oversee determinations made by clearing agencies concerning
membership standards and the weight, if any, to be given to portfolio
size and transaction volume.\240\
---------------------------------------------------------------------------

    \236\ See supra note 211 (citing LCH Letter, MFA (Kaswell)
Letter, and CME Letter); see also Barnard Letter at 1 (supporting
generally the thrust of the Commission's proposals in the Proposing
Release, particularly proposed Rule 17Ad-22 concerning standards for
clearing agencies); BlackRock Letter at 2 (supporting Rules 17Ad-
22(b)(1)-(7) because these rules will benefit the markets by
reducing concentration risk, increasing the diversity of market
participants involved in governance, enhancing competition and
lowering costs for customers of clearing members).
    \237\ See The DTCC (April) Letter at 19.
    \238\ See id.
    \239\ See The DTCC (April) Letter at 19-20.
    \240\ See The DTCC (April) Letter at 20.
---------------------------------------------------------------------------

c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(6) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies.
    We believe that imposing minimum thresholds on the size or
transaction volume of a participant's portfolio would not function as a
good indicator of whether the participant is able to meet its
obligations to a CCP.\241\ The Commission believes that trading volume
and portfolio size alone are poor grounds for limiting participant
access to central clearing, and that sole use of these criteria could
indicate unfair discrimination against certain market participants and
thus should be prohibited as the sole basis for determining membership.
---------------------------------------------------------------------------

    \241\ Rule 17Ad-22(b)(6) would not prohibit a clearing agency
from imposing maximum portfolio sizes or transaction volume amounts.
---------------------------------------------------------------------------

    New participants to a CCP that do not, at least initially, intend
to transact in substantial size or volume may nevertheless have the
operational and financial capacity to perform the activities that other
participants are able to perform. Therefore, the Commission believes
that Rule 17Ad-22(b)(6) will help facilitate compliance with the
requirement in Section 17A of the Exchange Act that the rules of a CCP
must permit fair and open access.\242\
---------------------------------------------------------------------------

    \242\ See supra note 210.
---------------------------------------------------------------------------

    For the same reasons discussed in connection with Rule 17Ad-
22(b)(5), the Commission is not persuaded by the comment that Rule
17Ad-22(b)(6) is likely to undermine the impartial development and
application of risk-based standards for membership.\243\ Specifically,
the rule does not prohibit a CCP from considering portfolio size and
transaction volume as one of several factors when reviewing a potential
participant's operations. Rather, the rule prohibits the establishment
of minimum portfolio sizes or transaction volumes that by themselves
would act as barriers to participation by new participants in clearing.
Rule 17Ad-22(b)(6) is an absolute bar to the sole use of these criteria
for determining membership. The Commission also does not believe that
it would be prudent to modify the rule text to make it more specific
and potentially more constraining because the factors that each CCP
considers when establishing appropriate membership criteria differ to
some degree based on the particular characteristics of the relevant
clearing agency and the markets it serves. As noted more generally in
Section II.B above, the Commission will consider whether to issue
further guidance to facilitate compliance as clearing agencies
establish, implement, maintain and enforce policies and procedures
responsive to Rule 17Ad-22(b)(6).
---------------------------------------------------------------------------

    \243\ See supra note 237.
---------------------------------------------------------------------------

3. Rule 17Ad-22(b)(7): Net Capital Restrictions
a. Proposed Rule
    Proposed Rule 17Ad-22(b)(7) would require a CCP to establish,
implement, maintain and enforce written policies and procedures
reasonably designed to provide a person that maintains net capital
\244\ equal to or greater than $50 million with the opportunity to
obtain membership at the CCP, with any net capital requirements being
scalable so that they are proportional to the risks posed by the
participant's activities to the CCP.
---------------------------------------------------------------------------

    \244\ Proposed Rule 17Ad-22(a)(5) would define ``net capital''
for the limited purposes of proposed Rule 17Ad-22(b)(7) to have the
same meaning as set forth in Rule 15c3-1 under the Exchange Act for
broker-dealers or any similar risk adjusted capital calculation for
all other prospective clearing members.
---------------------------------------------------------------------------

b. Comments Received
    Some commenters supported proposed Rule 17Ad-22(b)(7).\245\ Several
commenters expressed support for the rule because it would require
access to a CCP to be scaled in a risk-based way.\246\ One of these
commenters expressed the hope that the CFTC would adopt a similar
requirement and urged the Commission to work together with the CFTC to
harmonize their respective rules in this area.\247\
---------------------------------------------------------------------------

    \245\ See MFA (Kaswell) Letter at 3; ISDA Letter at 4; BlackRock
Letter at 1.
    \246\ See ISDA Letter at 4; MFA (Kaswell) Letter at 3; BlackRock
Letter at 1.
    \247\ See ISDA Letter at 4. See also Derivatives Clearing
Organization General Provisions and Core Principles, supra note 38
(in which the CFTC adopted Rule 39.12(a)(2)(iii) to require that a
DCO shall not set a minimum capital requirement of more than $50
million for any person that seeks to become a clearing member in
order to clear swaps).
---------------------------------------------------------------------------

    Another commenter supportive of Rule 17Ad-22(b)(7) urged the
Commission to modify the rule to eliminate the ability of a CCP to
raise its minimum net capital threshold above $50 million.\248\ This
commenter stressed that if the Commission declined to take such action
when adopting a final rule, then the Commission should (i) Require the
clearing agency's rationale to meet a higher burden of proof than
currently proposed; (ii) require the clearing agency to demonstrate not
only that it

could not effectively manage the risk using other measures but also
that raising the minimum capital requirement is the least restrictive
means by which to address the risk posed to the clearing agency; and
(iii) review the clearing agency's showing and make an express
determination that no other, less- competitively-restrictive measures
are available to the clearing agency to manage the risk
effectively.\249\
---------------------------------------------------------------------------

    \248\ See MFA (Kaswell) Letter at 4-5 (noting that the CFTC in
the DCO Release adopted rule 39.12(a)(2)(iii) in a form that does
not permit adjustment of the $50 million net capital requirement for
membership).
    \249\ See MFA (Kaswell) Letter at 4-5.
---------------------------------------------------------------------------

    One commenter stated that net capital, without regard to other risk
factors, does not conclusively establish creditworthiness or any of the
other generally accepted qualifications for becoming a member of a
CCP.\250\ Another commenter agreed with this assertion, but cited it as
support for Rule 17Ad-22(b)(7) on the basis that clearing members with
net capital closer to $50 million may have other characteristics that
make their risk profile less risky than clearing members with greater
amounts of net capital.\251\
---------------------------------------------------------------------------

