as a result of the BCBS capital framework's treatment of QCCPs. In
particular, if U.S. clearing agencies do not obtain QCCP status from
foreign banking regulators who have adopted rules conforming to the
BCBS capital framework because, for instance, the regulatory framework
is not consistent with the PFMI, foreign bank members of U.S. clearing
agencies may have incentives to move their clearing business to
clearing agencies in jurisdictions where they might obtain lower
capital requirements under the BCBS capital framework.\675\
---------------------------------------------------------------------------

    \674\ See supra note 43.
    \675\ See supra notes 44-45 and infra Part III.B.1.e (discussing
the BCBS capital framework and the economic effect of QCCP status
under the BCBS capital framework, respectively).
---------------------------------------------------------------------------

d. Concentration
    The economic effects associated with the amendments to Rule 17Ad-22
may also be partially determined by the economic characteristics of
clearing agencies. Generally, the economic characteristics of FMIs,
including clearing agencies, include specialization, economies of
scale, barriers to entry, and a limited number of competitors.\676\
Such characteristics, coupled with the particulars of an FMI's legal
mandate, could result in market power, leading to lower levels of
service, higher prices, and under-investment in risk management
systems.\677\
---------------------------------------------------------------------------

    \676\ See supra note 39 (defining ``financial market
infrastructure'').
    \677\ Cf. PFMI, supra note 2, at 11.
---------------------------------------------------------------------------

    The centralization of clearing activities in a relatively small
number of clearing agencies somewhat insulated from market forces may
result in a reduction in their incentives to innovate and to invest in
the development of appropriate risk management practices on an ongoing
basis,\678\ particularly when combined with the cost reduction
pressures noted previously.\679\ However, the Commission notes that the
inverse may not necessarily hold. In other words, additional
competition in the market for clearing services may not necessarily
result in improved risk management. For instance, aggressive price-
cutting in a ``race to the bottom'' may result in clearing agencies
accepting lower-quality collateral, requiring lower margin and default
fund contributions, lowering access requirements, or holding lower
reserves, potentially undermining their risk management efforts.\680\
---------------------------------------------------------------------------

    \678\ The Commission notes that this result depends on the
relationship between the cost of innovations in risk management and
the private benefits to a clearing agency in terms of reduced
default risk. Absent competitive pressures, a clearing agency may
nevertheless invest in the development of risk management practices
so long as the marginal benefits of risk reduction exceed the
marginal cost.
    \679\ See Kenneth J. Arrow, Economic Welfare and the Allocation
of Resources for Invention 609-626, in The Rate and Direction of
Inventive Activity: Economic and Social Factors (NBER, 1962),
available at http://www.nber.org/chapters/c2144.pdf.
    \680\ See CPSS, Market Structure Development in the Clearing
Industry: Implications for Financial Stability, at sec. 5 (Nov.
2010), available at http://www.bis.org/publ/cpss92.pdf; see also
Siyi Zhu, Is There a `Race to the Bottom' in Central Counterparties
Competition?--Evidence from LCH.Clearnet SA, EMCF and EuroCCP, DNB
Occasional Studies, Vol. 9, No. 6 (2011); John Kiff et al., Credit
Derivatives: Systemic Risks and Policy Options (IMF Working Paper
No. 254, Nov. 2009), available at http://www.imf.org/external/pubs/ft/wp/2009/wp09254.pdf.
---------------------------------------------------------------------------

    Market power may raise particular issues with respect to the
allocation of benefits and costs flowing from these amendments to Rule
17Ad-22 and precipitate changes in the structure of the financial
networks that are served by covered clearing agencies. For example, as
a result of limited competition,\681\ existing covered clearing
agencies may easily pass the incremental costs associated with enhanced
standards on to their members, who may share these costs with their
customers, potentially resulting in increased transaction costs in
cleared securities.
---------------------------------------------------------------------------

