[Federal Register Volume 88, Number 232 (Tuesday, December 5, 2023)]
[Rules and Regulations]
[Pages 84454-84511]
[FR Doc No: 2023-25807]

Vol. 88

Tuesday,

No. 232

December 5, 2023

Part III

 Securities and Exchange Commission

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17 CFR Part 240

Clearing Agency Governance and Conflicts of Interest; Final Rule

Federal Register / Vol. 88 , No. 232 / Tuesday, December 5, 2023 /
Rules and Regulations

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-98959; File No. S7-21-22]
RIN 3235-0695

Clearing Agency Governance and Conflicts of Interest

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting rules under the Securities Exchange Act of 1934 (``Exchange
Act'') to improve the governance of clearing agencies registered with
the Commission (``registered clearing agencies'') by reducing the
likelihood that conflicts of interest may influence the board of
directors or equivalent governing body (``board'') of a registered
clearing agency. The rules identify certain responsibilities of the
board, increase transparency into board governance, and, more
generally, improve the alignment of incentives among owners and
participants of a registered clearing agency. In support of these
objectives, the rules establish new requirements for board and
committee composition, independent directors, management of conflicts
of interest, and board oversight.

DATES:
    Effective date: February 5, 2024.
    Compliance date: The applicable compliance dates are discussed in
Part III of this release.

FOR FURTHER INFORMATION CONTACT: Matthew Lee, Assistant Director,
Stephanie Park, Senior Special Counsel, Claire Noakes, Special Counsel,
Jenny Ogasawara, Branch Chief, and Haley Holliday, Attorney-Adviser, at
(202) 551-5710, Office of Clearance and Settlement, Division of Trading
and Markets; Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: The Commission is adopting 17 CFR 240.17ad-
25 (``Rule 17Ad-25'') under the Exchange Act to establish new
requirements for the board governance of registered clearing agencies
and for the management of conflicts of interest by registered clearing
agencies.\1\ Below is a table of citations to the rules being adopted
in this release:
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    \1\ This adopting release also modifies the proposed CFR
designations to ensure the regulatory text conforms with section
2.13 of the Document Drafting Handbook. See 1 CFR 21.11; Office of
the Federal Register, Document Drafting Handbook (Aug. 2018 Edition,
Revision 2.1, dated Oct. 2023), https://www.archives.gov/files/federal-register/write/handbook/ddh.pdf. Because the Commission
proposed the new rules to contain an uppercase letter in their CFR
citations, the Commission is modifying the CFR section designations
at adoption to replace each such uppercase letter with the
corresponding lowercase letter. Accordingly, 17 CFR 240.17Ad-25 will
be designated at adoption as 17 CFR 240.17ad-25.

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           Commission reference                CFR citation  (17 CFR)
------------------------------------------------------------------------
Securities Exchange Act of 1934
 (``Exchange Act''):
  Rule 17Ad-25............................  Sec.   240.17ad-25.
  Rule 17Ad-25(a).........................  Sec.   240.17ad-25(a).
  Rule 17Ad-25(b).........................  Sec.   240.17ad-25(b).
  Rule 17Ad-25(b)(1)......................  Sec.   240.17ad-25(b)(1).
  Rule 17Ad-25(b)(2)......................  Sec.   240.17ad-25(b)(2).
  Rule 17Ad-25(b)(2)(i)...................  Sec.   240.17ad-25(b)(2)(i).
  Rule 17Ad-25(b)(2)(ii)..................  Sec.   240.17ad-
                                             25(b)(2)(ii).
  Rule 17Ad-25(b)(2)(iii).................  Sec.   240.17ad-
                                             25(b)(2)(iii).
  Rule 17Ad-25(c).........................  Sec.   240.17ad-25(c).
  Rule 17Ad-25(c)(1)......................  Sec.   240.17ad-25(c)(1).
  Rule 17Ad-25(c)(2)......................  Sec.   240.17ad-25(c)(2).
  Rule 17Ad-25(c)(3)......................  Sec.   240.17ad-25(c)(3).
  Rule 17Ad-25(c)(4)......................  Sec.   240.17ad-25(c)(4).
  Rule 17Ad-25(c)(4)(i)...................  Sec.   240.17ad-25(c)(4)(i).
  Rule 17Ad-25(c)(4)(ii)..................  Sec.   240.17ad-
                                             25(c)(4)(ii).
  Rule 17Ad-25(c)(4)(iii).................  Sec.   240.17ad-
                                             25(c)(4)(iii).
  Rule 17Ad-25(c)(4)(iv)..................  Sec.   240.17ad-
                                             25(c)(4)(iv).
  Rule 17Ad-25(d).........................  Sec.   240.17ad-25(d).
  Rule 17Ad-25(d)(1)......................  Sec.   240.17ad-25(d)(1).
  Rule 17Ad-25(d)(2)......................  Sec.   240.17ad-25(d)(2).
  Rule 17Ad-25(e).........................  Sec.   240.17ad-25(e).
  Rule 17Ad-25(f).........................  Sec.   240.17ad-25(f).
  Rule 17Ad-25(f)(1)......................  Sec.   240.17ad-25(f)(1).
  Rule 17Ad-25(f)(2)......................  Sec.   240.17ad-25(f)(2).
  Rule 17Ad-25(f)(3)......................  Sec.   240.17ad-25(f)(3).
  Rule 17Ad-25(f)(3)(i)...................  Sec.   240.17ad-25(f)(3)(i).
  Rule 17Ad-25(f)(3)(ii)..................  Sec.   240.17ad-
                                             25(f)(3)(ii).
  Rule 17Ad-25(f)(4)......................  Sec.   240.17ad-25(f)(4).
  Rule 17Ad-25(f)(4)(i)...................  Sec.   240.17ad-25(f)(4)(i).
  Rule 17Ad-25(f)(4)(ii)..................  Sec.   240.17ad-
                                             25(f)(4)(ii).
  Rule 17Ad-25(f)(5)......................  Sec.   240.17ad-25(f)(5).
  Rule 17Ad-25(f)(6)......................  Sec.   240.17Ad-2525(f)(6).
  Rule 17Ad-25(g).........................  Sec.   240.17ad-25(g).
  Rule 17Ad-2525(g)(1)....................  Sec.   240.17Ad-2525(g)(1).
  Rule 17Ad-25(g)(2)......................  Sec.   240.17ad-25(g)(2).
  Rule 17Ad-25(h).........................  Sec.   240.17ad-25(h).
  Rule 17Ad-25(i).........................  Sec.   240.17ad-25(i).
  Rule 17Ad-25(i)(1)......................  Sec.   240.17ad-25(i)(1).
  Rule 17Ad-25(i)(2)......................  Sec.   240.17ad-25(i)(2).
  Rule 17Ad-25(i)(3)......................  Sec.   240.17ad-25(i)(3).
  Rule 17Ad-25(i)(4)......................  Sec.   240.17ad-25(i)(4).
  Rule 17Ad-25(j).........................  Sec.   240.17ad-25(j).
------------------------------------------------------------------------

    With respect to board governance, Rules 17Ad-25(b), (e), and (f)
establish requirements for board composition and independent directors,
as discussed in Part II.A. Rules 17Ad-25(c) and (d) establish
requirements for the nominating and risk management committees of the
board, as discussed in Parts II.B and II.C respectively. With respect
to conflicts of interest, Rules 17Ad-25(g) and (h) establish
requirements for policies and procedures to identify, document, and
mitigate or eliminate such conflicts of interest, as well as an
obligation of directors to report such conflicts to the registered
clearing agency, as discussed in Part II.D. In addition, Rules 17Ad-
5(i) and (j) establish obligations of the board to oversee the
management of risks from relationships with service providers for core
services, as discussed in Part II.E, and to solicit, consider and
document the views of stakeholders, as discussed in Part II.F.
    As discussed further in Part III, the compliance date for Rule
17Ad-25 is December 5, 2024, except that the compliance date for the
independence requirements of the board and board committees in Rules
17Ad-25(b)(1), (c)(2), and (e) is December 5, 2025.

Table of Contents

I. Introduction
II. Discussion of Comments Received and Final Rules
    A. Board Composition and Requirements for Independent Directors
    1. Proposed Rules 17Ad-25(b), (e), and (f)
    2. Overall Views
    3. Criteria for Independence
    4. Incentive Structures
    5. Ownership Structures
    6. Circumvention
    B. Nominating Committee
    1. Proposed Rule 17Ad-25(c)
    2. As ``Exclusive Venue'' for Considering Nominees
    3. Approach to Representation of Small and Medium-Sized Firms
    4. Percent of Directors That Are Independent Directors
    C. Risk Management Committee
    1. Proposed Rule 17Ad-25(d)
    2. RMC of the Board
    3. Annual Requirement To Re-Evaluate RMC Membership
    4. Harmonization With CFTC and EMIR Requirements
    5. Other Comments
    D. Conflicts of Interest
    1. Proposed Rules 17Ad-25(g) and (h)
    1. Mitigation or Elimination of Conflicts
    2. Use of ``Reasonably Designed'' Policies and Procedures
Approach
    E. Management of Risks From Relationships With Service Providers
for Core Services
    1. Proposed Rule 17Ad-25(i)
    2. Definition of Service Provider for Core Services
    3. Roles of Senior Management and the Board
    F. Obligation To Formally Consider Stakeholder Viewpoints
    1. Proposed Rule 17Ad-25(j)
    2. Concern Regarding Duplicative Requirements
    3. Proposed Scope of ``Governance and Operations''
    4. Frequency and Method of Outreach
    5. Use of Fora To Satisfy the Rule
    6. Documentation of Stakeholder Views
    7. Harmonization With CFTC Requirements for RWG
III. Compliance Dates
IV. Economic Analysis
    A. Introduction
    B. Economic Baseline
    1. Description of Market
    2. Overview of the Existing Regulatory Framework

    3. Divergent Incentives of Registered Clearing Agency
Stakeholders
    4. Current Governance Practices
    C. Consideration of Benefits and Costs as Well as the Effects on
Efficiency, Competition, and Capital Formation
    1. Economic Considerations for Final Rule Regarding Board
Composition
    2. Economic Considerations for Final Rules Regarding the
Nominating Committee
    3. Economic Considerations for Final Rules Regarding the Risk
Management Committee
    4. Economic Considerations for Final Rules Regarding Conflicts
of Interest Involving Directors or Senior Managers
    5. Economic Considerations for Final Rules Regarding Management
of Risks From Relationships With Service Providers for Core Services
    6. Economic Considerations for Final Rules Regarding Formalized
Solicitation, Consideration, and Documentation of Stakeholders'
Viewpoints
    D. Reasonable Alternatives to the Final Rules
    1. Allow More Flexibility in Governance, Operations, and Risk
Management
    2. Adopt More Prescriptive Governance Requirements
    3. Establish Limits on Participant Voting Interests
    4. Increase Shareholders' At-Risk Capital (``Skin in the Game'')
    5. Increase Public Disclosure
    6. Require Risk Working Group in Addition to Risk Committee
V. Paperwork Reduction Act
    A. Rule 17Ad-25(b)
    B. Rule 17Ad-25(c)
    C. Rule 17Ad-25(d)
    D. Rule 17Ad-25(g)
    E. Rule 17Ad-25(h)
    F. Rule 17Ad-25(i)
    G. Rule 17Ad-25(j)
    H. Chart of Total PRA Burdens
VI. Regulatory Flexibility Act
    A. Registered Clearing Agencies
    B. Certification
VII. Other Matters
Statutory Authority