    \250\ See The DTCC (April) Letter at 20.
    \251\ See MFA (Kaswell) Letter at 3.
---------------------------------------------------------------------------

    Several commenters expressed concern over proposed Rule 17Ad-
22(b)(7).\252\ One commenter stated that the proposed $50 million net
capital standard could create conditions where a clearing member at
that net capital level might use its $50 million of net capital to
access multiple clearing agencies.\253\ Commenters suggested that this
standard would increase the likelihood that the clearing member would
not be able to meet capital calls close in time from multiple clearing
agencies.\254\ To address this concern about margin call risk, the
commenter suggested that the rule should be modified to require: (i)
Daily reporting from each clearing member of its capital cover for the
potentially numerous assessments that it could be subject to from each
clearing agency where it is a member; (ii) the clearing member to
conduct regular stress tests at an ``extreme but plausible'' market
level in relation to the potentially numerous clearing agency
assessments that it could be subject to, and to provide the results to
each clearing agency where it is a member; and (iii) each clearing
agency to monitor and assess, on a daily basis, the ability of a
clearing member and its related affiliates to meet these potential
assessment exposures and share this daily analysis with other CCPs and
any relevant prudential regulator.\255\ The commenter stated that
unless regulators and clearing agencies are able and willing to commit
to these actions, then it believes that a far larger minimum net
capital requirement, such as $1 billion, is appropriate.\256\
---------------------------------------------------------------------------

    \252\ See The OCC Letter at 12; The DTCC (April) Letter at 9.
    \253\ See ISDA Letter at 3.
    \254\ See id.
    \255\ See id.
    \256\ See id.
---------------------------------------------------------------------------

    Another commenter expressed concern that because not all market
participants use a net capital computation, the proposed rule could
give unfair advantages to some market participants over others in terms
of gaining and retaining membership at a CCP.\257\ The commenter
concluded that proposed Rule 17Ad-22(b)(7) should not be adopted, and
instead CCPs should continue to determine membership standards subject
to Commission oversight (including capital requirements and other
measures of creditworthiness) as well as how best to ensure that access
to the clearing agency is fair and open.\258\
---------------------------------------------------------------------------

    \257\ See The DTCC (April) Letter at 20.
    \258\ See id.
---------------------------------------------------------------------------

    One commenter noted the Commission's reference in the Proposing
Release to the tiered membership standards of the FICC as an example of
capital-related requirements that differentiate between types of
participants.\259\ The commenter stated its opposition to ``tiers'' in
the membership structure of CCPs on the basis that they can have
discriminatory or anti-competitive effects.\260\ Finally, another
commenter stated it generally does not see the need for the approach
proposed in Rule 17Ad-22(b)(7) because it believes the Commission has
other tools at its disposal to review membership standards on a case-
by-case basis that account for the nature of a particular clearing
agency's activities and the risks associated with those
activities.\261\
---------------------------------------------------------------------------

    \259\ See MFA (Kaswell) Letter at 4.
    \260\ See id.
    \261\ See The OCC Letter at 12.
---------------------------------------------------------------------------

c. Final Rule
    The Commission is adopting Rule 17Ad-22(b)(7) with certain
modifications, including the clarification discussed in Sections II.B.4
and III.A regarding the application of the rule only to registered
clearing agencies. As noted by the commenters expressing support for
the rule,\262\ we believe that persons that maintain a net capital
level of equal to or greater than $50 million, as well as an
appropriate level of financial expertise, should not be denied
participation in a CCP based solely on their net capital levels,
provided that such persons are able to comply with other reasonable
membership standards. In the Proposing Release, we cited recent broker-
dealer reporting data available to the Commission reflecting that the
$50 million threshold for net capital is a standard that provides the
potential for approximately 4% of the total number of broker-dealers or
approximately 201 firms could be eligible to gain clearing membership
at one of the registered clearing agencies.\263\ According to this
data, raising the net capital requirement to $100 million would have
reduced the community of eligible broker-dealers by 73 firms or 35% to
128 eligible firms, while reducing the net capital threshold to as low
as $25 million would increase the number of broker-dealer potentially
eligible for membership by 86 firms or 43% to 287 firms (approximately
6% of broker-dealers). The Commission believes that firms that maintain
a net capital level of equal to or greater than $50 million have
sufficient financial resources to participate at some level in a CCP
provided that they are able to comply with other reasonable membership
standards and is concerned that some firms with less than $50 million
of net capital may not have sufficient financial resources to fulfill
membership obligations. The rule also ensures that each clearing agency
will have the flexibility to develop scalable policies and procedures
to limit the activities of participants based on their level of net
capital.\264\ For example, a CCP can place limits on its potential
exposure to participants operating at certain net capital thresholds by
restricting the maximum size of the portfolio such participants are
permitted to maintain at the clearing agency. Accordingly, the
Commission believes the $50 million minimum standard strikes the proper
balance between promoting open access to central clearing among
participants that have the capacity to participate without posing undue
risk to CCPs. The Commission also believes that Rule 17Ad-22(b)(7)
would facilitate sound