    \681\ See generally Nadia Linciano, Giovanni Siciliano &
Gianfranco Trovatore, The Clearing and Settlement Industry:
Structure Competition and Regulatory Issues (Italian Secs. & Exch.
Comm'n Research Paper 58, May 2005), available at http://www.ssrn.com/abstract=777508 (concluding in part that the core
services offered by the clearance and settlement industry tend
toward natural monopolies because the industry can be characterized
as a network industry, where consumers buy systems rather than
single goods, consumption externalities exist, costs lock-in
consumers once they choose a system, and production improves with
economies of scale); Heiko Schmiedel, Markku Malkam[auml]ki & Juha
Tarkka, Economies of Scale and Technological Development in
Securities Depository and Settlement Systems, at 10 (Bank of Fin.
Discussion Paper 26, Oct. 2002), available at http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0226.pdf (``The overall results of this study reveal the
existence of substantial economies of scale among depository and
settlement institutions. On average, the centralized U.S. system is
found to be the most cost effective settlement system and may act as
the cost saving benchmark.'').
---------------------------------------------------------------------------

    If incremental increases in costs lead clearing agencies to charge
higher prices for their services, then certain clearing members may
choose to terminate membership and cease to clear transactions for
their customers. Should this situation occur, the result may be further
concentration among clearing members, where each remaining member
clears a higher volume of transactions. In this case, clearing agencies
and the financial markets they serve would be more exposed to these
larger clearing members. Moreover, customers would have fewer resources
or options for obtaining such services, clearing agencies would have
fewer non-defaulting members to take on defaulting members portfolios,
and clearing agencies that rely on clearing members to participate in
default auctions would hold auctions with fewer participants. The
remaining clearing members may, however, each internalize more of the
costs their activity in cleared markets imposes on the financial
system.
    The increased importance of a small set of clearing members, in
turn, may result in firms not previously systemically important
increasing in systemic importance. This is particularly true for
clearing members that participate in multiple markets, both cleared and
not cleared.\682\ However, adequate regulation of capital levels and
margin amounts at surviving clearing members could mean that, though
shocks to these members may be larger, the propagation of shocks may be
limited to a smaller set of entities and their equity holders.
---------------------------------------------------------------------------

    \682\ See, e.g., Mark J. Roe, Clearinghouse Overconfidence, 101
Cal. L. Rev. 1641 (2013), available at http://scholarship.law.berkeley.edu/californialawreview/vol101/iss6/3
(arguing that counterparty risk concentrated within CCPs may be
transferred to the broader financial system through links between
clearing members and their clients).
---------------------------------------------------------------------------

e. QCCP Status and Externalities on Clearing Members
    An effect of the amendments to Rule 17Ad-22 is that covered
clearing agencies required to comply with the adopted rules may be more
likely to qualify as QCCPs in non-U.S. jurisdictions that have adopted
the BCBS capital framework's QCCP definition. Under the BCBS capital
framework, a QCCP is defined as an entity operating as a CCP that is
prudentially supervised in a jurisdiction where the relevant regulator
has established, and publicly indicated that it applies to the CCP on
an ongoing basis, domestic rules and regulations that are consistent
with the PFMI.\683\ Because the amendments to Rule 17Ad-22 are
consistent with the PFMI, the Commission believes that foreign bank
clearing members of certain covered clearing agencies and foreign banks

clearing indirectly through clearing members of covered clearing
agencies may benefit from covered clearing agencies obtaining QCCP
status. In particular, bank clearing members and bank indirect
participants of covered clearing agencies that could attain QCCP status
would face lower capital requirements with respect to cleared
derivatives and repurchase agreement transactions because, under the
BCBS capital framework, capital requirements for bank exposures to
QCCPs are lower than capital requirements for bank exposures to non-
qualifying CCPs for these products. Although the FRB and the Office of
the Comptroller of the Currency have already adopted rules implementing
the BCBS capital framework that would identify all covered clearing
agencies (with the exception of ICEEU) as QCCPs for the purposes of
applying risk weights to assets at U.S. banks,\684\ the adopted
amendments to Rule 17Ad-22 may result in non-U.S. bank clearing members
experiencing lower capital requirements related to exposures against
covered clearing agencies relative to a baseline scenario in which
foreign banking regulators do not determine that a covered clearing
agency is a QCCP.\685\
---------------------------------------------------------------------------