I. Introduction

    Clear and transparent governance arrangements are integral to
ensuring that a clearing agency is resilient because, among other
things, such arrangements promote accountability and reliability in
decision-making.\2\ Since the enactment of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act'') in 2010,\3\ the
Commission has adopted a series of rules intended to promote the
resilience of registered clearing agencies,\4\ with the goal of
establishing an evolving regulatory framework.\5\ As discussed in
greater detail in the Governance Proposing Release,\6\ the Commission
has continued to observe and learn from the recurring tensions that
exist in the incentive structure of a clearing agency, including their
potential effect on the participants of the clearing agency and the
broader financial system.\7\ Accordingly, the Governance Proposing
Release included new rules designed to help ensure that a registered
clearing agency can effectively balance the differing incentives that
exist among the clearing agency, its participants, and other key
stakeholders.\8\ The proposed rules included more specific and defined
parameters and requirements for governance intended to build upon and
strengthen the existing requirements in Rule 17Ad-22 that have a
broader and principles-based focus.\9\
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    \2\ Release No. 34-95431 (Aug. 8, 2022), 87 FR 51812, 51813
(Aug. 23, 2022) (``Governance Proposing Release'').
    \3\ Public Law 111-203, 124 Stat. 1376 (2010).
    \4\ See, e.g., 17 CFR 240.17Ad-22 (``Rule 17Ad-22''); see also
Release No. 34-88616 (Apr. 9, 2020), 85 FR 28853, 28855 (May 14,
2020) (``CCA Definition Adopting Release''); Release No. 34-78961
(Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016) (``CCA Standards
Adopting Release''); Release No. 34-68080 (Oct. 22, 2012), 77 FR
66219 (Nov. 2, 2012) (``Clearing Agency Standards Adopting
Release'').
    \5\ Governance Proposing Release, supra note 2, at 51814.
    \6\ Id. at 51814-51819.
    \7\ Id. at 51814 (describing the same as ``clearing members and
the larger financial community'').
    \8\ Id.
    \9\ Id.
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    The Commission received comments on the Governance Proposing
Release from registered clearing agencies, participants of registered
clearing agencies and their customers, industry groups representing
clearing agencies, their participants, and other market participants,
academics, individual investors, and other interested parties.\10\ Many
commenters were supportive of the proposed rules, though some
commenters also expressed concerns regarding specific elements of
certain rules. In Part II below, the Commission discusses these
comments in detail and modifications made in response to the comments.
In addition, the Commodity Futures Trading Commission (``CFTC'')
recently adopted new requirements applicable to risk management
committees (``RMCs'') and risk working groups (``RWGs'') of derivatives
clearing organizations (``DCOs''),\11\ topics which are also addressed
in the context of registered clearing agencies by the Commission's
final rules discussed below. The Commission's final rules promote
similar outcomes as the CFTC's rules, such as ensuring robust board
oversight of senior management, and informing the board of stakeholder
views, though in some cases the Commission has taken a different
approach as to specific requirements because Rule 17Ad-25 also
addresses additional topics, including board composition, director
independence, and conflicts of interest. The differing approaches are
explained further in Parts II.C.4 and II.F.7. Finally, these rules are
being adopted pursuant to section 765 of the Dodd-Frank Act with
respect to clearing of security-based swaps,\12\ which specifically
directs the Commission to adopt rules to mitigate conflicts of interest
for security-based swap clearing agencies.\13\
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    \10\ The Commission voted to issue the Governance Proposing
Release on August 8, 2022. The release was posted on the Commission
website that day, and comment letters were received beginning the
following day. The comment period closed on October 7, 2022.
Comments received are available on the Commission's website at
https://www.sec.gov/comments/s7-21-22/s72122.htm. The Commission has
considered all comments received since August 8, 2022.
    \11\ See Governance Requirements for Derivatives Clearing
Organizations, Final Rule, 88 FR 44675 (July 13, 2023).
    \12\ Public Law 111-203, 124 Stat. 1376 (2010).
    \13\ See Governance Proposing Release, supra note 2, at 51819 &
n.49 (stating ``the targeted set of proposed rules for governance
included in this release can help ensure that the framework
effectively addresses the considerations set forth in Section 765
with respect to clearing of security-based swaps. Although Section
765 directed the Commission to focus on conflicts of interest
specifically with respect to security-based swap clearing agencies,
the Commission believes that conflicts of interest concerns can
arise across all registered clearing agencies regardless of the
asset classes served.'').
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II. Discussion of Comments Received and Final Rules

A. Board Composition and Requirements for Independent Directors

1. Proposed Rules 17Ad-25(b), (e), and (f)
    Proposed Rules 17Ad-25(b), (e), and (f) would establish
requirements related to independent directors serving on the board of a
registered clearing agency. First, proposed Rule 17Ad-25(b)(1) would
require that a majority of the directors be independent directors, as
defined in proposed Rule 17Ad-25(a). The proposed rule would also
provide that, if a majority of the voting interests issued as of the
immediately prior record date are directly or indirectly held by
participants of the registered clearing agency, then at least 34
percent of directors must be independent directors. Proposed Rule 17Ad-
25(a) would define an ``independent director'' to mean a director that
has no material relationship with the registered clearing agency, or
any affiliate thereof. Proposed Rule 17Ad-25(a) also would define
``material relationship'' to mean a relationship, whether compensatory
or otherwise, that reasonably could affect the independent judgment or
decision-

making of the director, and includes relationships that existed during
a lookback period of one year counting back from making the initial
independence determination made in accordance with proposed Rule 17Ad-
25(b)(2). In addition, proposed Rule 17Ad-25(a) would define
``affiliate'' to mean a person that directly or indirectly controls, is
controlled by, or is under common control with the registered clearing
agency. Proposed Rule 17Ad-25(b)(2) would require that a registered
clearing agency broadly consider all the relevant facts and
circumstances, including under proposed Rule 17Ad-25(g), on an ongoing
basis, to affirmatively determine that a director does not have a
material relationship with the registered clearing agency or an
affiliate of the registered clearing agency, and is not precluded from
being an independent director under proposed Rule 17Ad-25(f), in order
to qualify as an independent director. In making such determination, a
registered clearing agency must: (i) identify the relationships between
a director, the registered clearing agency, and any affiliate thereof,
along with the circumstances set forth in proposed Rule 17Ad-25(f);
(ii) evaluate whether any relationship is likely to impair the
independence of the director in performing the duties of director; and
(iii) document this determination in writing. Such documentation
requirements would be subject to the recordkeeping and retention
requirements that apply to all self-regulatory organizations (``SROs'')
under Exchange Act section 17(a)(2) and rules thereunder.
    Proposed Rule 17Ad-25(e) would require that, if any committee has
the authority to act on behalf of the board, the composition of that
committee must have at least the same percentage of independent
directors as is required under these rules for the board, as set forth
in proposed paragraph (b)(1).
    Proposed Rule 17Ad-25(f) would describe certain circumstances that
would always exclude a director from being an independent director.
These circumstances would include: (1) the director is subject to
rules, policies, and procedures by the registered clearing agency that
may undermine the director's ability to operate unimpeded, such as
removal by less than a majority vote of shares that are entitled to
vote in such director's election; (2) the director, or a family member,
has an employment relationship with or otherwise receives compensation,
other than as a director, from the registered clearing agency or any
affiliate thereof, or the holder of a controlling voting interest of
the registered clearing agency; (3) the director, or a family member,
is receiving payments from the registered clearing agency, or any
affiliate thereof, or the holder of a controlling voting interest of
the registered clearing agency that reasonably could affect the
independent judgment or decision-making of the director, other than the
following: (i) compensation for services as a director to the board or
a committee thereof; or (ii) pension and other forms of deferred
compensation for prior services not contingent on continued service;
(4) the director, or a family member, is a partner in, or controlling
shareholder of, any organization to or from which the registered
clearing agency, or any affiliate thereof, or the holder of a
controlling voting interest of the registered clearing agency, is
making or receiving payments for property or service, other than the
following: (i) payments arising solely from investments in the
securities of the registered clearing agency, or affiliate thereof; or
(ii) payments under non-discretionary charitable contribution matching
programs; (5) the director, or a family member is employed as an
executive officer of another entity where any executive officers of the
registered clearing agency serve on that entity's compensation
committee; or (6) the director, or a family member, is a partner of the
outside auditor of the registered clearing agency, or any affiliate
thereof, or an employee of the outside auditor who is working on the
audit of the registered clearing agency, or any affiliate thereof.
Proposed Rules 17Ad-25(f)(2) through (6) would be subject to a lookback
period of one year, counting back from making the initial determination
required by proposed Rule 17Ad-25(b)(2).
    Proposed Rule 17Ad-25(a) would define ``family member'' to include
any child, stepchild, grandchild, parent, stepparent, grandparent,
spouse, sibling, niece, nephew, mother-in-law, father-in-law, son-in-
law, daughter-in-law, brother-in-law, or sister-in-law, including
adoptive relationships, any person (other than a tenant or employee)
sharing a household with the director or a nominee for director, a
trust in which these persons (or the director or a nominee for
director) have more than fifty percent of the beneficial interest, a
foundation in which these persons (or the director or a nominee for
director) control the management of assets, and any other entity in
which these persons (or the director or a nominee for director) own
more than fifty percent of the voting interests.
    The Commission is adopting Rules 17Ad-25(b), (e), and (f) generally
as proposed but with technical changes to Rule 17Ad-25(a), Rule 17Ad-
25(b)(1), Rule 17Ad-25(b)(2), Rule 17Ad-25(b)(2)(i), and Rule 17Ad-
25(b)(2)(iii), for the reasons discussed below. In making the technical
change to the definition of ``material relationship'' in Rule 17Ad-
25(a), the Commission is embedding the reference to a lookback period
that was proposed in a standalone sentence into the initial sentence
relating to relationships that could affect the independent judgment or
decision-making of a director, in order to clarify that the lookback
period is part of the overall reference to these relationships. In
making the technical change to Rule 17Ad-25(b)(1), the Commission is
replacing the term ``voting rights'' with ``voting interests,'' which
would be consistent with the terms used elsewhere in the rule text, and
which remains consistent with the concept as proposed. In making the
technical change to Rule 17Ad-25(b)(2), the Commission is deleting the
last proviso that stated, ``in order to qualify as an independent
director,'' because this reference is unnecessary and does not describe
all of the requirements for qualifying as an independent director. In
making the technical change to Rule 17Ad-25(b)(2)(i), the Commission is
reordering the language requiring identification of the relationships
between a director and a registered clearing agency, and a director and
any affiliate of a registered clearing agency. The proposed rule text
implied that there needed to be identification of relationships between
the registered clearing agency and its affiliates, which is not
intended. In making the technical change to Rule 17Ad-25(b)(2)(iii),
the Commission is specifying that the documentation requirement applies
to both the registered clearing agency's evaluation of director
independence and its ultimate determination (i.e., whether the director
qualifies as an independent director or is not an independent
director). Under the proposed text, the phrase ``this determination''
was intended to encompass broad consideration of all the relevant facts
and circumstances on an ongoing basis. The Commission is modifying the
text in adopted Rule 17Ad-25(b)(2)(iii) to be ``the evaluation and
determination'' to specify that the documentation requirement applies
to both the evaluation of independence and the ultimate determination
regarding independence.
    In the Governance Proposing Release, the Commission stated that an