risk management practices by the clearing agencies. The CCPs that seek
Commission permission to employ a higher net capital requirement as a
condition for membership at the clearing agency must demonstrate to the
Commission that such a requirement is necessary to mitigate risks that
could not otherwise be effectively managed by other measures. The CCPs
seeking to implement such requirements should examine and articulate
the benefits of higher net capital requirements and link the nature and
degree of participation with the potential risks posed by the
participant.
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    \262\ See supra note 245.
    \263\ Even if proposed Rule 17Ad-22(b)(7) is successful in
encouraging the broadening of membership in CCPs that clear CDS, the
Commission believes the number of broker-dealers newly eligible for
clearing membership that become clearing members as a result of this
change is likely to be substantially less than 201.
    \264\ The Commission notes that some clearing agencies currently
utilize capital-related requirements that differentiate among types
of participants. For instance, the FICC has maintained a $50 million
net worth requirement and $10 million excess net capital requirement
for its Category 1 Dealer Netting Members and a $25 million net
worth requirement and $10 million excess net capital requirement for
its Category 2 Dealer Netting Members. This type of arrangement
would continue to be acceptable under Rule 17Ad-22(b)(7).
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    The Commission also does not believe that $50 million net capital
standard contained in Rule 17Ad-22(b)(7) would give an advantage to
some prospective members at a CCP over others. Further, the rule
explicitly is not intended in any way to create an ``entitlement'' to
membership for firms with more than $50 million in capital. Upon
adoption of Rule 17Ad-22, a registered CCP cannot restrict access
because a participant does not have a net capital level of $50 million
or more; however, the CCP's policies and procedures can prescribe other
reasonable membership standards and can be reasonably designed to limit
the activities of the participant in comparison to the activities of
other participants that maintain a higher net capital level. For
example, as a way to help make its requirements scalable, a registered
CCP may elect to place limits on its potential exposure to participants
operating at certain net capital thresholds by restricting the maximum
size of the portfolio such participants are permitted to maintain at
the CCP.
    Rule 17Ad-22(b)(7) also permits a registered CCP to provide for a
higher net capital requirement (i.e., higher than $50 million) as a
condition for membership at the clearing agency if the clearing agency
demonstrates to the Commission that such a requirement is necessary to
mitigate risks that could not otherwise be effectively managed by other
measures, such as scalable limitations on the transactions that the
participants may clear through the CCP, and the Commission approves the
higher net capital requirement as part of a rule filing or clearing
agency registration application. While the Commission is sympathetic to
commenters who asked the Commission to eliminate the ability in Rule
17Ad-22(b)(7) of a clearing agency to impose a higher net capital
requirement and argued for a heightened burden of proof in such
cases,\265\ the Commission has decided not to modify this part of the
rule. Specifically, the Commission recognizes the benefit of
maintaining flexibility to allow a CCP to impose higher net capital
requirements in circumstances where that is necessary to mitigate risks
that could not otherwise be effectively managed by other measures. For
the same reason, the Commission is declining to modify the rule to
prohibit a CCP from having tiered membership standards. The Commission
is not persuaded by commenters who stated that use of tiered membership
standards by clearing agencies is by itself anti-competitive because
the Commission believes the approach taken by the rule permits well
capitalized mid-tier firms to compete directly with large dealers and
notes that Section 17A of the Exchange Act expressly requires that the
rules of a clearing agency not be designed in a way that the rules
discriminate among participants in their use of clearing agency
services.\266\ It is the Commission's view that tailoring participant
membership standards based on participant risk profile is neither
discriminatory nor anti-competitive. In addition, the use of scalable
limitations on the transactions that the participants may clear and
settle through the clearing agency is likely to be a key tool for
allowing a clearing agency to comply with Rule 17Ad-22(b)(7) without
encountering the delay and operational difficulties of having to
request Commission approval to impose a net capital requirement that
exceeds $50 million and without compromising the clearing agency's risk
management standards.\267\
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    \265\ See supra notes 248-249 and accompanying text.
    \266\ See id.
    \267\ Compare with note 258 and accompanying text (the
Commission is not persuaded by the position that Rule 17Ad-22(b)(7)
should not be adopted, but agrees with the commenters premise that
clearing agencies should retain some discretion to allow their
expertise to inform participation standards within the requirements
of the rule).
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    Finally, the Commission did not make any changes to Rule 17Ad-
22(b)(7) in response to suggestions that the rule could create margin
call risk because a participant with the minimum net capital level
might access multiple clearing agencies.\268\ The Commission does not
believe that the rule will increase margin call risk. While the
Commission understands the concerns raised by this commenter, the
Commission believes that the clearing agencies themselves are best
positioned to address this issue due to their expertise in this area,
as well as their other regulatory obligations related to their risk
management and financial well-being. Rule 17Ad-22(d)(2) requires
clearing agencies to establish, implement, maintain and enforce written
policies and procedures reasonably designed to require participants to
have sufficient financial resources and robust operational capacity to
meet obligations arising from participation in the CCP and have
procedures in place to monitor that participation requirements are met
on an ongoing basis. Accordingly, a small clearing member should not be
able to expose a clearing agency to significant risk even if it is able
to clear at multiple CCPs.\269\ The Commission also will be able to
monitor the financial strength of clearing members that are registrants
pursuant to other financial reporting requirements. Accordingly, we
believe that it is important to allow CCPs enough flexibility to
determine the most effective approach for mitigating any potential call
risk. In addition, the Commission will continue to monitor this issue
and will consider whether any regulatory changes are necessary based on
experience with the $50 million capital standard. The Commission will
also consider any further action responsive to this issue after
receiving input from interested parties through the outreach described
in Section II.B.
---------------------------------------------------------------------------

    \268\ See supra notes 253-256 and accompanying text.
    \269\ For example, CCPs that participate in the Shared Market
Information System (SHAMIS) will be able to see a clearing member's
risk and financial information across participating CCPs, and a CCP
also could on its own initiative require clearing members to
directly report their clearing activity at other clearing agencies.
Other similar systems may develop in the future.
---------------------------------------------------------------------------

E. Record of Financial Resources and Annual Audited Financial
Statements: Rules 17Ad-22(c)(1)-(2)

1. Rule 17Ad-22(c)(1): Record of Financial Resources for Central
Counterparties
a. Proposed Rule
    Proposed Rule 17Ad-22(c)(1) would provide that each fiscal quarter
(based on calculations made as of the last business day of the clearing
agency's fiscal quarter), or at any time upon Commission request, a CCP
shall calculate and maintain a record \270\ of the financial resources
necessary to meet its requirement in proposed Rule 17Ad-22(b)(3) and
sufficient documentation to explain the methodology it uses to compute
such financial resource requirement.
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    \270\ See Exchange Act Rule 17a-1 (17 CFR 240.17a-1). Clearing
agencies may destroy or otherwise dispose of records at the end of
five years consistent with Exchange Act Rule 17a-6 (17 CFR 240.17a-
6).