    \683\ See supra notes 44-45 and accompanying text (discussing
the BCBS capital framework).
    \684\ See infra Part III.B.1.e.
    \685\ The Commission notes that benefits to banks that may arise
as a result of the rules may be contingent upon regulators in other
jurisdictions taking action to recognize the QCCP status of covered
clearing agencies.
---------------------------------------------------------------------------

    The BCBS capital framework affects capital requirements for bank
exposures to central counterparties in two important ways. The first
relates to trade exposures, defined under the BCBS capital framework as
the current and potential future exposure of a clearing member or
indirect participant in a CCP arising from OTC derivatives, exchange-
traded derivatives transactions, and securities financing transactions.
If these exposures are held against a QCCP, they will be assigned a
risk weight of 2%. In contrast, exposures against non-qualifying CCPs
do not receive lower capital requirements relative to bilateral
exposures and are assigned risk weights between 20% and 100%, depending
on counterparty credit risk. Second, the BCBS capital framework imposes
a cap on risk weights applied to default fund contributions, limiting
risk-weighted assets (subject to a 1250% risk weight) to a cap of 20%
of a clearing member's trade exposures against a QCCP. This is in
contrast to treatment of exposures against non-qualifying CCPs, which
are uncapped and subject to a 1250% risk weight. Because QCCP status
generally impacts capital treatment, any benefits of attaining QCCP
status will likely accrue, at least in part, to foreign clearing
members or foreign indirect participants subject to the BCBS capital
framework.\686\ As a result of lower risk weights applied to exposures
and a cap on capital requirements against default fund obligations,
clearing members of QCCPs subject to BCBS capital framework may
experience an improved capital position relative to bank members of
non-QCCPs. This may lower funding costs for bank members of QCCPs.\687\
---------------------------------------------------------------------------

    \686\ For a discussion of the effects of QCCP status on
competition between bank and non-bank clearing members, see Part
III.B.2.a.
    \687\ See supra note 597 (noting that the Commission currently
expects the lower capital treatment under the BCBS capital framework
to affect registered clearing agencies FICC, ICEEU, and OCC, each of
which would meet the definition of a ``covered clearing agency'').
---------------------------------------------------------------------------

    Non-U.S. banks that are constrained by BCBS tier one capital
requirements would face a shock to risk-weighted assets once capital
rules come into force.\688\ The size of the shock depends on
regulators' determinations with regard to QCCP status. Regardless of
the size of the shock and to come into compliance with capital rules,
however, affected banks will have to raise capital or reduce leverage.
In the absence of perfect markets, these banks may incur ongoing costs
as a result.
---------------------------------------------------------------------------

    \688\ As discussed above, the FRB and Office of Comptroller of
the Currency have adopted rules implementing capital requirements
under the BCBS capital framework that make capital treatment for
exposures to CCPs independent of the adopted rules for U.S. banks
regulated by these two agencies, and therefore the Commission
believes no benefits would accrue to U.S. bank clearing members of
FICC and OCC.
---------------------------------------------------------------------------

    In quantifying the benefits of achieving QCCP status, the
Commission based its estimate on publicly available information with
regard to OCC.\689\ To estimate the upper bound for the potential
benefits accruing to bank clearing members at OCC as a result of QCCP
status, the Commission identified a sample of 28 bank clearing members
at OCC and, for each bank, collected information about total assets,
risk weighted assets, net income and tier one capital ratio at the
holding company level for 2015.\690\ The Commission then allocated
trade exposures and default fund exposures across the sample of bank
clearing members based on the level of risk-weighted assets.\691\ The
Commission measured the impact on risk-weighted assets for non-U.S.
bank clearing members under two different capital treatment regimes.
The first regime is in the absence of QCCP status, assuming a 100% risk
weight applied to trade exposures and 1250% risk weight applied to
default fund exposures for non-U.S. members. In the second regime, OCC
obtains QCCP status, and banks are allowed to apply a 2% risk weight
applied to trade exposures and a 1250% risk weight to default fund
exposures up to a total exposure cap of 20% of trade exposures.\692\ If
OCC is determined to be a QCCP, then the increase in risk weighted
assets will be smaller in magnitude, implying a smaller adjustment at
lower cost. The Commission estimates that benefits associated with OCC
obtaining QCCP status stemming from lower capital requirements against
trade exposures to QCCPs as a result of the adopted rules to have an
upper bound of $1.2 billion per year, or approximately 0.73% of the
total 2015 net income reported by the sample of bank clearing members
at OCC.
---------------------------------------------------------------------------