independent director can bolster a board's ability to perform
effectively by reducing the potential for financial or other
relationships between directors and those persons who are overseen by
directors, such as management.\14\ Even the appearance of conflicts of
interest can reduce confidence in the functioning of the registered
clearing agency among direct and indirect participants of the
registered clearing agency, other stakeholders, and the public,
particularly during periods of market stress when general confidence in
market resilience may be low.\15\ Indeed, as discussed in the
Governance Proposing Release, each of the registered clearing agencies
already requires a portion of their directors to have some
characteristics of independence (establishing, for example,
``nonexecutive'' or ``public'' directors).\16\ Further, the structure
of a registered clearing agency and the risk management tools that it
employs affect how the interests of owners, participants, and other
types of stakeholders align. For example, as discussed in the
Governance Proposing Release, the risk mutualizing and trade guaranty
features provided by many registered clearing agencies provide for the
shift of the consequences of one party's actions to another in certain
circumstances, such as after a participant default.\17\ These features
both affect how different stakeholders maximize their own self-interest
and also distinguish the governance of a registered clearing agency
from other corporate entities. The Commission stated its belief that
registered clearing agency processes involving risk management or
director nominations are also implicated in managing the dynamics
between owners and participants.\18\ The ability of a registered
clearing agency to help ensure effective risk management and loss
allocation in the event of a default or non-default loss is linked to
the interests of the owners of the clearing agency, who may also have
financial relationships with the participants (or be the participants)
of such registered clearing agency. The Commission stated its belief
that requiring a certain percentage of independent directors helps
promote the ability of the board to perform its oversight of management
function and to support a plurality of viewpoints voiced at the board
level.\19\ Independent directors would help ensure that, when the
interests between owners and participants diverge, the balancing of
interests is more manageable because the board would not be composed
entirely of directors who have material relationships either to
management (such as under a situation where managers approve payments
from the registered clearing agency to such director), owners, or
participants of the registered clearing agency. Achieving balance
between stakeholders with divergent views could help the board
adequately consider the respective needs of all such stakeholders and
help promote the integrity of, and public confidence in, the registered
clearing agency's risk management function.
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    \14\ See Governance Proposing Release, supra note 2, at 51821.
    \15\ See id. at 51819; see also id. at 51812 n.3 (explaining
that examples of indirect participants are customers or clients of
direct participants or clearing members since they rely on services
provided by a direct participant to access the services of the
clearing agency).
    \16\ See id. at 51844.
    \17\ See id. at 51822.
    \18\ See id.
    \19\ See id. at 51823.
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    Comments on the proposed board composition requirements and
requirements for independent directors are discussed below.
2. Overall Views
    Of the comments received on the Governance Proposing Release, the
majority were from individuals. Several expressed high-level views
either in support or against the proposal,\20\ referencing, for
example, their concerns that retail investors are being cheated due to
clearing agency greed or conflicts of interest, or requesting retail
investor representation on the board. Several commenters were
specifically concerned with incidents of failures to deliver with their
transactions, but did not discuss the rule proposals in the Governance
Proposing Release.\21\ Many commenters were under the mistaken
impression that the proposal would alter the status of certain entities
as SROs.\22\ However, the Exchange Act clearly defines registered
clearing agencies as SROs,\23\ and the proposed rule would have no
impact on this status. As a general matter, the concerns expressed by
these commenters regarding the perception of conflicts of interest at a
registered clearing agency highlight the need to adopt Rule 17Ad-25,
including the provisions for independent directors and to address
conflicts of interest, to promote confidence in registered clearing
agency governance through requirements intended to ensure transparency,
fair representation, and effective decision-making at the board level.
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    \20\ See, e.g., Timothy Washington (Aug. 12, 2022)
(``Washington''); Andres Loubriel (Aug. 12, 2022) (``Loubriel'');
Gerald (Aug. 12, 2022) (``Gerald''); Dylan Crosby (Aug. 12, 2022)
(``Crosby''); Anonymous (Aug. 12, 2022) (``Anonymous 1''); Josh
Zimmerman (Aug. 12, 2022) (``Zimmerman''); Nathan Rohde (Aug. 13,
2022) (``Rohde''); Ian Marshall (Aug. 17, 2022) (``Marshall'');
Anonymous (Aug. 26, 2022) (``Anonymous 4''); Harun Krishnan (Aug.
26, 2022) (``Krishnan''); Matthew Fry (Aug. 26, 2022) (``Fry''); the
Delois Albert Brassell Estate (Sept. 3, 2022) (``Delois Albert
Brassell Estate''); Kaleab Tesema (Sept. 7, 2022) (``Tesema'');
Jamario (Oct. 6, 2022) (``Jamario''); Ben Passlow (May 11, 2023)
(``Passlow'') (each expressing views in support); see also Val
Ayrapetov (Aug. 9, 2022) (``Ayrapetov''); George (Aug. 12, 2022)
(``George''); Anonymous (Aug. 12, 2022) (``Anonymous 2''); M.B.
(Oct. 6, 2022) (``M.B.'') (requesting creation of a retail-specific
board member) (each expressing views against).
    \21\ See, e.g., Crosby, Loubriel; Zimmerman.
    \22\ See Anonymous 1; Christopher Hewitt (Aug. 12, 2022)
(``Hewitt''); Mason Smith (Aug. 12, 2022) (``Smith''); Samuel Ryan
(Aug. 12, 2022) (``Ryan''); Keith Clark (Aug. 12, 2022) (``Clark'');
Dillon (Aug. 12, 2022) (``Dillon''); Evan (Aug. 12, 2022) (``Evan
Letter''); John J. Kozubal (Oct. 6, 2022) (``Kozubal''); James Fox
(Oct. 6, 2022) (``Fox''); Joe (Oct. 7, 2022) (``Joe''); Anonymous
(Oct. 12, 2022) (``Anonymous 5''); Anonymous (Oct. 13, 2022)
(``Anonymous 6''); Kens Bane (Jan. 16, 2023) (``Bane'').
    \23\ See 15 U.S.C. 78c(a)(23), (26).
---------------------------------------------------------------------------

    Several comments from representatives of trade groups or registered
clearing agencies expressed general support for having an independent
director requirement as a ``good first step,'' \24\ appropriately
designed to reduce the risk of conflicts of interest \25\ and provide
diverse viewpoints \26\ in a ``pragmatic'' \27\ way. One commenter
supported the independent director requirement because it was
consistent with public company listing rules and would be particularly
useful in capturing a range of perspectives when combined with the
requirement of a nominating committee to consider a broad range of
views.\28\ Another commenter viewed the requirements as consistent with
independent director requirements that were already incorporated into
its

governance structure.\29\ Another group of commenters supported the
independent director requirement because it was consistent with a
whitepaper issued by the group in 2019 concerning the need for enhanced
governance at clearing agencies to address their risk-related
concerns.\30\
---------------------------------------------------------------------------

    \24\ See Thomas Price, Managing Director, Operations/Technology,
Robert Toomey, Managing Director, Associate General Counsel, Head of
Capital Markets, Joseph Corcoran, Managing Director, Associate
General Counsel, Securities Industry and Financial Markets
Association (Oct. 28, 2022) (``SIFMA'') at 2.
    \25\ See Chris Barnard (Sept. 9, 2022) (``Barnard''); Stephen W.
Hall, Legal Director and Securities Specialist, and Houston Shaner,
Senior Counsel, Better Markets, Inc. (Oct. 7, 2022) (``Better
Markets'') at 5; Murray Pozmanter, Managing Director, President,
Clearing Agency Services & Head of Global Business Operations,
Depository Trust & Clearing Corporation (Oct. 7, 2022) (``DTCC'') at
2.
    \26\ William C. Thum, Managing Director and Assistant General
Counsel, SIFMA Asset Management Group (Oct. 13, 2022) (``SIFMA
AMG'') at 8.
    \27\ Ulrich Karl, Head of Clearing, International Swaps and
Derivatives Association, Inc. (Oct. 28, 2022) (``ISDA'') at 6.
    \28\ Paolo Saguato, Assistant Professor of Law, George Mason
University Antonin Scalia Law School (Oct. 6, 2022) (``Saguato'') at
3.
    \29\ Kara Dutta, Assistant General Counsel, Intercontinental
Exchange, Inc. (Nov. 11, 2022) (``ICE'') at 2.
    \30\ See Frank Baldi, Managing Director, Head of Financial
Institutions and Emerging Markets Credit Risk, Barclays, et al.
(Oct. 18, 2022) (``Barclays et al.'') at 1.
---------------------------------------------------------------------------

    One commenter cautioned against ``completely'' independent
directors (i.e., independent from owners and participants, such as
academics) creating a situation where clearing agency participants
could be under-represented.\31\ As discussed further below, the
Exchange Act requires that the rules of the clearing agency assure a
fair representation of its shareholders and participants in the
selection of its directors and administration of its affairs. Another
commenter that supported the proposed requirements cautioned against
going any further than the proposal--such as by requiring certain types
of stakeholders to be represented--stating that a board's effectiveness
comes from the skills, personal attributes (including leadership and
integrity), and relevant business and risk management experience of its
directors, and not simply by drawing directors from various stakeholder
groups.\32\ As discussed further below, Rules 17Ad-25(b) and (e)
address the composition of the board and board committees, and does not
go further to address the composition of an advisory group (the
constitution of which can serve a wider set of stakeholders because its
members need not already be serving on the board to serve on such an
advisory group). Exchange Act section 17A(b)(3)(c) directs the
Commission to only register clearing agencies whose rules assure a fair
representation of participants in, among other things, the selection of
directors.\33\ In terms of the skills and effectiveness of a board,
other requirements of Rule 17Ad-25 help promote highly qualified and
effective candidates serving as independent directors. For example, as
discussed in Part II.B below, Rule 17Ad-25(c) as adopted requires
policies and procedures for a registered clearing agency's nominating
committee to have a written process for evaluating directors and
nominees for director, including taking into account each nominee's
expertise, availability, and integrity, and demonstrating that the
board of directors, taken as a whole, has a diversity of skills,
knowledge, experience, and perspectives.
---------------------------------------------------------------------------

    \31\ ISDA at 6.
    \32\ ICE at 2-3.
    \33\ See 15 U.S.C. 78q-1(b)(3)(c).
---------------------------------------------------------------------------

    Another commenter did not see the problem that the proposed rules
would solve, indicating the group's belief that the approach to board
composition and board independence was too prescriptive, which could
prevent a registered clearing agency from having governance measures
that are uniquely suited to manage risks particular to the registered
clearing agency.\34\ As stated in the Governance Proposing Release, the
requirements regarding the representation of independent directors are
appropriate to facilitate the consideration and management of diverse
stakeholder interests by the board in the overall decision-making
process of the registered clearing agency.\35\ Regarding the level of
prescriptiveness, Rule 17Ad-25(f) identifies situations that, in the
Commission's judgment, create material relationships with the
registered clearing agency that are incompatible with being an
independent director but, other than these specific exclusions,
registered clearing agencies would have discretion to evaluate whether
a director's relationships to the registered clearing agency are
material. Because Rule 17Ad-25 provides registered clearing agencies
with such discretion, the Commission set forth the list of specific
exclusions in Rule 17Ad-25(f) to ensure a consistent, minimum standard
for independent directors across registered clearing agencies.\36\
Therefore, the Commission disagrees that the rules are overly
prescriptive because of the levels of discretion that are allowed, and
disagrees that unique governance measures could not be adopted by
registered clearing agencies.
---------------------------------------------------------------------------

    \34\ Global Association of Central Counterparties (Oct. 7, 2022)
(``CCP12'') at 1; see also SIFMA at 3; ICE at 3.
    \35\ See Governance Proposing Release, supra note 2, at 51821.
    \36\ See id. at 51824 (``Establishing a materiality and
reasonableness threshold for such relationships provides a
registered clearing agency with discretion to apply this requirement
across a range of fact patterns while ensuring that they ultimately
facilitate the fair representation of owners and participants.'').
---------------------------------------------------------------------------

3. Criteria for Independence
    One commenter supported the requirement for establishing an overall
level of independent directors at 34 percent for participant-owned
registered clearing agencies as being sufficient and without the
drawbacks of too many independent directors.\37\ Another commenter
disagreed with the proposal, stating that the Commission should not
impose any percentage of independent directors given the differences in
organizational structure, markets, and products cleared, among other
things, across registered clearing agencies.\38\ A separate commenter
supported the requirement for independent directors because it would
mitigate potential conflicts and also provide better board oversight of
the registered clearing agency's risk management and other
functions.\39\ The proposed requirements for the percentage of
independent directors strike a reasonable balance between the competing
interests of management, owners, participants, and any parties falling
into more than one of those categories. In the Governance Proposing
Release, the Commission considered whether a clearing agency's
particular organizational structures, markets served, or products
cleared support differing minimum levels of independence, and stated
that the percentage of participant ownership of the clearing agency is
an important factor against which to set the minimum standard for
director independence. Commenters have not identified another specific
factor that would support modifying the proposed threshold. Further,
Rule 17Ad-25 does not impede registered clearing agencies from
considering a broad pool of potential candidates to serve as
independent directors, to appropriately reflect their different
organizational structures, markets served, and products cleared.
Therefore, the Commission is adopting the percentages as proposed.
---------------------------------------------------------------------------

    \37\ Joseph P. Kamnik, Senior Special Advisor and Regulatory
Counsel, Options Clearing Corporation (Oct. 7, 2022) (``OCC'') at
23.
    \38\ CCP12 at 3.
    \39\ SIFMA AMG at 8.
---------------------------------------------------------------------------

    One commenter supported aspects of the ``independent director''
definition but stated that the proposed requirement that a majority of
directors be independent is unlikely to resolve all conflicts of
interest because registered clearing agency owners will still have
ultimate approval of, and influence over, independent directors. The
commenter also explained that independent directors still have
fiduciary duties to the registered clearing agency and are constrained
to act in service of shareholder value when reviewing risk
priorities.\40\ The value of a particular element of Rule 17Ad-25 is
not diminished even though it does not address all potential conflicts
of interest. Rule 17Ad-25 is intended to

bolster the overall quality of governance (and therefore risk
management) at a registered clearing agency. The same commenter also
requested clarification that material relationship would include
director compensation that is tied to registered clearing agency
equity, revenue, volume, or scope of products.\41\ While Rule 17Ad-
25(f) identifies specific circumstances that establish a material
relationship, the definition of ``material relationship'' in Rule 17Ad-
25(a) is broad. Circumstances where director compensation includes
elements that generate potential conflicts of interest, such as those
tying monetary compensation to equity, revenue, volume of activity, or
scope of products, generally could create a material relationship under
Rule 17Ad-25(a).
---------------------------------------------------------------------------