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

b. Comments Received
    Commenters generally supported proposed rule 17Ad-22(c)(1).\271\
---------------------------------------------------------------------------

    \271\ See The DTCC (April) Letter at 7; see also Barnard Letter
at 1 (supporting generally the thrust of the Commission's proposals
in the Proposing Release, particularly proposed rule 17Ad-22
concerning standards for clearing agencies); LCH Letter at 1
(stating its general belief that the rules in the Proposing Release
``will help establish a comprehensive regulatory framework to reduce
risk, increase transparency and promote market integrity within the
financial system.'').
---------------------------------------------------------------------------

c. Final Rule
    We are adopting Rule 17Ad-22(c)(1) as proposed, except for the
clarification discussed in Sections II.B.4 and III.A regarding the
application of the rule only to registered clearing agencies. The
Commission believes that it is appropriate to require registered
clearing agencies to make these calculations quarterly or at any time
based on the request of the Commission because it provides a periodic
update of the financial resources that are needed by the clearing
agencies as market conditions change. The structure of Rule 17Ad-
22(c)(1) also provides flexibility for the Commission to request such
calculations on a real-time basis, which we believe to be useful during
periods of market stress or other circumstances where more timely
information is desired. The Commission believes that these calculations
and related documentation will also help our oversight of compliance by
clearing agencies with Rule 17Ad-22(b)(3) by providing a clear record
of the method used by the clearing agency to maintain sufficient
financial resources.
2. Rule 17Ad-22(c)(2): Clearing Agency Annual Audited Financial
Statements
a. Proposed Rule
    Rule 17Ad-22(c)(2), as proposed, would require a clearing agency to
post on its Web site an annual audited financial report. Each financial
report would be required to: (i) Be a complete set of financial
statements of the clearing agency for the most recent two fiscal years
of the clearing agency and be prepared in accordance with U.S.
generally accepted accounting principles (``U.S. GAAP''), except that
for a clearing agency that is a corporation or other organization
incorporated or organized under the laws of any foreign country, the
financial statements may be prepared according to U.S. GAAP or
International Financial Reporting Standards as issued by the
International Accounting Standards Board (``IFRS''); (ii) be audited in
accordance with standards of the Public Company Accounting Oversight
Board by a registered public accounting firm that is qualified and
independent in accordance with Rule 2-01 of Regulation S-X (17 CFR
210.2-01); and (iii) include a report of the registered public
accounting firm that complies with paragraphs (a) through (d) of Rule
2-02 of Regulation S-X (17 CFR 210.2-02).
b. Comments Received
    Commenters generally supported proposed Rule 17Ad-22(c)(2).\272\ In
response to a question asked by the Commission in the Proposing
Release, one commenter stated that it does not believe the Commission
should require a reconciliation to U.S. GAAP for reports prepared using
IFRS because it believes that IFRS is a high-quality set of accounting
standards that is widely recognized, understood and used by investors
when evaluating investment opportunities.\273\ The commenter also asked
the Commission to consider allowing non-U.S. based clearing agencies to
prepare their financial statements in accordance with accounting
standards generally accepted in the clearing agency's particular
jurisdiction so long as the financial statements are accompanied by a
reconciliation to U.S. GAAP.\274\ The commenter suggested that not
allowing this flexibility could force non-U.S. based clearing agencies
to post financial statements on their Web site that do not conform to
the clearing agency's local accounting and financial reporting
requirements.\275\
---------------------------------------------------------------------------

    \272\ See The DTCC (April) Letter at 7; ENY Letter at 2.
    \273\ See ENY Letter at 1.
    \274\ See id. at 2.
    \275\ See id.
---------------------------------------------------------------------------

c. Final Rule
    We are adopting Rule 17Ad-22(c)(2) as proposed, except for the
clarification discussed in Sections II.B.4 and III.A regarding the
application of the rule only to registered clearing agencies. We have
also changed references to ``annual audited financial report'' to
``annual audited financial statements'' to be consistent with the term
used in Regulation S-X. Furthermore, we have clarified that a
registered clearing agency will be required to post its financial
statements of income, changes in stockholders' equity and other
comprehensive income and cash flows \276\ within 60 days after the end
of its fiscal year, which is consistent with the staff guidance on
meeting the requirements of Section 17A in its Announcement of
Standards for the Registration of Clearing Agencies.\277\ The
Commission believes that requiring the disclosure of the clearing
agency's annual audited financial statements to be an additional layer
of information about the activities and financial strength of the
clearing agency that market participants may find useful in assessing
their use of the clearing agency's services.\278\
---------------------------------------------------------------------------

    \276\ The added language, ``changes in stockholders' equity and
other comprehensive income,'' does not change the substance of the
rule as provided in the Proposing Release. This language has been
added in the final rule to clarify the scope of what is meant by a
complete set of financial statements consistent with customary
industry accounting practices.
    \277\ See Exchange Act Release No. 16900 (June 17, 1980), 45 FR
41920 (June 23, 1980) (``Accordingly, a clearing agency should
undertake in its rules to furnish to participants, within 60 days
following the close of the clearing agency's fiscal year,
unconsolidated audited comparative financial statements which are
prepared in accordance with generally accepted accounting principles
and are covered by a report prepared by its independent public
accountant.'').
    \278\ The requirements of proposed Rule 17Ad-22(c)(2) concerning
the audited annual financial statements would apply individually to
each respective clearing agency.
---------------------------------------------------------------------------

    Consistent with recommendations from commenters, we are adopting
Rule 17Ad-22(c)(2) in a form that does not require a reconciliation to
U.S. GAAP for clearing agency reports that are prepared using
IFRS.\279\ We appreciate the request made by commenters for the
Commission to consider allowing non-U.S. based clearing agencies to
prepare their financial statements in accordance with accounting
standards generally accepted in their home jurisdiction so long as the
financial statements are accompanied by a reconciliation to U.S.
GAAP.\280\ However, we also recognize the advantages of financial
statement disclosure that are limited to more widely applied bases of
accounting and may offer more utility to market participants,
regulators and other stakeholders of clearing agencies. Therefore, we
have limited the different bases of accounting upon which the annual
audited financial statements may be prepared to IFRS and U.S. GAAP.
---------------------------------------------------------------------------

    \279\ See supra note 273.
    \280\ See supra notes 274-275 and accompanying text.
---------------------------------------------------------------------------