    \689\ Under the BCBS capital framework, ICCEU and FICC's
repurchase agreement segment would also be eligible for QCCP status.
However, FICC does not report counterparties to repo agreements, and
ICEEU does not separately report exposures related to security-based
swap clearing, so we are currently unable to quantify potential
benefits related to QCCP status for these entities.
    \690\ The Commission used the set of entities it identified as
banks on OCC's member list, available at http://www.optionsclearing.com/membership/member-information/. For U.S.
bank holding companies, 2015 total assets, risk weighted assets, net
income, and tier 1 capital ratios were collected from Y-9C reports
available at the National Information Center, https://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For non-U.S. bank holding companies,
Commission staff obtained corresponding data from financial
statements and supplementary financial materials posted to bank Web
sites. Where necessary, values were converted back to U.S. dollars
at December 31, 2015 exchange rates obtained from the Federal
Reserve, available at http://www.federalreserve.gov/releases/h10/hist/.
    \691\ For example, one bank in the sample, with 5.53% of total
risk-weighted assets, was assigned 5.53% of the total trade and
default fund exposures while another bank in the sample, with 4.21%
of total risk weighted assets, was assigned 4.21% of these
exposures. Because trade exposures of OCC members against OCC are
nonpublic, the Commission used the balance of OCC margin deposits
and deposits in lieu of margin held at OCC, $73.54 billion, as a
proxy for trade exposures. OCC's 2015 clearing fund deposits were
valued at $12.08 billion. See OCC, 2015 Annual Report, available at
http://www.optionsclearing.com/components/docs/about/annual-reports/occ-2015-annual-report.pdf.
    \692\ The BCBS capital framework allows banks to compute default
fund exposures in two ways. Method 1 involves computing capital
requirements for each member proportional to its share of an
aggregate capital requirement for all clearing members in a scenario
where to average clearing members default. The Commission currently
lacks data necessary to compute default fund exposures under this
approach, instead we use Method 2, which caps overall exposure to a
QCCP at 20% of trade exposures. See BCBS capital framework, supra
note 44, Annex 4, paras. 121-25 (outlining two methods for computing
default fund exposures).
---------------------------------------------------------------------------

    The Commission's analysis is limited in several respects and relies
on several

assumptions. First, a limitation of our proxy for trade exposures and
our use of OCC's clearing fund is that the account balances include
deposits by bank clearing members, who would experience lower capital
requirements under the BCBS capital framework, and non-bank clearing
members who would not. The Commission assumes, for the purposes of
establishing an upper bound for the benefits to market participants
that are associated with QCCP status for OCC under the adopted rules,
that the balance of both OCC's margin account and OCC's default fund
are attributable only to bank clearing members. Additionally, we assume
an extreme case where, in the absence of QCCP status, trade exposures
against a CCP would be assigned a 100% risk weight, causing the largest
possible shock to risk-weighted assets for affected banks.
    Lower capital requirements on trade exposures to OCC would produce
effects in the real economy only under certain conditions. First,
agency problems, taxes, or other capital market imperfections could
result in banks targeting a particular capital structure. Second,
capital constraints on bank clearing members subject to the BCBS
capital framework must bind so that higher capital requirements on bank
clearing members subject to the BCBS capital framework in the absence
of QCCP status would cause these banks to exceed capital constraints if
they chose to redistribute capital to shareholders or invest capital in
projects with returns that exceed their cost of capital. Using publicly
available data, however, it is not currently possible to determine
whether capital constraints will bind for bank clearing members when
rules applying the BCBS capital framework come into force, so to
estimate an upper bound for the effects of QCCP status on bank clearing
members we assume that tier one capital constraints for all bank
clearing members of OCC would bind in an environment with zero weight
placed on bank exposures to CCPs.\693\
---------------------------------------------------------------------------