    \40\ Better Markets at 13.
    \41\ Id. at 12.
---------------------------------------------------------------------------

    The same commenter also suggested that the definition of ``material
relationship'' be modified to include any interests that create a
reasonable appearance of clouding the judgment of a director, on the
basis that even the appearance of a bias erodes trust.\42\ Trust is
important, especially during times of market stress, but the proposed
definition does not need to be modified to address this concern. The
definition of ``material relationship'' already contains a
``reasonableness'' element, requiring that such relationships be
assessed as they would be perceived by a reasonable person, which would
allow a clearing agency to consider and address relationships that
create the appearance of a conflict. This reasonableness requirement
applies even to relationships or situations that are otherwise not
among the exclusions in Rule 17Ad-25(f), because Rule 17Ad-25(f)
applies in addition to how the definition of independent director is
applied by a registered clearing agency. In this regard, clearing
agencies generally should consider this reasonableness element in the
context of participants, vendors, or non-controlling shareholders of
the clearing agency or its affiliates. Employees of participants may be
subject to disqualification under this reasonableness requirement, even
if they are not subject to disqualification under Rule 17Ad-25(f). The
reasonableness element would apply to an evaluation of the
qualifications necessary for being an independent director, which will
be contingent on the broad set of facts and circumstances under
consideration. The definition also includes relationships that
reasonably could affect the independent judgment or decision-making of
the director, which seeks to address outcomes that reasonably could
happen, even if they have not yet in fact happened. Therefore, the
Commission is not modifying the rule in response to this comment.\43\
---------------------------------------------------------------------------

    \42\ Id. at 18-19.
    \43\ See infra Part II.D.2 (similarly addressing comments with
respect to the ``reasonableness'' requirement in Rule 17Ad-25(g)).
---------------------------------------------------------------------------

    The commenter further suggested expanding the definition of
``family member'' to include first cousins.\44\ The Commission
considered this expansion, and also reviewed prior Commission
rationales on the appropriate scope of ``family member'' definitions
under other Commission rules.\45\ In those prior rulemakings, the
Commission concluded that the scope of family members included there
(which is identical to the scope proposed in the Governance Proposing
Release) provides adequate coverage to address regulatory interests
because any close ties between a director and a relative that are not
already within the definition of ``family member'' (such as cousins of
various degrees) can be addressed by using the other provision that
applies to all persons who share a household with the director, as a
proxy for such close ties rather than serving as a generalized proxy
for a particular category of relatives. Moreover, the exclusions that
relate to family member activities in Rule 17Ad-25(f) are designed to
be a floor, not a ceiling, meaning that other fact patterns may
preclude a director from meeting the independence requirement pursuant
to the general requirements in Rule 17Ad-25(b) instead of a specific
exclusion in Rule 17Ad-25(f).
---------------------------------------------------------------------------

    \44\ Better Markets at 20.
    \45\ See, e.g., Disclosure of Certain Relationships and
Transactions Involving Management, Securities Act Release No. 6441,
Exchange Act Release No.19290, Investment Company Act No. 12865
(Dec. 2, 1982), 47 FR 55661, 55663 (Dec. 14, 1982) (discussing
whether to apply a rule to a class of relatives that is broader than
those who live in a household with a reporting person, because there
is not complete overlap between the two categories. The Commission
considered whether to apply the rule to relatives who could take
advantage of financial transactions with a reporting person without
living in that reporting person's household. As a corollary, some
members of a household may not be relatives either, but both
categories were contemplated as a proxy for the existence of close
ties between two people).
---------------------------------------------------------------------------

    One commenter stated that many of the prohibitions in Rule 17Ad-
25(f)(4) were ``overbroad'' and that not all payments from participants
should preclude an independence determination; rather, in the
commenter's view, Rule 17Ad-25(f)(4) should include a de minimis
threshold and an exemption for the payment of clearing fees.\46\ The
commenter stated that, in the absence of a de minimis threshold, the
rule could exclude registered clearing agency participants that are
only receiving a nominal sum for a small service provided to the
registered clearing agency. The commenter further stated that clearing
fees are a relatively inconsequential component of market participants'
cost of business, and it is unlikely that a director could reduce
clearing fees without oversight because clearing fee changes must be
filed with the Commission. In particular, the commenter stated that its
fee refunds should not be covered by this exclusion (which the
Commission understands to apply when accrued clearing fees exceed the
registered clearing agency's targeted capital amount, so refunding an
overpayment does not implicate the same potential conflict as does
receiving a payment). Another commenter stated that, in the absence of
a de minimis threshold, the rule could exclude candidates for
independent director who are only receiving de minimis payments or
remuneration or clearing fees.\47\
---------------------------------------------------------------------------

    \46\ OCC at 6.
    \47\ CCP12 at 3.
---------------------------------------------------------------------------

    The exclusion in Rule 17Ad-25(f)(4) would apply to directors who
are partners or controlling shareholders of a registered clearing
agency participant.\48\ The scope of this exclusion is narrow, however;
employees, managers, and non-controlling shareholders of a participant
could still qualify, allowing for a broad range of potential candidates
who have experience with the participant's business. Additionally,
although the payments received or made between, for example, a
participant and a registered clearing agency may be inconsequentially
small from the perspective of the registered clearing agency or the
participant as a business entity, that same payment may be meaningful
to an individual who is a director and who is a controlling shareholder
of the participant. For example, that individual's equity stake in the
participant may result in extra personal income for every dollar saved
or earned. Due to the potential for personal enrichment, the Commission
is not adopting a de minimis amount of payments that would allow a
participant's controlling shareholder to serve as an independent
director. Because the Commission is not incorporating any de minimis
carve out,

it is not addressing how to calculate such de minimis amount.
Accordingly, the Commission also is not addressing whether fee refunds
should be included in calculations to establish a de minimis amount of
such payments. Nonetheless, and regardless of the circumstances, such
controlling shareholder of a participant could still serve on the board
as a non-independent director.
---------------------------------------------------------------------------

    \48\ Specifically, Rule 17Ad-25(f)(4) applies to directors who
are partners or controlling shareholders of any organization to or
from which the registered clearing agency is making or receiving
payments, which would include clearing fee payments made by a
participant as a clearing member.
---------------------------------------------------------------------------

    A commenter also suggested, as an alternative to explicitly carving
out payments for clearing fees from the exclusion in Rule 17Ad-
25(f)(4), that the Commission specify that the term ``partner'' therein
only refers to someone who has an equity ownership stake in the
organization.\49\ The term ``partner,'' as used in Rule 17Ad-25(f)(4)
as adopted, refers to those with an equity ownership stake in an
organization such as an limited partnership or limited liability
partnership and does not include any person who simply has the term
``partner'' in her job title without also holding an equity ownership
stake in the organization that is sending or receiving payments to or
from a registered clearing agency, an affiliate thereof, or a holder of
a controlling voting interest of the registered clearing agency.
---------------------------------------------------------------------------

    \49\ OCC at 7.
---------------------------------------------------------------------------

    One commenter suggested that the Commission require board
representation by customers of registered clearing agency participants
because such customers are bound to registered clearing agency
obligations that are theoretically uncapped, bear mutualized risk, and
could provide unique perspectives on risk management issues.\50\
Another commenter requested that the Commission add a requirement for
registered clearing agency boards to have representatives from
customers of registered clearing agency participants, such as buy-side
market participants, due to their understanding of the risks and
impacts of registered clearing agency decisions on a wide variety of
such market participants and their clients.\51\
---------------------------------------------------------------------------

    \50\ SIFMA AMG at 8.
    \51\ Sarah A. Bessin, Associate General Counsel, and Nhan
Nguyen, Assistant General Counsel, Investment Company Institute
(Oct. 7, 2022) (``ICI'') at 7.
---------------------------------------------------------------------------

    In considering the application of the rule, it is important to
distinguish the contractual obligations and liabilities that exist
between registered clearing agency participants and the registered
clearing agency itself on the one hand, and between registered clearing
agency participants and their own customers on the other. The
Commission does not agree that customers of registered clearing agency
participants are bound to the clearing agency for uncapped obligations.
Customers of registered clearing agency participants do face
contractual performance risk vis-[agrave]-vis their counterparty to a
given transaction when they rely on a registered clearing agency
participant to facilitate the clearing of such transaction on the
customer's behalf, but the risk of non-performance in this case differs
from the risk that parties to contracts generally assume. Notably,
because the registered clearing agency may guarantee the transaction,
the risk to the customer may be lower than other types of contractual
relationships due to this extra layer of protection (notwithstanding
the particular arrangements that may exist between the participant and
its customer in the event of a default). The risk exposure between a
participant and its customer is thus different in nature and scope than
the risk exposure between a registered clearing agency and its
participant. Consequently, the nature of these contractual obligations
does not support extending by Commission rule representation on the
board of a registered clearing agency to the customers of registered
clearing agency participants. However, the Commission recognizes the
importance of the board considering the views of stakeholders,
including customers of registered clearing agency participants, and the
Commission has provided opportunities for such views to be considered
under Rule 17Ad-25(c) when nominating directors, and when soliciting
viewpoints and feedback consistent with Rule 17Ad-25(j).\52\
---------------------------------------------------------------------------

    \52\ See infra Parts II.B.3 (discussing the requirements in Rule
17Ad-25(c)(4)(ii) for the nominating committee to demonstrate that
it has considered whether a particular nominee would complement the
other board members, such that, if elected, the board, taken as a
whole, would represent the views of the owners and participants,
including a selection of directors that reflects the range of
different business strategies, models, and sizes across
participants, as well as the range of customers and clients the
participants serve) and II.F (discussing the requirements in Rule
17Ad-25(j) to solicit, consider, and document stakeholder
viewpoints).
---------------------------------------------------------------------------

    One commenter agreed with the Commission's approach to allow
registered clearing agencies (and in particular, nominating committees
thereof) to exercise judgment to determine what constitutes materiality
under the ``material relationship'' definition, rather than have it
further defined, such as by numerical thresholds of financial
compensation.\53\ The commenter stated that such numerical thresholds
would not be useful if established in advance. Likewise, the commenter
stated that the concept of ``control'' should be left to the
determination of the nominating committee of the registered clearing
agency, as long as the analysis is documented and auditable.\54\ The
Commission agrees that numerical thresholds may not reflect the
potential intersection of a director's personal finances and the
``material relationship'' definition, particularly when such thresholds
have been formulated ex ante, and that, more generally, it is
appropriate for the nominating committee to determine whether a
director qualifies as an independent director, as further discussed in
Part II.B.2 below.\55\
---------------------------------------------------------------------------

    \53\ Claire O'Dea, Director, Government Relations and Regulatory
Strategy, Americas, London Stock Exchange Group (Oct. 7, 2022)
(``LSEG'') at 3-4.
    \54\ Id. at 4.
    \55\ See infra Part II.B.2 (further discussing the purview of
the nominating committee and the comment regarding ``control'').
---------------------------------------------------------------------------

    One commenter drew a comparison between the Commission's required
levels of independent directors and the levels of a related category
under the European Market Infrastructure Regulation (``EMIR'') \56\
called Independent Non-Executive Directors (``INEDs'').\57\ The
commenter stated that currently EMIR requires at least one-third (and
no fewer than two) of clearing agency board members to be INEDs. The
commenter stated that requiring more INEDs would not result in greater
transparency or objective governance, and that requiring a majority of
the board to be INEDs would result in large boards that are
``functionally inefficient.'' \58\ The commenter also pointed out that
the INED definition excluded representatives of clearing agency
participants, regardless of whether those clearing agency participants
were shareholders or not. Consequently, the commenter requested greater
alignment between EMIR and the Commission's proposal. The Commission
supports alignment where practicable and concludes that the two
provisions are not in conflict with one another as currently structured
based on the following: although the EMIR standard has a lower
percentage requirement, it also defines independence more strictly than
the Commission's proposal, and so the pool of eligible directors under
EMIR is smaller than under Rule 17Ad-25. For example, if a clearing
agency dually

registered under EMIR and with the Commission had a board with six
persons, with two persons representing a controlling shareholder, two
persons who were risk management professionals at two participants, and
two persons who were independent academics, then that board could (with
all other factors being met) comply with both the Commission's
requirement of a majority of independent directors (four out of six),
and the EMIR requirement of one-third INEDs (two out of six).
Therefore, the requirements for INEDs under EMIR and for independent
directors under the Commission's proposal do not conflict with each
other.
---------------------------------------------------------------------------