F. Minimum Standards for Registered Clearing Agencies: Rules 17Ad-
22(d)(1)-(15)

    Rule 17Ad-22(d) sets forth certain minimum standards regarding the
operations of registered clearing agencies providing CCP or CSD
services. The standards established in Rule 17Ad-22 address areas
including: (1) Transparent and enforceable rules and procedures; (2)
participation requirements; (3) custody of assets and

investment risk; (4) operational risk; (5) money settlement risk; (6)
cost-effectiveness; (7) links; (8) governance; (9) information on
services; (10) immobilization and dematerialization of securities
certificates; (11) default procedures; (12) timing of settlement
finality; (13) delivery versus payment; (14) risk controls to address
participants' failures to settle; and (15) physical delivery risks.
    Like Rules 17Ad-22(b) and (c), Rule 17Ad-22(d) is designed to work
in tandem with the Commission's existing mandate under Section 17A of
the Exchange Act by establishing minimum standards for clearing agency
operations. In particular, Congress directed the Commission to
facilitate the establishment of (1) a national system for the prompt
and accurate clearance and settlement of transactions in securities
(other than exempt securities) and (2) linked or coordinated facilities
for clearance and settlement of transactions in securities, securities
options, contracts of sale for future delivery and options thereon, and
commodity options. \281\ In using its authority, the Commission must
consider the public interest, the protection of investors, the
safeguarding of securities and funds, and the maintenance of fair
competition among brokers and dealers, clearing agencies, and transfer
agents.\282\ When Congress established this system for the regulation
of clearing agencies in 1975, Congress found that:
---------------------------------------------------------------------------

    \281\ See 15 U.S.C. 78q-1(a)(2)(A).
    \282\ See 15 U.S.C. 78q-1(b)(3)(A)-(I).
---------------------------------------------------------------------------

     The prompt and accurate clearance and settlement of
securities transactions, including the transfer of record ownership and
the safeguarding of securities and funds related thereto, are necessary
for the protection of investors and persons facilitating transactions
by and acting on behalf of investors.
     Inefficient procedures for clearance and settlement impose
unnecessary costs on investors and persons facilitating transactions by
and acting on behalf of investors.
     New data processing and communications techniques create
the opportunity for more efficient, effective, and safe procedures for
clearance and settlement.
     The linking of all clearance and settlement facilities and
the development of uniform standards and procedures for clearance and
settlement will reduce unnecessary costs and increase the protection of
investors and persons facilitating transactions by and acting on behalf
of investors. \283\
---------------------------------------------------------------------------

    \283\ See 15 U.S.C. 78q-1(a)(1).
---------------------------------------------------------------------------

    These findings serve as objectives in the Commission's ongoing
efforts to enhance efficiency and reduce risk in the operation of the
U.S. clearance and settlement system. Over the years, the Commission's
view of the actions by a clearing agency that are necessary to meet
these objectives as well as the other requirements in Section 17A has
changed with prevailing market conditions and as new technologies are
developed. For example, in the years after the October 1987 market
break, the Commission worked to implement a number of changes in the
securities markets, including the reduction of the standard settlement
time frame for a securities transaction to the third day after the
securities trade date (i.e., T+3) and the conversion to a same-day
funds settlement system.\284\ In 2004, in a concept release titled
Securities Transaction Settlement, the Commission noted at that time
that (1) size and growth of the securities markets; (2) tighter
linkages among markets and market participants; and (3) a possible
wide-scale regional disruption prompted the Commission to consider
shortening the standard T+3 securities settlement cycle even further to
mitigate the possibility of systemic disruptions and to facilitate a
more efficient clearance and settlement system.\285\
---------------------------------------------------------------------------

    \284\ See 17 CFR 240.15c6-1; Exchange Act Release No. 34-26051
(Aug. 31, 1988), 53 FR 34852 (Sept. 8, 1988).
    \285\ See Concept Release: Securities Transaction Settlement,
Release No. 34-49405 (Mar. 11, 2004).
---------------------------------------------------------------------------

    Over time, changes to the U.S. legal framework have also led to
enhancements in the operation of the U.S. clearance and settlement
system. For example, the adoption of Revised Article 8 of the Uniform
Commercial Code in 1995 strengthened the laws governing the holding and
transfer of securities.\286\ In response, clearing agencies changed
their rules to provide greater legal certainty to their direct
investors and provide greater protection to investors.\287\ Amendments
to the U.S. bankruptcy code in 2005 similarly provided an opportunity
for enhanced legal protections for clearing agencies and clearing
agency participants.\288\
---------------------------------------------------------------------------

    \286\ See generally James S. Rogers, Policy Perspectives on
Revised U.C.C. Article 8 (1996), Boston College Law School Faculty
Papers, Paper 343, available at http://lawdigitalcommons.bc.edu/cgi/viewcontent.cgi?article=1346&context=lsfp.
    \287\ Securities and Exchange Act Release Nos. 39924 (Apr. 27,
1998), 63 FR 24584 (May 4, 1998) and 36781 (Jan. 26, 1996), 61 FR
3958 (Feb. 2, 1996).
    \288\ Bankruptcy Abuse Prevention and Protection Act of 2005,
Public Law 109-8, 119 Stat. 23.
---------------------------------------------------------------------------

    Consistent with these examples of how the Commission's approach to
administrative oversight and practices by clearing agencies have
changed over time to meet the objectives of Section 17A, the Commission
believes that Rule 17Ad-22(d) creates standards for various aspects of
the payment, clearance and settlement process and that to meet these
standards clearing agencies will likely need to update their rules and
procedures as market conditions evolve (e.g., through new products and
trading strategies), to keep pace with relevant changes in technology,
and appropriately respond to other conditions.\289\ The discussion
below provides greater detail regarding each respective standard
covered in Rules 17Ad-22(d)(1)-(15). As indicated in Section II.B the
Commission intends to observe clearing agency practices as they are
developed to establish, implement, maintain and enforce policies and
procedures that are intended to achieve compliance with Rules 17Ad-
22(d)(1)-(15). Monitoring those practices and through cognizance of
changes in other relevant areas that affect a clearing agency's
operation and governance, such as market conditions, technology, or
international standards, the Commission may modify Rules 17Ad-22(d)(1)-
(15) over time or adopt additional rules as appropriate. The Commission
may also choose to issue further guidance concerning its rules for
clearing agencies.
---------------------------------------------------------------------------

    \289\ See supra note 71.
---------------------------------------------------------------------------

1. Rule 17Ad-22(d)(1): Transparent and Enforceable Rules and Procedures
a. Proposed Rule
    Rule 17Ad-22(d)(1), as proposed, would require clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to provide for a well-founded,
transparent and enforceable structure for each aspect of their
activities in all relevant jurisdictions.\290\
---------------------------------------------------------------------------