    \693\ The Commission notes that, at present, no bank in its
sample of bank clearing members of OCC is bound by capital
requirements under the BCBS capital framework. For U.S. bank holding
companies, tier 1 capital ratios were collected from Y-9C reports
available at the National Information Center, https://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For non-U.S. bank holding companies,
Commission staff obtained corresponding data from financial
statements and supplementary financial materials posted to bank Web
sites. The Commission used data from 2013-2016 for its sample of
U.S. bank clearing members, and from 2012-2015 for its sample of
non-U.S. bank clearing members and assumed no bank-specific
countercyclical capital buffers for these banks. This suggests a
minimum tier 1 capital ratio of 10.1%, exceeding the BCBS minimum by
1.6%.
---------------------------------------------------------------------------

    For the purposes of quantifying potential benefits from QCCP
status, the Commission has also assumed that banks choose to adjust to
new capital requirements by deleveraging. In particular, the Commission
assumed that banks would respond by reducing risk-weighted assets
equally across all risk classes until they reach the minimum tier one
capital ratio under the Basel framework of 8.5%. We measure the ongoing
costs to each non-U.S. bank by multiplying the implied change in total
assets by each bank's return on assets, estimated using up to 14 years
of annual financial statement data.\694\
---------------------------------------------------------------------------

    \694\ This data has been taken from Compustat and from publicly
available financial statements. Due to data limitations, for certain
banks a shorter window was used for this calculation. The minimum
sample window was six years.
---------------------------------------------------------------------------

    The BCBS capital requirements for exposures to CCPs yield
additional benefits for QCCPs that the Commission is currently unable
to quantify due to lack of data concerning client clearing arrangements
by banks. For client exposures to clearing members, the BCBS capital
framework allows participants to reflect the shorter close-out period
of cleared transactions in their capitalized exposures. The BCBS
framework's treatment of exposures to CCPs also applies to client
exposures to CCPs through clearing members. This may increase the
likelihood that bank clients of bank clearing members that are subject
to the BCBS capital framework share some of the benefits of QCCP
status.
    Furthermore, the fact that the BCBS capital framework applies to
bank clearing members may have important implications for competition
and concentration. While Rule 17Ad-22(e) may extend lower capital
requirements against exposures to CCPs to non-U.S. bank clearing
members of covered clearing agencies,\695\ the benefits of QCCP status
will still be limited to bank clearing members. However, the costs
associated with compliance with Rule 17Ad-22(e) may be borne by all
clearing members, regardless of whether or not they are supervised as
banks. A potential consequence of this allocation of costs and benefits
may be ``crowding out'' of members of QCCPs that are not banks and will
not experience benefits with respect to the BCBS capital framework.
This may result in an unintended consequence of increased concentration
of clearing activity among bank clearing members. As noted in Part
III.B.1.d, this increased concentration could mean that each remaining
clearing member becomes more important from the standpoint of systemic
risk transmission.
---------------------------------------------------------------------------

    \695\ See supra note 45 and accompanying text (noting that banks
supervised by the FRB and Office of the Comptroller of the Currency
would treat covered clearing agencies as QCCPs for the purposes of
calculating regulatory capital ratios).
---------------------------------------------------------------------------

    In addition to benefits for bank clearing members, certain benefits
resulting from QCCP status may also accrue to covered clearing
agencies. If banks value lower capital requirements attributable to
QCCP status, bank clearing members may prefer membership at QCCPs to
membership at CCPs that are not QCCPs. A flight of clearing members
from covered clearing agencies in the absence of QCCP status would
result in default-related losses being mutualized across a narrower
member base. Additionally, if the flight from covered clearing agencies
results in lower transactional volume at these clearing agencies, then
economies of scale may be lost, resulting in higher clearing fees and
higher transaction costs in cleared products.
2. Effect on Competition, Efficiency, and Capital Formation
    The amendments to Rule 17Ad-22 and Rule 17Ab2-2 have the potential
to affect competition, efficiency, and capital formation. As with the
rest of the benefits and costs associated with the amendments to Rule
17Ad-22, the Commission believes that several of the effects described
below only occur to the extent that covered clearing agencies do not
already have operations and governance mechanisms that conform to the
requirements in Rule 17Ad-22(e). Additionally, the Commission believes
that consistency with international regulatory frameworks, as embodied
by the PFMI, which may promote the integrity of cleared markets, could
have substantial effects on competition, efficiency, and capital
formation.
a. Competition
    Two important characteristics of the market for clearance and
settlement services are high fixed costs and economies of scale. Large
investments in risk management and information technology
infrastructure costs, such as financial data database and network
maintenance expenses, are components of high fixed costs for clearing
agencies. Consequently, the clearance and settlement industry exhibits
economies of scale in that the average total cost per transaction,
which includes fixed costs, diminishes with the increase in transaction
volume as high fixed costs are spread over a larger number of
transactions.
    Furthermore, high fixed costs translate into barriers to entry that