    \56\ See Regulation (EU) No 648/2012 of the European Parliament
and of the Council of 4 July 2012 on OTC derivatives, central
counterparties and trade repositories, as amended, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:02012R0648-20200101.
    \57\ LSEG at 3.
    \58\ Id.
---------------------------------------------------------------------------

    The commenter also stated that operating under two definitions of
``independent director'' would require a dual registrant to undertake
two sets of analyses because a director could qualify as independent
under one standard but not the other, though the commenter also stated
that the Commission's approach would not raise any compliance issues by
itself.\59\ The commenter encouraged alignment where possible. In this
situation, the additional burden of conducting evaluations under these
two standards is insignificant, because the evaluation process of a
director's material relationships is highly fact-specific. The
evaluation of whether a director meets the standard for independence
generally should be broad and thorough, and it generally should turn on
the specific facts of each director's individual circumstances. A broad
inquiry that satisfies the requirement to determine whether material
relationships exist will likely already reveal whether a candidate
meets the criteria set forth in each respective jurisdiction, so it is
unlikely that fully aligning the Commission's rules with the EMIR
standard will result in cost or time savings.
---------------------------------------------------------------------------

    \59\ Id. at 6.
---------------------------------------------------------------------------

    In connection with the request for harmonization, the commenter
stated that EMIR's limited INED requirement helps ensure that the board
retains expertise sufficient to make decisions about budget,
investments, and commercial strategy.\60\ As discussed above, the
Commission's definition of ``independent director'' would allow
participants with experience on these strategic matters to also qualify
as an independent director, so the concern from the commenter that a
majority of the board being independent directors would result in
inexperienced decision makers is misplaced, due to the differences in
the scope of the respective definitions of INED and the Commission's
proposal.
---------------------------------------------------------------------------

    \60\ Id. at 4.
---------------------------------------------------------------------------

    With respect to the inclusion of affiliates of the registered
clearing agency in the definition of ``material relationship'' and in
Rule 17Ad-25(f), the commenter expressed preference for consistency
with how EMIR handles affiliates.\61\ The commenter stated that under
the EMIR regulatory framework, a clearing agency that is part of a
group must evaluate whether it has the necessary level of independence
to meet its regulatory obligations as a distinct legal person, and
whether its independence could be compromised by the group structure or
by any board member also being a member of the board of other entities
of the same group. Therefore, under EMIR, if a clearing agency has the
necessary level of independence to meet its regulatory requirements, a
director could be considered independent even if she held a non-
executive role at another clearing agency within the same group, which
allows for consistency in risk management and cross-fertilization of
ideas within a group.
---------------------------------------------------------------------------

    \61\ Id. at 5.
---------------------------------------------------------------------------

    The Commission used the term ``affiliates'' in the definition of
``independent director'' with respect to material relationships, and
the exclusions in Rule 17Ad-25(f), to ensure an appropriate minimum
standard across clearing agencies with respect to the board composition
requirements in the rule. If affiliate relationships were excluded from
the definition of ``independent director'' with respect to material
relationships, a registered clearing agency could create an
organizational structure where a majority of the board is aligned--such
as through compensation--with an affiliate of the clearing agency.
Benefits associated with the exchange of ideas can be obtained in other
manners, such as information sharing agreements among affiliated
companies. At the clearing agency, risk management should be tailored
to the specific risks facing a particular registrant consistent with
the statutory requirements for registration as a clearing agency, not
with respect to its overall corporate group or affiliates. While
affiliate relationships may, in some instances, enable a clearing
agency to see risks outside of its own particular clearing agency
function or services, consistency across affiliates is not per se an
important risk management goal. A registered clearing agency generally
should focus on identifying and managing the risks that it faces,
rather than risks to its affiliates. Therefore, the Commission is
adopting the definition of ``material relationship'' and the exclusions
in Rule 17Ad-25(f) to include affiliates of a clearing agency as
proposed.
    As to the adequacy of the Commission's use of one-year lookback
periods in Rule 17Ad-25(f), one commenter recommended a longer period
of three to five years as an adequate lookback period.\62\ The
commenter stated that there is a five-year requirement under EMIR, and
that a one-year requirement could be considered too short because some
payments may not be received by a director for a while (e.g., some
payments may be deferred for up to four years), some projects to which
a person has played a key role may not yet be delivered, and informal
relationships may continue. The obligation not to have a material
relationship applies in an ongoing manner, not simply to a moment in
time. Although the lookback period that applies to the ``material
relationship'' definition and to the list of exclusions in Rule 17Ad-
25(f) covers the one-year period prior to the date that a determination
of independence is made, delayed payments that a director might receive
while serving as an independent director would be addressed due to the
ongoing application of Rule 17Ad-25(f). For instance, if an independent
director received payments in the third year of his or her term, such
payments were related to relationships that existed two years prior to
the start of that term, and such payments precluded a director from
being independent under Rule 17Ad-25(f), then the director would cease
to qualify as an independent director at the time of the payment--
irrespective of the lookback period. Consequently, extending the
lookback period is not necessary to address any delayed or deferred
activity because a director must meet the standard for an ``independent
director'' on an ongoing basis under the requirements of Rule 17Ad-
25(b).
---------------------------------------------------------------------------

    \62\ LSEG at 5.
---------------------------------------------------------------------------

    Several commenters stated that the possible inclusion of employees
of clearing agency participants as independent directors on registered
clearing agency boards would bring several benefits, including
increasing the candidate pool, providing industry expertise, promoting
a strong alignment between the risk management and operational
integrity of the registered clearing agency, and bringing diverse

perspectives.\63\ One commenter disagreed, stating that the definition
of ``material relationship'' should be expanded to ensure that
employees or other representatives of participants be excluded from
qualifying as independent,\64\ while another commenter stated that the
candidate pool from among employees of clearing agency participants
would shrink under the proposed rules.\65\ Having qualified,
experienced persons serving in these director roles promotes sound risk
management practices at the registered clearing agency because such
persons bring necessary technical experience in clearing agency risk
management. The Commission supports the inclusion of employees of
participants in the potential pool of candidates for independent
director in order to make such experienced personnel available for
consideration as candidates, provided that such personnel do not have
relationships that would preclude them from being independent
directors. The Commission acknowledges that the candidate pool would
shrink to the extent that experienced employees of participants also
have material relationships that pose a conflict of interest (for
example, if such employees' judgment or independent decision-making
could be affected by their relationships with a participant), other
than being an employee of a participant.
---------------------------------------------------------------------------

    \63\ See DTCC at 4; Saguato at 3 (supporting the inclusion of
employees of participants because they have substantial financial
exposure and a commitment to the resilience of the participant).
    \64\ James Tabacchi, Chairman, Independent Dealer and Trader
Association (Oct. 7, 2022) (``IDTA'') at 1; see also Zimmerman
(expressing general concerns about potential conflicts of interest
among directors and senior managers).
    \65\ CCP12 at 3.
---------------------------------------------------------------------------

    Additionally, a separate commenter requested that the independent
director definition explicitly require independence from dominant
market participants.\66\ The commenter stated that the derivatives
markets, within which the Commission regulates clearing agencies for
security-based swaps, continue to be dominated by a few market
participants, thereby concentrating risk and skewing incentives towards
the largest clearing agency participants, at the expense of appropriate
risk management and competition.\67\ The commenter suggested that the
lowering of the majority requirement to 34 percent of independent
directors when participants are a majority of owners should have
restrictions as to the size of the clearing agency participants that
can qualify, to exclude dominant market participants.\68\ The commenter
disagreed with the Commission that existing regulations, such as Rule
17Ad-22, have adequately addressed market dominance by certain
participants, and stated that anecdotal evidence from abroad suggests
that clearing agencies hold such dominant participants to less scrutiny
with respect to risk management requirements, while small and medium-
sized entities struggle to maintain access to central clearing.\69\
---------------------------------------------------------------------------

    \66\ Better Markets at 16.
    \67\ Id. at 10.
    \68\ Id. at 17.
    \69\ Id. at 16-17.
---------------------------------------------------------------------------

    The liability inherent to being a clearing agency participant, to
which participants of all sizes subject themselves, aligns their
interests with the goal of a well-managed registered clearing agency,
even if incentives to free-ride, and thereby have the costs of managing
the clearing agency borne by other participants, remain. Because
Exchange Act section 17A(b)(3)(C) states that ``the Commission may
determine that the representation of participants is fair if they are
afforded a reasonable opportunity to acquire voting stock of the
clearing agency, directly or indirectly, in reasonable proportion to
their use of such clearing agency,'' \70\ it remains appropriate to not
summarily restrict representation based on volume of use, which is what
the commenter is requesting. Therefore, the Commission is not removing
the ability of employees or other representatives of certain sizes of
clearing agency participants to qualify as independent directors,
provided all other requirements of Rule 17Ad-25 are met.
---------------------------------------------------------------------------

    \70\ 15 U.S.C. 78q-1(b)(3)(C).
---------------------------------------------------------------------------

4. Incentive Structures
    One commenter requested that the Commission undertake a
comprehensive study of how various ownership models allocated
incentives among owners and participants of registered clearing
agencies, stating that different ownership models might each require a
special regulatory approach to ensure a full alignment of incentives
among stakeholders.\71\ In particular, the commenter stated that
conflicts of interest arise in the investor-owned model, where some
participants are not owners but still face mutualized risk at the
clearing agency, as compared to a participant-owned model. The rule
already addresses the distinction between clearing agencies that are
majority-owned by participants and other types of clearing agencies by
applying a 34 percent independent director requirement to the former
category. The commenter expressed the view that applying a different
standard for independent directors between participant-owned and
investor-owned clearing agencies is unnecessary, in part, because the
commenter read the economic analysis in the Governance Proposing
Release to state that all participant-owned clearing agencies already
have boards with a majority of independent directors.\72\ However,
Table 3 in the Governance Proposing Release discussed different
criteria that applied to certain directors,\73\ and the Governance
Proposing Release did not discuss the extent to which these criteria
may differ from the proposed definition of and proposed requirements
for independent directors. Importantly, although registered clearing
agencies may currently label some directors as ``independent,'' such
directors may not meet the requirements for an ``independent director''
under Rule 17Ad-25. Application of Rule 17Ad-25 to existing registered
clearing agencies will impose composition standards that better serve
the goals of Exchange Act section 17A than current practice.
Additionally, Rule 17Ad-25 will apply to prospective applicants that
may seek to be registered clearing agencies in the future--not only the
current set--and so establishing a standard that existing registered
clearing agencies may already satisfy can nonetheless still ensure a
certain minimum standard across potential future applicants and
registrants. Therefore, the Commission is not modifying the application
of the 34 percent independent directors versus a majority of
independent directors in the final rule.
---------------------------------------------------------------------------

    \71\ Saguato at 2.
    \72\ Id. at 3.
    \73\ See Governance Proposing Release, supra note 2, at 51844.
---------------------------------------------------------------------------

    The same commenter also stated that, if a requirement for a
majority of independent directors leads to effective board oversight of
management, then all registered clearing agencies--not just those that
are investor-owned--should be subject to that standard.\74\ However,
the ``independent director'' requirement in Rule 17Ad-25 considers, in
addition to a director's independence from management, a director's
material relationships with a registered clearing agency's affiliates,
owners, vendors, customers, and controlling interests of participants.
Because the requirements in Rule 17Ad-25 preclude an individual from
serving as an independent director when such material relationships
reasonably could affect the independent judgment or decision-making of
the director, a registered clearing agency that is majority-owned by
participants

could determine that an employee of an owner-participant has
relationships that preclude the employee from serving as an independent
director--not on the basis of her employment relationship to the
participant but rather other potential entanglements that may emerge
from the employee's other material relationships with the clearing
agency. For example, if an employee of an owner of a clearing agency
received stock options as part of a compensation package, that employee
has interests tied to the profits of the clearing agency distinct from
an employee who receives stock options of a clearing agency participant
that is not also an owner of a clearing agency. The existence of such
interests tied to profit that carry through ownership structures back
to the clearing agency poses a potential conflict of interest for a
director of that clearing agency. In this way, a registered clearing
agency may determine that employees of owners are less likely than
employees of participants to satisfy the independent director
requirement. Applying a 51 percent requirement to registered clearing
agencies that are majority-owned by their participants could, in the
view of a registered clearing agency evaluating the material
relationships of its nominees for independent directors, result in
minority representation of owners and participants. Therefore, the rule
applies a lower threshold to participant-owned clearing agencies to
provide the shareholders of such a registered clearing agency greater
discretion to nominate, as independent directors, candidates from
among, for example, the employees of participant-owners. Applying the
higher standard to all clearing agencies, solely to insulate the board
from influence by management, could restrict access to representatives
of participant-owners in a way that may impair the board's ability to
oversee the clearing agency's risk management function effectively.
---------------------------------------------------------------------------