    \290\ A relevant jurisdiction would include, among others,
activities (1) In the United States, (2) involving any means of
interstate commerce, or (3) in respect to providing clearing
services to any U.S. person. For clearing agencies that operate in
multiple jurisdictions, this also could include resolving possible
conflicts of laws issues that the clearing agency may encounter.
---------------------------------------------------------------------------

b. Comments Received
    Commenters generally supported Rule 17Ad-22(d)(1).\291\
---------------------------------------------------------------------------

    \291\ See The DTCC (April) Letter at 7 (noting its support for
proposed Rule 17Ad-22(d)(1) as drafted); see also Better Markets
Letter at 2 (stating generally that ``[i]n fashioning the rules, and
in accordance with the Dodd-Frank Act, the Commission has
appropriately taken into account international standards governing
clearance and settlement''); Barnard Letter at 1 (supporting
generally the thrust of the Commission's proposals in the Proposing
Release, particularly proposed Rule 17Ad-22 concerning standards for
clearing agencies); The OCC Letter at 7 (applauding the Commission
generally for choosing to incorporate many aspects of the current
CPSS-IOSCO Recommendations in the Proposing Release); LCH Letter at
1 (stating its general belief that the rules in the Proposing
Release ``will help establish a comprehensive regulatory framework
to reduce risk, increase transparency and promote market integrity
within the financial system'').

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

c. Final Rule
    The Commission is adopting Rule 17Ad-22(d)(1) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies. We
believe that well-founded, transparent and enforceable policies and
procedures established to underpin a clearing agency's operational and
business activities are essential to reduce legal risks and enhance a
clearing agency's ability to facilitate the prompt and accurate
clearance and settlement of securities transactions and safeguard
securities and funds as required for the protection of investors by
Section 17A of the Exchange Act.\292\
---------------------------------------------------------------------------

    \292\ 15 U.S.C. 78q-1(a)(1)(A).
---------------------------------------------------------------------------

    To achieve compliance with Rule 17Ad-22(d)(1), a clearing agency
must have written policies and procedures \293\ in place that, at a
minimum, address the significant aspects of a clearing agency's
operations and risk management to provide a well-founded legal
framework and must be clear, internally consistent, and readily
accessible by the public in order to provide a transparent legal
framework. In addition, the clearing agency must be able to enforce its
policies and procedures that contemplate enforcement by the clearing
agency. Moreover, policies and procedures that govern or create
remedial measures that a party other than the clearing agency (such as
a clearing member) can undertake to seek redress or to promote
compliance with applicable rules must be enforceable.\294\ Examples of
legal risk in the operation of a clearing agency include, among other
things, the likelihood that the policies and procedures of a clearing
agency are incomplete, opaque, or not enforceable and will therefore
adversely affect the functioning of the clearing agency.\295\ The
Commission believes that it is helpful for a clearing agency to bear
these risk factors in mind and that it should also consider the extent
to which changes in the legal framework affecting the clearing agency
may require changes to its organization and practices to ensure that
the establishment, implementation, maintenance and enforcement of its
policies and procedures continues to provide for a well-founded,
transparent and enforceable structure that protects the interests of
the clearing agency and its participants.
---------------------------------------------------------------------------

    \293\ Clearing agencies are SROs as defined in Section 3(a)(26)
of the Exchange Act. A stated policy, practice, or interpretation of
an SRO, such as a clearing agency's written policies and procedures,
would generally be deemed to be a proposed rule change, unless (1)
it is reasonably and fairly implied by an existing rule of the self-
regulatory organization or (2) it is concerned solely with the
administration of the self-regulatory organization and is not a
stated policy, practice, or interpretation with respect to the
meaning, administration, or enforcement of a SRO's existing rule.
See 17 CFR 240.19b-4.
    \294\ The Commission believes that Rule 17Ad-22(d)(1) would
augment the Exchange Act requirement that the rules of the clearing
agency must provide that its participants shall be appropriately
disciplined for any violation of any provision of the rules of the
clearing agency. See 15 U.S.C. 78q-1(b)(3)(G).
    \295\ See generally RSSS Recommendation 1, Legal Framework and
RCCP Recommendation 1, Legal Risk, supra note 33.
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2. Rule 17Ad-22(d)(2): Participation Requirements
a. Proposed Rule
    Rule 17Ad-2(d)(2), as proposed, would require clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to require participants to have
sufficient financial resources and robust operational capacity to meet
obligations arising from participation in the clearing agency; have
procedures in place to monitor that participation requirements are met
on an ongoing basis; and have participation requirements that are
objective, publicly disclosed, and permit fair and open access.
b. Comments Received
    Some commenters supported proposed Rule 17Ad-22(d)(2).\296\
---------------------------------------------------------------------------

    \296\ See The DTCC (April) Letter at 7; see also Better Markets
Letter at 2; Barnard Letter at 1; The OCC Letter at 7; LCH Letter at
1.
---------------------------------------------------------------------------

    One commenter stated its specific preference for proposed Rule
17Ad-22(d)(2) to facilitate the Commission's regulation of access at
clearing agencies compared to Rules 17Ad-22(b)(5), (6) and (7) for
CCPs.\297\ The commenter suggested that adoption of Rule 17Ad-22(d)(2),
though not a prescriptive rule, would give the Commission a broad level
of plenary authority over participant access to clearing agencies.\298\
---------------------------------------------------------------------------

    \297\ See The OCC Letter at 12.
    \298\ See id.
---------------------------------------------------------------------------

    One commenter recommended that the Commission should take an
expansive, prescriptive approach to its rule requirements for clearing
agency participation and participant monitoring.\299\ The commenter
asked that the Commission be more detailed in the requirements of its
proposed rules that address participation standards, like Rule 17Ad-
22(d)(2).\300\ The commenter suggested that the Commission should apply
this approach within several categories of clearing agency operation
that it believes comprise risk management.\301\
---------------------------------------------------------------------------

    \299\ See Barnard Letter at 1; ISDA Letter at 3-4.
    \300\ See ISDA Letter at 3-4.
    \301\ See id. (citing the following areas as components of a
clearing agency's risk management framework: (1) Board and senior
management oversight; (2) an organizational structure that conforms
to the overall strategy and risk policy set by the board; (3) that
individuals permitted to take risk on behalf of the clearing member
have a strong understanding of the organization's risk profile, the
products it trades, and approved trading limits; (4) risk management
that is independent and reports directly to senior management or the
board; and (5) strong systems and procedures for controlling,
monitoring, and reporting risk (including for transactions with
affiliates)).
---------------------------------------------------------------------------