preclude competition. Lower competition is an important source of
market power for clearing agencies. As a result, clearing agencies
possess the ability to exert market power and influence the fees
charged for clearance and settlement services in the markets they
serve.\696\ Any costs resulting from the adopted amendments may have
the effect of raising already high barriers to entry. As the potential
entry of new clearing agencies becomes more remote, existing clearing
agencies may be able to reduce service quality, restrict the supply of
services, or increase fees above marginal cost in an effort to earn
economic rents from participants in cleared markets.\697\
---------------------------------------------------------------------------

    \696\ See, e.g., CCA Standards proposing release, supra note 5,
at 29593.
    \697\ See id.
---------------------------------------------------------------------------

    Even if they could not take advantage of a marginal increase in
market power, clearing agencies may use their market power to pass any
increases in costs that flow from the adopted amendments to their
members. This may be especially true in the cases of member-owned
clearing agencies, such as DTC, FICC, NSCC, and OCC, where members lack
the opportunity to pass costs through to outside equity holders.
Allowing clearing members to serve on the board of directors of a
covered clearing agency may align a covered clearing agency's
incentives with its membership. Certain complications may also arise,
however, when clearing members sit on boards of covered clearing
agencies as members of the board and may choose to allocate the costs
of enhanced risk management inefficiently across potential competitors,
in an effort to reduce their own share of these costs.
    Members who are forced to internalize the costs of additional
requirements under Rule 17Ad-22(e) may seek to terminate their
membership. Additionally, prospective clearing members may find it
difficult to join clearing agencies, given the additional costs they
must internalize.\698\ Remaining clearing members may gain market power
as a result, enabling them to extract economic rents from their
customers. Rent extraction could take the form of higher transaction
costs in cleared markets, thereby reducing efficiency, as discussed
below.
---------------------------------------------------------------------------

    \698\ See supra Part III.B.1.d (discussing concentration both in
the market for clearing services and among clearing members).
---------------------------------------------------------------------------