    \74\ Saguato at 3.
---------------------------------------------------------------------------

    One commenter agreed that the proposed requirements for independent
directors address conflicts of interest, but the commenter also stated
that the solution was incomplete to address the problem and so
recommended that the Commission also adopt a ``skin-in-the-game''
requirement.\75\ Specifically, this commenter stated its belief that it
is necessary to align the incentives between a clearing agency and its
participants by requiring the clearing agency to subject a meaningful
amount of its own capital to potential loss after a default of a
participant, in particular after the defaulting participant's margin
and guaranty fund contributions are used to satisfy its obligations,
but before any margin or guaranty fund contributions of other non-
defaulting participants are used to satisfy the obligations of the
defaulting participant. This idea seeks to encourage a clearing agency
to manage risks well, to prevent its own capital from being lost during
a default. This commenter's suggestion is beyond the scope of the
present rulemaking.
---------------------------------------------------------------------------

    \75\ Better Markets at 5-6, 12-14.
---------------------------------------------------------------------------

    One commenter expressed concern that employees of participants who
are acting as independent directors and representing the interests of
the clearing agency could have conflicts of interest between these two
roles.\76\ The commenter recommended that the Commission impose a
requirement for such persons to have due regard to market stability in
their role at the clearing agency. Directors do not need to have a
specific obligation applied to them in their individual capacity to
consider market stability. Rules 17Ad-22(e)(2)(ii) and (iii) require
covered clearing agencies to establish, implement, maintain and enforce
written policies and procedures reasonably designed to provide for
governance arrangements that clearly prioritize the safety and
efficiency of the covered clearing agency and support the public
interest requirements in Exchange Act section 17A.\77\ These existing
requirements are sufficient to ensure a registered clearing agency has
due regard for financial stability.
---------------------------------------------------------------------------

    \76\ See ISDA at 6.
    \77\ See 17 CFR 240.17Ad-22(e)(2)(ii), (iii); see also 17 CFR
240.17Ad-22(d)(8) (requiring registered clearing agencies that are
not covered clearing agencies to establish, implement, maintain and
enforce governance arrangements that are clear and transparent to
fulfill the public interest requirements in Exchange Act section
17A).
---------------------------------------------------------------------------

    One commenter agreed with the Commission's concerns that a small
number of participants--if allowed to exercise control over a clearing
agency--can promote margin or other requirements that are not
commensurate with the risks of a participant's specific products,
portfolio market, business model, and size, which could lead to a
concentration of risk in a few dominant market participants who
benefit.\78\ The commenter suggested that the Commission adopt rules
that would address non-independent directors and would require
diversity among participant representation on the board, based on size
and level of specialization by said participants. Otherwise, the
commenter suggested, the representation among participants will be
lopsided, leading to greater concentration of risk among the clearing
agency's largest participants. The Commission agrees that the interests
of participants are not always homogenous or aligned, and therefore,
the interests of smaller participants can diverge from those of the
largest. However, the Exchange Act requirement for fair representation
allows for the consideration of proportionality as an element.\79\
Although all participants are equally exposed to default risk, larger
firms may be more impacted by policies that apply based on transaction
volume. Thus, it can be appropriate to apportion representation
according to use of the clearing agency, even if an effect of this
approach is to be disproportionate as to the number of small, medium,
or large participants represented on the board relative to the total
number of small, medium, or large participants in a clearing agency's
customer base at any particular time. Further, there could be arguments
that reducing the degree of proportionality of representation relative
to use of the clearing agency could lead to negative externalities that
disproportionately impact larger participants. Accordingly, the
Commission is declining to expand the scope of this rule to develop
participant categories and to require certain level of participant
representation on the board as non-independent directors among those
categories.
---------------------------------------------------------------------------

    \78\ IDTA at 2-3.
    \79\ See 15 U.S.C. 78q-1(b)(3)(C) (``The Commission may
determine that the representation of participants is fair if they
are afforded a reasonable opportunity to acquire voting stock of the
clearing agency, directly or indirectly, in reasonable proportion to
their use of such clearing agency.'').
---------------------------------------------------------------------------

5. Ownership Structures
    One commenter stated that the largest clearing agency participants
do not necessarily need personal influence over a director because they
possess economic leverage over the clearing agency.\80\ Additionally,
the commenter requested that special attention be paid towards
participants at registered clearing agencies that clear derivatives
products because of the risk posed to effective governance by an
``oligopoly'' of market power exercised by certain derivatives
dealers.\81\ Instead of relying on independent directors as a bulwark
against conflicts of interest, the commenter suggested restoration of
the ownership limits that were previously proposed in Regulation MC to
address market concentration.\82\ The commenter further suggested that
the Commission go beyond what was originally proposed in Regulation MC
and add restrictions

on commercial arrangements for volume, such as volumetric discounts,
rebates, or revenue sharing. This suggestion goes beyond the scope of
this rulemaking because they concern restrictions on commercial
arrangements rather than requirements for board composition and
governance.
---------------------------------------------------------------------------

    \80\ Better Markets at 14.
    \81\ Id. at 10.
    \82\ Id. at 15; see also Exchange Act Release No. 63107 (Oct.
14, 2010), 75 FR 65882 (Oct. 26, 2010) (proposing Regulation MC).
---------------------------------------------------------------------------

    The commenter also suggested expanding the definition of
``affiliate'' to deem all owners and shareholders as affiliates, under
the reasoning that a handful of dominant shareholders could ``collude''
among one another to exercise constructive control over a clearing
agency, even if each individual shareholder did not meet the definition
for control itself.\83\ Many participants are also shareholders of a
clearing agency, and so if the affiliate definition were to be
expanded, it would restrict employees of many participants from meeting
the independent director definition as a result of the exclusion in
Rule 17Ad-25(f)(2). The Commission is concerned that such an expanded
definition could interfere with the ability of a clearing agency to
afford fair representation to participants, as contemplated by Exchange
Act section 17A(b)(3)(C), which discusses the ability of participants
to participate in board governance. In addition, Rule 17Ad-25 includes
elements directed at the problems of ``collusion'' in multiple ways,
and Rules 17Ad-25(g) and (h), and the associated requirements to
address and disclose conflicts of interest, are better suited to
address such potential ``collusion'' among certain shareholders because
they are broad-based and not restricted to one potential source of
conflicts (i.e., affiliates).\84\
---------------------------------------------------------------------------

    \83\ Better Markets at 19.
    \84\ See infra Part II.D (further discussing final Rules 17Ad-
25(g) and (h)).
---------------------------------------------------------------------------

6. Circumvention
    One commenter expressed concern that the proposal did not specify
who at the clearing agency should determine whether a fact pattern
meets the definition of ``material relationship,'' reasoning that if
the board can make that determination, there could be an incentive on
the board of directors to give each other a ``free pass'' as to their
potentially objectionable relationships.\85\ Instead, the commenter
suggested an explicit requirement for disinterested compliance officers
or qualified outside professionals to determine whether material
relationships exist. The proposed rules did not specify who at the
clearing agency should evaluate relationships under this definition,
and the Commission has modified the final rules to specify that the
nominating committee is required to evaluate all board members under
the independent director standard, as discussed further in Part II.B.2.
---------------------------------------------------------------------------

    \85\ Better Markets at 19.
---------------------------------------------------------------------------

    Some commenters provided recommendations that went beyond the
composition of the board and instead addressed the authority of a board
more generally. Specifically, some commenters requested that the
Commission apply more rigorous governance procedures to clearing
agencies with respect to their emergency powers as set forth in their
rulebooks, which the commenters stated were broad and vaguely
defined.\86\ But emergency powers exist at two levels for many clearing
agencies: those provisions that impact the rights and obligations of
the board, as set forth in the organizational documents of the legal
entity itself (such as the ability of the board to act without a quorum
in the event of an emergency, such as a terrorist attack),\87\ and
those provisions that impact the clearing agencies' rights and
obligations with respect to the clearing members.\88\ Although the
Commission's rules do not directly impact the parameters around which
emergency powers can be exercised, either at the board level or under
the rules of the clearing agency, they do address who will make
decisions when exercising such emergency powers. Ensuring that
decision-making processes are clear, transparent, and fair, and that
market participants have confidence in those processes in an
emergency--including that neither clearing agency owners nor
participants will dominate the decision-making process to achieve their
own ends--can help reassure those who may be significantly impacted by
such decisions. Rule 17Ad-25 meaningfully addresses such generalized
concerns about the fair and even-handed use of emergency powers by
establishing new standards for board governance applicable to
registered clearing agencies.
---------------------------------------------------------------------------

    \86\ Barclays et al. at 3; see also SIFMA at 4 (stating that
``greater transparency and a more rigorous governance process,
including consultation with primary regulators, regarding the use of
emergency powers should help further confidence in the overall
financial system and ensure that affected stakeholders are aware and
have buy-in when such powers are used.''); ISDA at 2.
    \87\ See, e.g., Bylaws, The Option Clearing Corporation, at
Article II, Section 15 (stating, ``During any emergency which
results, directly or indirectly, from an attack (including a
terrorist attack) on the United States or on a locality in which the
Corporation maintains an office or customarily holds meetings of the
Board of Directors, or from a war, armed hostilities, insurrection
or other calamity involving the United States or any such locality,
or from any nuclear or atomic disaster, or from any other
catastrophe, disaster, (including any environmental or natural
disaster), communications systems failure, or other similar
condition, in which a quorum (as specified in Article III of the By-
Laws) of the Board of Directors or a standing committee thereof
cannot readily be convened for action (an ``Emergency''), the
following provisions of this Section 15 shall be operative
notwithstanding any other provision in any of the sections (other
than Section 110) of the Delaware Corporation Law or in the
Certificate of Incorporation, By-Laws or Rules of the Corporation.
The Chairman, Chief Executive Officer, Chief Operating Officer or,
if it is not feasible for the Chairman, Chief Executive Officer, or
Chief Operating Officer to take such action, then another officer
who is a Designated Officer is authorized to declare the existence
of such Emergency and to declare this By-Law to be in effect.''),
https://www.theocc.com/company-information/documents-and-archives/by-laws-and-rules.
    \88\ See, e.g., ``Rule 38: Market Disruption and Force
Majeure,'' DTC Rulebook, https://www.dtcc.com/-/media/Files/Downloads/legal/rules/dtc_rules.pdf.
---------------------------------------------------------------------------

    Finally, one commenter suggested that the majority independent
director requirement could be evaded by any supermajority requirement
for voting or quorums of the board.\89\ The Commission is aware that
some registered clearing agencies currently apply supermajority
requirements in certain scenarios, such as a requirement that three-
fourths of an entire board shall constitute a quorum for purposes of
electing the board chair.\90\ Policies and procedures to identify,
mitigate, or eliminate existing or potential conflicts of interest
required under Rule 17Ad-25(g) generally should provide for the
clearing agency to evaluate whether any supermajority requirements in
any of the registered clearing agency's rules, policies, and procedures
would allow directors with potential conflicts of interest to steer the
clearing agency in service of those personal interests by avoiding any
mechanisms that might require mitigation or elimination (e.g., recusal
by the director on the matter at hand) of the conflict of interest. A
registered clearing agency generally should consider whether its
policies and procedures under Rule 17Ad-25(g) are ``reasonably
designed'' if provisions of its rules, policies or procedures would
allow non-independent directors to exercise disproportionately greater
control of certain board decisions beyond what their numbers would
otherwise allow.\91\
---------------------------------------------------------------------------

    \89\ Better Markets at 18.
    \90\ See Organizational Certificate of the Depository Trust
Corporation, https://www.dtcc.com/legal/rules-and-procedures.
    \91\ See infra Part II.D.2 (further discussing the ``reasonably
designed'' and ``reasonableness'' elements of Rules 17Ad-25(g) and
(h)).