    One commenter supported the requirement in Rule 17Ad-22(d)(2) for
clearing members to have written policies and procedures for risk
management but also emphasized the importance of placing emphasis on
practical experience in risk management.\302\ The commenter urged the
Commission to require that participants in a clearing agency must be
able to participate in its default management process, which includes
the ability to bid for the portfolios of other clearing members.\303\
The commenter also stated that if a clearing agency admitted a clearing
member that was unable to participate in default management, it would
reduce available resources and liquidity, place heightened burdens on
other clearing members, and reduce the likelihood that the clearing
agency's risk management process would operate effectively.\304\
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    \302\ See ISDA Letter at 4.
    \303\ See ISDA Letter at 5.
    \304\ See id.
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    One commenter encouraged the Commission to prohibit clearing
agencies from imposing rules or engaging in conduct that is prejudicial
to indirect clearing participants compared to direct clearing
participants (e.g., with respect to eligibility or the timing of
clearing or processing of trades), and stated that if a transaction
satisfies a clearing agency's rules then the clearing process for that
trade should be the same regardless of whether it involves direct or
indirect clearing participants.\305\
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    \305\ See MFA (Kaswell) Letter at 7 (further stating that this
includes ``barriers to competitive price provision by a liquidity
provider that is an indirect clearing participant versus a direct
clearing participant'' because ``when an indirect clearing
participant trades with another indirect clearing participant, the
clearing process should be identical and as prompt as when one of
the parties is a direct clearing participant so long as the
transaction satisfies the relevant clearing agency's rules,
requirements and standards otherwise applicable to such trades.'');
MFA (Baker) Letter Attachment 1, at 1.

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    Some commenters expressed concern that clearing agency participants
may rely on the resources and services of a third party to meet the
requirements developed by clearing agencies pursuant to Rule 17Ad-
22(d)(2).\306\ One commenter expressed that it does not believe that a
clearing member should be able to use a credit facility funding
arrangement from an unaffiliated entity to satisfy financial resource
requirements developed by a clearing agency pursuant to Rule 17Ad-
22(d)(2).\307\ The commenter noted that in this case the clearing
member receives only a contractual right to funds, may need to attempt
to enforce that right at a time of stressed liquidity, and does not
have rights to monitor the financial resources of the liquidity
facility.\308\ The same commenter stated that participants should not
be permitted to outsource default management.\309\ It argued that
preventing the outsourcing of default management arrangements is
critical to mitigate risks associated with outsourcing.\310\
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    \306\ See ISDA Letter at 4-5.
    \307\ See ISDA Letter at 4.
    \308\ See id.
    \309\ See ISDA Letter at 5.
    \310\ See id. (noting (1) the fact that the third party does not
``have skin in the game'' and (2) the third party service provider
could inappropriately bind a clearing member to accept positions
from a defaulting clearing member that it is not equipped to handle.
The commenter also pointed out that conflicts of interest could
exacerbate these risks if the third party service provider is
operated by a competing clearing member).
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    Several commenters argued that Rule 17Ad-22(d)(2) is only
appropriate for CCPs.\311\ As noted below, Rule 17Ad-22(d)(2) only
applies to these entities.
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    \311\ See Omgeo Letter at 10; TriOptima Letter at 6-7.
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c. Final Rule
    The Commission is adopting Rule 17Ad-22(d)(2) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies.
    Rule 17Ad-22(d)(2) is intended to reduce the likelihood of defaults
by participants, while also providing flexibility for clearing agencies
to tailor standards that are linked to the obligations of the
participant. The Commission believes the rule fosters compliance with
the requirement under Section 17A of the Exchange Act that the rules of
a clearing agency must not be designed to permit unfair discrimination
in the admission of participants by requiring standards that are
designed to be measurable, open and fair.\312\
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    \312\ 15 U.S.C. 78q-1(b)(3)(F).
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    We agree with those commenters who supported Rule 17Ad-22(d)(2) as
a mechanism to help ensure that clearing agencies meet the Exchange Act
requirements in their participation standard practices.\313\ However,
we are not persuaded by the position that Rule 17Ad-22(d)(2) is so
coextensive with the requirements of Rules 17Ad-22(b)(5), (6) and (7)
that it renders the adoption of those rules unnecessary.\314\ As
discussed above, Rules 17Ad-22(b)(5), (6) and (7) are responsive to
specific concerns about access to CCPs that have been brought to the
attention of the Commission in connection with efforts to promote
central clearing of security-based swaps by the financial services
industry, government regulators and legislators in response to the
recent financial crisis.\315\ We believe that Rule 17Ad-22 promotes the
compliance of all clearing agencies with the requirement in Section 17A
of the Exchange Act that a clearing agency's rules may not be designed
to permit unfair discrimination in the admission of participants or
among participants in the use of the clearing agency. We also believe
this complements the design of Rules 17Ad-22(b)(5), (6) and (7) to
specifically promote compliance with the fair access requirement by
CCPs.
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    \313\ See supra note 296.
    \314\ See supra note 297.
    \315\ See discussion supra Section II.B.
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    We agree with commenters that comprehensive and explicit
requirements are an appropriate part of a clearing agency's risk
management framework, including participation standards.\316\ We also
agree with commenters who stated that it is important for the
Commission to promote clearing agencies' use of practical experience in
establishing, implementing, maintaining and enforcing their policies
and procedures concerning participation standards and that the
inability of a clearing member to participate in the default management
process during a default would be problematic.\317\ Accordingly, we
believe that it is important to allow clearing agencies enough
flexibility to use their market experience to shape the rules, policies
and procedures addressing participation standards and for the
Commission to oversee the suitability of those standards through its
oversight, including the SRO rule filing process, periodic inspections
and examinations, and day-to-day monitoring of the activities of
clearing agencies. Because of the importance of clearing agency
flexibility and the existing oversight mechanisms, the Commission
declines to adopt more prescriptive requirements under Rule 17Ad-
22(d)(2) at this time.
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    \316\ See supra notes 299-300.
    \317\ See supra note 302 and accompanying text.
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    We agree with commenters that credit facility arrangements
represent a contractual right to funds and that enforcement of that
contractual right may become more difficult during stressed market
conditions.\318\ However, we do not believe that the rule should
completely prohibit participants from using credit facility
arrangements with an unaffiliated entity to satisfy financial resource
requirements to a clearing agency because such credit facility
arrangements can be an important tool that allows clearing agencies to
access liquidity quickly in times of stress avoiding an immediate need
to liquidate assets. Instead, we expect clearing agencies to use their
expertise to establish rules, policies and procedures that properly
reflect the extent to which credit facility arrangements are
appropriate for participants at the particular clearing agency based on
the particular clearance and settlement services it provides.
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    \318\ See supra notes 306-308 and accompanying text.
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    We agree with commenters who stated that clearing agencies should
not process trades differently on the sole basis of whether the trade
is between direct clearing members or involves participants that access
the clearing agency through those clearing members, and so the
Commission does not find it necessary to create disparate standards for
the treatment of direct and indirect participants.\319\
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    \319\ See supra note 305 and accompanying text.
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3. Rule 17Ad-22(d)(3): Custody of Assets and Investment Risk
a. Proposed Rule
    Proposed Rule 17Ad-22(d)(3) would require clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to hold assets in a manner whereby risk
of loss or of delay in access to them is minimized, and invest in
instruments with minimal credit, market and liquidity risks. Compliance
with the requirement is intended to improve the ability of the clearing
agency to meet its settlement