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

B. Nominating Committee

1. Proposed Rule 17Ad-25(c)
    Proposed Rule 17Ad-25(c)(1) would require each registered clearing
agency to establish a nominating committee and a written evaluation
process whereby such nominating committee shall evaluate individual
nominees to serve as directors. Proposed Rule 17Ad-25(c)(2) would
require that (i) independent directors compose a majority of the
nominating committee, and (ii) an independent director chair the
nominating committee. Proposed Rule 17Ad-25(c)(3) would require the
nominating committee to specify and document fitness standards, which
must be approved by the board. Such fitness standards for serving as a
director would need to be consistent with all the requirements of
proposed Rule 17Ad-25, and also would include that the individual
nominee is not subject to any statutory disqualification as defined
under section 3(a)(39) of the Exchange Act.\92\ Proposed Rule 17Ad-
25(c)(4) would require the nominating committee to document the outcome
of the clearing agency's written evaluation process in a manner that is
consistent with the written fitness standards required under proposed
Rule 17Ad-25(c)(3). The process would require the nominating committee
to: (i) take into account each nominee's expertise, availability, and
integrity, and demonstrate that the board, taken as a whole, has a
diversity of skills, knowledge, experience, and perspectives; (ii)
demonstrate that the nominating committee has considered whether a
particular nominee would complement the other board members, such that,
if elected, the board, taken as a whole, would represent the views of
the owners and participants, including a selection of directors that
reflects the range of different business strategies, models, and sizes
across participants, as well as the range of customers and clients the
participants serve; (iii) demonstrate that the nominating committee
considered the views of other stakeholders who may be affected by the
decisions of the registered clearing agency, including transfer agents,
settlement banks, nostro agents, liquidity providers, technology or
other service providers; and (iv) identify whether each selected
nominee would meet the definition of independent director in proposed
Rules 17Ad-25(a) and (f), and whether each selected nominee has a known
material relationship with the registered clearing agency or any
affiliate thereof, an owner, a participant, or a representative of
another type of stakeholder of the registered clearing agency described
in (iii) above.
---------------------------------------------------------------------------

    \92\ As explained in the Governance Proposing Release, supra
note 2, at 51828 & n.107, 15 U.S.C. 78q-1(a)(3)(C) identifies the
circumstances that subject a person to ``statutory
disqualification'' with respect to membership or participation in,
or association with a member of, a self-regulatory organization,
such as a registered clearing agency.
---------------------------------------------------------------------------

    In the Governance Proposing Release, the Commission explained that
some registered clearing agencies currently use governance arrangements
other than a nominating committee to select certain directors.\93\ It
also explained that, while the proposed rule would not prohibit such
approaches, it would require that any such nominees be submitted first
to the nominating committee for evaluation--before being considered by
the boardpursuant to a written evaluation process established by the
registered clearing agency.\94\
---------------------------------------------------------------------------

    \93\ Governance Proposing Release, supra note 2, at 51829
(describing these arrangements other than a nominating committee as
``other governing bodies and/or constituents of their organizational
structure'').
    \94\ Id.
---------------------------------------------------------------------------

    With respect to proposed Rule 17Ad-25(c)(4)(iii), which would give
the nominating committee discretion to determine how to consider the
views of other stakeholders, the Commission stated that relevant
stakeholders generally would include persons and entities that access
the national system for clearance and settlement indirectly (e.g.,
institutional and retail investors), entities that rely on the national
system for clearance and settlement to more effectively provide
services to investors and market participants, and other market
infrastructures.\95\
---------------------------------------------------------------------------

    \95\ Id. at 51830.
---------------------------------------------------------------------------

    Commenters generally supported the proposed rules addressing the
nominating committee.\96\ As discussed in more detail below, commenters
sought clarity regarding discussion in the Governance Proposing Release
stating that the nominating committee would be the ``exclusive venue''
for considering director nominees, as discussed further below. In
addition, some commenters recommended modifying the proposed approach
to participation by small and medium-sized firms on the board, and
regarding the percent of directors that are independent directors
serving on the nominating committees. The Commission addresses each of
these topics in Parts II.B.2 through II.B.4.
---------------------------------------------------------------------------

    \96\ See, e.g., Better Markets at 4; DTCC at 5; IDTA at 4; ISDA
at 6; LSEG at 8; OCC at 3; Saguato at 3. But see ICE at 3
(describing the proposed approach as ``too prescriptive'').
---------------------------------------------------------------------------

2. As ``Exclusive Venue'' for Considering Nominees
    Several commenters sought clarity regarding statements in the
Governance Proposing Release that the nominating committee be the
``exclusive'' venue for considering nominees.\97\ As discussed further
below, the Commission is modifying the rule being adopted to address
more clearly scenarios in which directors may be nominated or appointed
directly by shareholders pursuant to the organizational documents of
the registered clearing agency outside of the process established by
the nominating committee.
---------------------------------------------------------------------------

    \97\ DTCC at 5; LSEG at 8; OCC at 7; Saguato at 4; see also
Governance Proposing Release, supra note 2, at 51830 (requesting
comment on the following: ``Is it appropriate for the Commission to
require that the nominating committee be the exclusive venue for
evaluating nominees for director to the board of directors? What
alternative arrangements or processes might also be appropriate for
evaluating director nominees?'').
---------------------------------------------------------------------------

    First, one commenter recommended that the Commission modify the
rule so that the nominating committee only conduct written evaluation
of nominees and not appointees that may be selected via other
mechanisms in the governance structure.\98\ For example, OCC allows
certain participant exchanges to select ``Exchange Director'' nominees
for election to OCC's board. The proposed rule text does not address
this specific type of selection process, but as discussed in the
Governance Proposing Release,\99\ proposed Rule 17Ad-25(c) would not
prohibit the selection of such directors appointed pursuant to such a
process. Nonetheless, as previously discussed in the Governance
Proposing Release, it would require that any such nominees be submitted
first to the nominating committee for evaluation--before being
considered by the board--pursuant to a written evaluation process
established by the registered clearing agency.\100\ This proposed
requirement would help ensure that nominees are evaluated in a manner
consistent with the requirements for independent directors and other
qualifications to serve.
---------------------------------------------------------------------------

    \98\ OCC at 7-8.
    \99\ See Governance Proposing Release, supra note 2, at 51829.
    \100\ See id.
---------------------------------------------------------------------------

    Accordingly, as proposed, Rule 17Ad-25(c) was intended to ensure
that, with respect to all nominees and appointed directors, the
nominating committee would evaluate each nominee or appointee for
director, no matter the source of her nomination or equivalent
selection as director, against the standards for fitness and

independence established by Rule 17Ad-25.\101\ This ensures that the
board, the participants of the registered clearing agency, and
ultimately other stakeholders and the public, have confidence in the
fitness of directors generally and in the independence standard applied
to directors to qualify as independent directors. The commenter's
recommended approach would be inconsistent with the purpose and intent
of proposed Rule 17Ad-25 because proposed Rule 17Ad-25(c) was intended
to ensure that, with respect to all directors, the nominating committee
would evaluate each nominee, no matter the source of their nomination,
against the standards for fitness and independence established by Rule
17Ad-25. To the extent that any directors are ``appointed,'' it is
appropriate to subject such ``appointees'' to the same standards as
other nominees for director. Doing so would not slow or otherwise
stymie the appointment of such directors because, regardless of how
they are selected to serve on the board, all directors are subject to
the same fitness standards and also would be subject to disclosure
requirements regarding the reporting of potential conflicts of interest
and material relationships.\102\ Specifically, Rule 17Ad-25(c)(4)(ii)
requires the nominating committee to demonstrate that it has considered
whether a particular nominee would complement the other board members,
such that, if elected, the board of directors, taken as a whole, would
represent the views of the owners and participants, including a
selection of directors that reflects the range of different business
strategies, models, and sizes across participants, as well as the range
of customers and clients the participants serve. Because this
requirement is focused on board composition, excluding any directors
from the requirement would undermine the purpose of the rule and the
ability of the nominating committee to evaluate board composition as a
whole.
---------------------------------------------------------------------------

    \101\ See Governance Proposing Release, supra note 2, at 51829
n.110 (providing the same example).
    \102\ See infra Part II.D (further discussing both a clearing
agency's entity-wide obligations and a director's specific
obligations relating to potential conflicts of interest and the
evaluation of material relationships).
---------------------------------------------------------------------------

    Similarly, proposed Rule 17Ad-25(c)(4)(iv) requires the nominating
committee to identify whether each nominee has a known material
relationship with the registered clearing agency or any affiliate
thereof, an owner, a participant, or a representative of another
stakeholder of the registered clearing agency. Because this requirement
establishes a baseline against which the registered clearing agency
will need to evaluate potential conflicts of interest, regardless of
whether a director is intended to be independent, the nominating
committee should evaluate appointed directors as well. Such requirement
helps ensure that the clearing agency can evaluate potential conflicts
of interest that may require a director to recuse as to certain matters
before the board. The Commission therefore is not modifying the rule to
exclude from evaluation by the nominating committee nominees or
directors who are appointed by other means pursuant to the organizing
documents of the registered clearing agency.
    Notwithstanding the above, the Commission is modifying Rule 17Ad-
25(c) in two ways: (a) the Commission is modifying paragraph (1) to add
that the nominating committee shall also ``evaluate the independence of
nominees and directors,'' in addition to evaluating nominees for
serving as directors, and (b) the Commission is modifying paragraph
(4)(iv) in two places to specify that the evaluation process applies to
nominees as well as directors. Pursuant to the latter modification, the
written evaluation process required by the rule shall identify whether
each nominee ``or director'' would meet the definition of independent
director and whether each ``such nominee or director'' has a known
material relationship with the registered clearing agency (or an
affiliate thereof).\103\ These changes ensure that the final rule
addresses the role of the nominating committee in evaluating directors
which it did not itself nominate because their nominations came through
different processes specified in the organizing documents of the
registered clearing agency. Separately, the Commission is also
modifying paragraph (4)(iii) to replace the term ``impacted'' with
``affected.'' This is a technical correction to avoid the use of
informal language in the rule text.
---------------------------------------------------------------------------

    \103\ See Rule 17Ad-25(b)(2) (requiring, among other things,
that the registered clearing agency broadly consider all the
relevant facts and circumstances on an ongoing basis to
affirmatively determine that a director does not have a material
relationship with the registered clearing agency or an affiliate of
the registered clearing agency).
---------------------------------------------------------------------------

    Second, as previously discussed in Part II.A.3, one commenter
stated that the concept of ``control'' as used in certain definitions
in and requirements of Rule 17Ad-25, should be left to the
determination of the nominating committee of the registered clearing
agency, as long as the analysis is documented and auditable.\104\ The
Commission agrees and Rule 17Ad-25(c)(1) accordingly includes a
requirement for a written evaluation process, so that the clearing
agency has documentation as to its determinations of control.
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    \104\ LSEG at 4.
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    Third, one commenter sought clarity as to whether the nominating
committee can perform other functions.\105\ Specifically, the commenter
explained that a registered clearing agency might establish one
committee that performs the entire function and role of the nominating
committee but also consider other governance functions more broadly.
Such an approach can be appropriate and consistent with the adopted
rule. Rule 17Ad-25(c), as discussed above and modified, requires that
the nominating committee evaluate each nominee for serving as a
director and evaluate the independence of nominees and directors. A
committee that performs these functions would satisfy the requirements
of the rule, even if it also performed additional functions as
specified in the organizing documents of the registered clearing
agency. A registered clearing agency, however, generally should take
account of the overall workload imposed on the nominating committee in
the organizing documents and ensure that the nominating committee has
sufficient time and resources to fulfill the functions required by Rule
17Ad-25(c), which include evaluating nominees and directors as
explained above and establishing the fitness standards for serving on
the board.
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    \105\ DTCC at 5.
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    Fourth, one commenter asked whether the board could take on the
functions of the nominating committee if it met all requirements
applicable to the nominating committee.\106\ Such an approach can be
appropriate and consistent with the rule. Consistent with the
requirements in Rule 17Ad-25(c)(2), such an approach would require that
a majority of the directors serving on the board be independent
directors--regardless of the ownership structure of the clearing
agency--and that the chair of the board be an independent director.
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    \106\ ICE at 3.
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3. Approach to Representation of Small and Medium-Sized Firms
    In addition to comments discussed in Part II.A.4 regarding
establishing a ``right of participation'' generally on the board by
small and medium-sized participants of the registered clearing agency,
commenters also expressed similar views specific to participation

on the nominating committee. Two commenters recommended that the
Commission specifically authorize such a right of participation on the
nominating committee.\107\
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    \107\ Better Markets at 20 (recommending that the Commission
mandate participation from smaller clearing members to guard against
a board that finds diversity within the ``oligopoly of large
dealers''); IDTA at 4 (recommending that the Commission be more
prescriptive in requiring that certain types of stakeholders, such
as ``not FSOC designated SIFIs'' be afforded a right to
participate).
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    Exchange Act section 17A(b)(3)(C) directs the Commission to ensure
the fair representation of owners and participants in the selection of
directors and the administration of affairs. As previously discussed in
Part II.A.4, it can be appropriate to apportion representation
according to use of the clearing agency, even if an effect of this
approach is to be disproportionate as to the number of small, medium,
or large participants represented on the board relative to the total
number of small, medium, or large participants that use the clearing
agency. In addition, reducing the degree of proportionality of
representation relative to use of the clearing agency could lead to
negative externalities. For these same reasons, the Commission is not
modifying the proposed rule to require a ``right of participation'' on
the nominating committee specific to small and medium-sized
participants.\108\ In proposing Rule 17Ad-25(c), the Commission stated
its belief that smaller participants and clients of participants
generally should be represented on clearing agency boards and board
committees, such that their views and perspectives are formally
considered in board decisions that may impact them.\109\ In particular,
the Commission explained that the diverse perspectives and expertise
that smaller participants and clients of participants can provide will
help inform a clearing agency's operations and thereby improve the
resilience of the registered clearing agency. Consistent with these
views, board governance, and through it the risk management function of
the clearing agency, benefits from diverse perspectives on risk
management issues from across the range of stakeholders--owners, direct
participants, and indirect participants--in a registered clearing
agency. Accordingly, proposed Rules 17Ad-25(c)(4)(i), (ii), and (iii)
require that clearing agencies take steps to facilitate diverse
perspectives and expertise on the board, including a requirement in
Rule 17Ad-25(c)(4)(ii) for the nominating committee to demonstrate that
it has considered whether a particular nominee would complement the
other board members, such that, if elected, the board of directors,
taken as a whole, would represent--among other things--the range of
different business strategies, models, and sizes across participants,
as well as the range of customers and clients the participants serve.
These requirements ensure that the nominating committee considers a
diverse set of backgrounds, experience, and skills in selecting and
evaluating nominees for the board.\110\ In this regard, a registered
clearing agency generally should provide in its governance arrangements
that the nominating committee explicitly consider some nominees that
represent the views of medium and small participants, but, in the
Commission's view, it is appropriate to leave discretion to the
clearing agency and its board to evaluate and select the appropriate
mix of nominees and directors mindful of its organizational documents,
markets served, and products cleared.
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    \108\ See supra notes 76-78 and accompanying text (not modifying
the rule to designate certain seats on the board for specific types
of clearing agency participants or their customers).
    \109\ Governance Proposing Release, supra note 2, at 51829.
    \110\ See infra Part II.F (further discussing Rule 17Ad-25(j),
which imposes an obligation on the board to formally consider
stakeholder viewpoints, also helps ensure that the board is actively
soliciting the views of those stakeholders who do not participate in
the board directly so that the views of such stakeholders can be
considered and incorporated into the board's risk management and
operations).
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    For the above reasons, the Commission is not modifying Rule 17Ad-
25(c) in response to these comments.
4. Percent of Directors That Are Independent Directors
    Some commenters expressed support for the proposed approach to
require that the chair of the nominating committee be an independent
director and that a majority of the directors serving on the nominating
committee be independent directors.\111\ One commenter recommended that
the Commission modify the proposal to require that all directors
serving on the nominating committee be independent directors.\112\ The
commenter stated that such an approach would help maintain the standard
for director independence and improve the overall quality of nominees.
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    \111\ DTCC at 5; ISDA at 6; LSEG at 9; Saguato at 3; see also
ICE at 3 (observing that, in its view, requiring written evaluations
of nominees is unnecessary if the committee is also composed of a
majority of independent directors).
    \112\ IDTA at 4.
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    The Commission is not requiring all directors serving on the
nominating committee be independent directors for two reasons. First,
as a general matter, the proposal sought to ensure an approach to board
governance that facilitates fair representation of both owners and
participants in the selection of directors and the administration of a
clearing agency's affairs.\113\ The proposed approach is consistent
with this requirement in part because it enables any individual
director, whether independent or not, to serve on the nominating
committee. Second, and mindful of the concern raised by the commenter,
the proposed rule would require that a majority of the directors
serving on the nominating committee be independent directors regardless
of the ownership structure of the registered clearing agency.\114\ A
majority of independent directors and a chair of the nominating
committee that is also an independent director is sufficient to ensure
the thoughtful consideration, evaluation, and selection of nominees,
particularly for nominees to serve as independent directors on the
board of a registered clearing agency. Given the definition of
``independent director'' used in Rule 17Ad-25, modifying the rule
further to require that only independent directors can serve on the
nominating committee would not clearly improve the functioning of the
nominating committee. Independent directors would already be a majority
of the nominating committee when making determinations, and as such,
directors intended to represent owners of the clearing agency cannot
comprise a majority of the nominating committee without also obtaining
support from independent directors as to particular decisions. Because
clearing agencies perform a unique and often systemically important
function that facilitates effective risk management in the U.S.
securities markets, enabling a wide range of stakeholders in the
registered clearing agency to serve on the nominating committee,
including directors who are not independent directors, can provide
expertise,

experience, and skills useful to the nominating committee's overall
purpose.
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    \113\ Governance Proposing Release, supra note 2 at 51818
(``Specifically, the Commission believes that addressing the
composition of a board and its committees will help ensure effective
governance, help promote transparency into decision-making
processes, facilitate fair representation of owners and
participants, and mitigate the potential effects of conflicts of
interest between owners and participants, large and small
participants, and direct and indirect participants.'').
    \114\ See supra Part II.A (further discussing Rule 17Ad-25(b),
which sets the general requirement for the number of independent
directors required to serve on the board based on the percentage of
ownership held by participants in the registered clearing agency).
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C. Risk Management Committee

1. Proposed Rule 17Ad-25(d)
    Proposed Rule 17Ad-25(d)(1) would require each registered clearing
agency to establish a risk management committee (or committees)
(``RMC'') to assist the board in overseeing the risk management of the
registered clearing agency. Proposed Rule 17Ad-25(d)(1) would also
require each RMC to reconstitute its membership on a regular basis and
at all times include representatives from the owners and participants
of the registered clearing agency. Proposed Rule 17Ad-25(d)(2) would
require that the RMC, in the performance of its duties, be able to
provide a risk-based, independent, and informed opinion on all matters
presented to it for consideration in a manner that supports the safety
and efficiency of the registered clearing agency.
    In the Governance Proposing Release, the Commission explained that
because all registered clearing agencies are currently covered clearing
agencies and, as such, are required to have RMCs as a part of their
governance arrangements under Rule 17Ad-22(e)(3)(iv),\115\ no parallel
requirement exists for registered clearing agencies that are subject to
Rule 17Ad-22(d).\116\ The Commission stated that because future
registered clearing agencies that are not covered clearing agencies
and, as a result, are subject to Rule 17Ad-22(d), will also likely face
risk management issues related to their activities, any clearing agency
subject to Rule 17Ad-22(d) will likely benefit from having a RMC.\117\
Accordingly, the Commission proposed Rule 17Ad-25(d) so that clearing
agencies subject to Rule 17Ad-22(d) will also be required to have RMCs
as a part of their governance arrangements.\118\ Additionally, the
Commission stated that proposed Rule 17Ad-25(d) would establish more
defined requirements related to the purpose and function of RMCs that
Rule 17Ad-22(e)(3)(iv) does not and that specific requirements imposed
by proposed Rule 17Ad-25(d) would help enhance risk management
governance across all registered clearing agencies.\119\
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    \115\ See 17 CFR 240.17Ad-22(e)(3)(iv); see also CCA Standards
Adopting Release, supra note 4, at 70807-09 (discussing that, under
Rule 17Ad-22(e)(3)(iv), a registered clearing agency's risk
management framework must provide risk management personnel with a
direct reporting line to, and oversight by, a RMC of the board of
directors).
    \116\ See Governance Proposing Release, supra note 2, at 51831.
    \117\ See id.
    \118\ See id.
    \119\ See id.
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    In the Governance Proposing Release, the Commission also stated
that it recognizes the importance of enabling the board to assign
certain tasks to a board committee to assist the board in discharging
its ultimate responsibility of ensuring the sound risk management of
the clearing agency.\120\ The Commission stated that for the RMC itself
to be effective, it must have a clearly defined purpose and obligations
to the board; therefore, the proposed rule would require the RMC to
provide a risk-based, independent, and informed opinion on all matters
presented to it in a way that supports the safety and efficiency of the
registered clearing agency.\121\
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    \120\ See id.
    \121\ See id.
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    Commenters generally supported the proposed approach to Rule 17Ad-
25(d).\122\ However, some commenters requested clarifications \123\ or
modifications to the rule.\124\ Other commenters disagreed with certain
aspects of the rule.\125\ Proposed Rule 17Ad-25(d) balances more
defined requirements with principles-based requirements relating to a
registered clearing agency's RMC. In keeping with this approach and to
address requests for clarifications and revisions to the rule, the
Commission adopts Rule 17Ad-25(d) as proposed, with certain
modifications. Specifically, Rule 17Ad-25(d)(1) has been modified to
reflect that: (1) the RMC is ``of the board'' of the registered
clearing agency; and (2) the RMC's membership must be ``re-evaluated
annually.'' Additionally, Rule 17Ad-25(d)(2) has been modified to
reflect that the RMC's work must support the ``overall risk management,
safety and efficiency of the registered clearing agency.'' Rule 17Ad-
25(d) establishes specific requirements as a minimum bar for RMCs
across all registered clearing agencies while also providing registered
clearing agencies with discretion to consider when and how to re-
evaluate the RMC membership annually and regarding the choice of the
RMC chair.
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    \122\ See, e.g., SIFMA at 3 (stating that it ``supports this
part of the rule and urges the Commission to adopt it . . .'');
Barclays et al. at 2 (stating that ``[w]hile it is reassuring that
all seven of the current clearing agencies include participant
representatives on their RMCs, we believe that the codification of
this practice into a requirement will be beneficial''); DTCC at 5
(stating that ``DTCC generally supports the requirements set forth
in proposed Rule 17Ad-25(d) regarding the establishment and function
of a board risk committee . . .''); ICI at 2 (stating that ``[w]hile
RMCs currently exist at some clearing entities, the proposed
requirements would promote greater consistency and a defined role
for these committees.'').
    \123\ See, e.g., DTCC at 5-6; OCC at 8-9.
    \124\ See, e.g., SIFMA AMG at 4-6; Barclays et al. at 2.
    \125\ See, e.g., OCC at 8-9 (stating that ``[a] requirement that
forces a registered clearing agency to replace well-informed risk
management experts with directors relatively unfamiliar with a
particular matter or the broader risk management framework would rob
the registered clearing agency of critical risk management
continuity.''); CCP12 at 4-5 (stating that ``[w]hile we agree that
it can be beneficial for a risk management committee to be a board
committee . . . we do not support making this a requirement . .
.''); ICE at 4 (stating that ``ICE supports the Commission's
proposal to require a SEC Registered CA to establish a risk
management committee but disagrees with the requirement that a risk
management committee be a committee of the board.'').
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2. RMC of the Board
    Many commenters had understood the proposed rule to require a
board-level RMC, as the Commission had intended the rule to require,
and supported the Commission's approach.\126\ A commenter requested
that the Commission clarify in a final rule that the board-level RMC is
``not merely an advisory body that only develops opinions or
recommendations for full board consideration and action.'' \127\
Another commenter stated that because risk management should be a
critical focus of the RMC, the RMC should have adequate representation
by clearing agency participants, and the proposed requirement would
help formalize such a structure and foster further consistency across
clearing agencies.\128\
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    \126\ See, e.g., LSEG at 10 (stating that ``this would be an
effective way to structure the committee. As a board sub-committee,
the RMC can be formally delegated certain authorities and would be