obligations by reducing the likelihood that assets securing participant
obligations to the clearing agency would be unavailable or insufficient
when the clearing agency needs to draw on them.
b. Comments Received
    Some commenters expressed concerns about the application and scope
of proposed Rule 17Ad-22(d)(3). One commenter stated that proposed Rule
17Ad-22(d)(3) is not sufficiently clear in its scope.\320\ The
commenter urged the Commission to make clear that Rule 17Ad-22(d)(3)
applies only to the assets of the clearing agency that are available to
facilitate settlement in the event of a participant default and not
those assets that are held in custody by the clearing agency.\321\
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    \320\ See The DTCC (April) Letter at 21.
    \321\ See The DTCC (April) Letter at 21-22 (remarking that it
believes this ambiguity is also contained in RCCP 7: Custody and
investment risks on which Rule 17Ad-22(d)(3) is modeled but noting
that proposed language for FMI Principle 16: Custody and investment
risk would resolve that ambiguity and asking the Commission to
revise Rule 17Ad-22(d)(3) as follows to make clear that the
requirements of the rule do not apply to assets of participants held
in custody: ``(d) Each clearing agency shall establish, implement,
maintain and enforce written policies and procedures reasonably
designed to, as applicable: (3) Hold its assets in a manner whereby
risk of loss or of delay in its access to them is minimized; and
invest such assets in instruments with minimal credit, market and
liquidity risks'').
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    However, another commenter asked the Commission to clarify that
proposed Rule 17Ad-22(d)(3) applies to customer assets only and not to
the assets of the clearing agency (or its sponsor).\322\ The commenter
noted that by defining the scope of Rule 17Ad-22(d)(3) that way the
rule would not apply to clearing agencies that perform post-trade
processing services (e.g., compression or collateral management) and do
not take in or retain any assets of their users.\323\ An additional
commenter agreed that Rule 17Ad-22(d)(3) should not apply to clearing
agencies that do not hold assets on behalf of participants.\324\
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    \322\ See TriOptima Letter at 7.
    \323\ See id.
    \324\ See Omgeo Letter at 10.
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c. Final Rule
    The Commission is adopting Rule 17Ad-22(d)(3) as proposed, except
for the clarification discussed in Sections II.B.4 and III.A regarding
the application of the rule only to registered clearing agencies. The
Commission believes that Rule 17Ad-22(d)(3) strengthens the requirement
in Section 17A(b)(3)(F) of the Exchange Act that the rules of a
clearing agency must be designed to ensure the safeguarding of
securities and funds in the custody or control of the clearing agency
or for which the clearing agency is responsible.\325\ Because the
purpose of Rule 17Ad-22(d)(3) is to help ensure assets are available in
the event of a participant default, Rule 17Ad-22(d)(3) would apply to
all assets held by a clearing agency that may be used for that purpose.
However, the Commission notes that Rule 17Ad-22(d)(3) may not apply to
the assets of a participant's customer depending on how a clearing
agency's operations are structured. The Commission does not expect that
registered clearing agencies would need to rely on their physical
assets, such as computers, furniture and buildings, to cover a
participant default under the rule.
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    \325\ 15 U.S.C. 78q-1(b)(3)(F).
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    We appreciate the concerns expressed by commenters who asked the
Commission to clarify how Rule 17Ad-22(d)(3) applies in the context of
the different services that a clearing agency may perform, and note
that Rule 17Ad-22 only applies to registered clearing agencies and does
not apply to entities that are exempt from registration as a clearing
agency.
4. Rule 17Ad-22(d)(4): Identification and Mitigation of Operational
Risk
a. Proposed Rule
    Rule 17Ad-22(d)(4), as proposed, would require clearing agencies to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to identify sources of operational risk
and minimize these risks through the development of appropriate
systems, controls, and procedures; implement systems that are reliable,
resilient and secure and have adequate scalable capacity; and have
business continuity plans that allow for timely recovery of operations
and ensure the fulfillment of a clearing agency's obligations.
    Rule 17Ad-22(d)(4) should help to ensure that clearing agencies are
able to operate with minimal disruptions, even during times of market
stress when there may be greater demands on their systems due to higher
volume. In addition, the rule would require that clearing agencies have
business continuity plans that allow for timely recovery of operations
and ensure the fulfillment of a clearing agency's obligations. This
requirement would be relevant in the event of, among other things,
deficiencies in information systems or internal controls, human errors,
management failures, unauthorized intrusions into corporate or
production systems, or disruptions from external events such as natural
disasters.
b. Comments Received
    Several commenters recommended that the rule should not apply to
the activities of clearing agencies that perform post trade processing
services. For example, one commenter reasoned that the application of
proposed Rule 17Ad-22(d)(4) to a clearing agency that performs post-
trade comparison services is unnecessary if that clearing agency is
operating pursuant to a conditional exemptive order from the
Commission.\326\ The commenter stated that the conditions of an
exemptive order can be tailored to provide the Commission with
sufficient regulatory oversight of a clearing agency's operational
risks.\327\
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    \326\ See Omgeo Letter at 10.
    \327\ See id. (identifying such measures as making the clearing
agency subject to: (1) The Commission's Automation Review Program,
(2) regular audits by Commission staff, (3) annual reports to the
Commission, (4) a duty to report systems outages to the Commission,
and (5) on-site inspections by Commission staff of the clearing
agency's facilities).
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