    The Commission also acknowledges that Rule 17Ad-22(e)(19) may
affect competition among firms that choose to become clearing members,
and those who provide clearing services indirectly, through a clearing
member. Monitoring and managing the risks associated with indirect
participation in clearing may be costly. If monitoring and managing the
risks associated with indirect participation in clearing proves costly
for clearing agencies and if clearing agencies are able to pass the
additional costs related to monitoring and managing risks to clearing
members, it may cause marginal clearing members unable to absorb these
additional costs to exit. While these exits may be socially efficient,
since they reflect the internalization of costs otherwise imposed upon
other participants in cleared markets through increased probability of
clearing agency default, they may nevertheless result in lower
competition among clearing members for market share, potentially
providing additional market power to the clearing members that remain.
Exits by clearing members could also reduce the resources available for
customers to obtain replacement clearing services.
    The Commission believes, however, that management of risks from
indirect participation is important in mitigating the risks that
clearing agencies pose to financial stability. The tiered participation
risk exposures, including credit, liquidity, and operational risks
inherent in indirect participation arrangements, may present risks to
clearing agencies, their members, and to the broader financial markets.
For instance, if the size of an indirect participant's positions is
large relative to a clearing member's capacity to absorb risks, this
may increase the clearing member's default risk. Consequently, a
clearing agency with indirect participation arrangements may be exposed
to the credit risk of an indirect participant through its clearing
members. Similarly, a margin call on, or a default by, an indirect
participant could constrain liquidity of its associated clearing
members, making it more difficult for these members to manage their
positions at the clearing agency.
    The consistency across regulatory frameworks contemplated by the
adopted rules may also affect competition. Financial markets in cleared
products are global, encompassing many countries and regulatory
jurisdictions. Consistency with international regulatory frameworks may
facilitate entry of clearing agencies into new markets. By contrast,
conflicting or duplicative regulation across jurisdictions, or even
within jurisdictions, may cause competitive friction that inhibits
entry and helps clearing agencies behave like local monopolists.
Consistency in regulation can facilitate competition among clearing
agencies so long as regulation is not so costly as to discourage
participation in any market. Additionally, the Commission believes that
Rule 17Ad-22(e)(23) may facilitate competition among clearing agencies
across jurisdictions by requiring public disclosures that enable market
participants to compare clearing agencies more easily.
    The consistency across regulatory requirements contemplated by the
adopted rules may affect competition among banks in particular.
Clearing derivative and repurchase agreement transactions through QCCPs
will result in lower capital requirements for banks under the BCBS
capital framework. Therefore, consistency with the PFMI may allow banks
that clear these products through covered clearing agencies to compete
on equal terms with banks that clear through other clearing agencies
accorded QCCP status. This effect potentially countervails higher
barriers to entry that enhanced risk management standards may impose on
clearing members by lowering the marginal cost of clearing these
transactions. Furthermore, covered clearing agencies potentially
compete with one another for volume from clearing members. Since
clearing members receive better treatment for exposures against QCCPs,
clearing members will find it less costly to deal with QCCPs. Failure
to establish requirements consistent with the PFMI may place U.S.
covered clearing agencies at a competitive disadvantage globally.
    The ability of covered clearing agencies to obtain QCCP status may
also affect competition among clearing agencies. Under the BCBS capital
framework, QCCP status would have practical relevance only for covered
clearing agencies providing CCP services for derivatives, security-
based swaps, and securities financing transactions. To the extent that
the adopted rules increase the likelihood that banking regulators that
have implemented the BCBS capital framework in their jurisdiction
recognize covered clearing agencies as QCCPs, banks that clear at
covered clearing agencies will experience lower capital requirements.
Since clearing agencies may compete for volume from clearing members
that are also banks, the adopted rules may remove a competitive
friction between covered clearing agencies and other clearing agencies
that enjoy recognition as QCCPs by banking regulators. As a corollary,
the adopted rules could potentially disadvantage any registered
clearing agencies that are not covered

clearing agencies.\699\ The Commission also notes that the ability of
registered clearing agencies to voluntarily apply for covered clearing
agency status under Rule 17Ab2-2(a) may potentially allow entrants to
achieve QCCP status if the Commission determines they should receive
covered clearing agency status and they otherwise meet the requirements
of the BCBS capital framework.
---------------------------------------------------------------------------

    \699\ See supra note 597 (noting that the Commission currently
expects the lower capital treatment under the BCBS capital framework
to affect registered clearing agencies FICC, ICEEU, and OCC, each of
which would meet the definition of a ``covered clearing agency'' in
Rule 17Ad-22(a)(5)).
---------------------------------------------------------------------------

    Further competitive effects may flow from the adoption as a result
of the determinations under Rule 17Ab2-2 for clearing agencies engaged
in activities with a more complex risk profile and clearing agencies
that are systemically important in multiple jurisdictions. These
entities will be responsible for maintaining additional financial
resources sufficient to cover the default of the two participant
families that would potentially cause the largest aggregate credit
exposures in extreme but plausible market conditions as well as
undertake an annual feasibility analysis for extending liquidity risk
management from ``cover one'' to ``cover two.'' These clearing agencies
will have to collect these resources from participants, either through
higher margin requirements or guaranty fund contributions, or
indirectly through third-party borrowing arrangements secured by member
resources. Regardless of how clearing agencies obtain these additional
resources, the requirement to do so potentially raises the costs to use
services provided by covered clearing agencies. Moreover, these
additional costs could raise barriers to entry in the market or to opt
out of clearing altogether.
b. Efficiency
    The amendments to Rule 17Ad-22 may affect efficiency in a number of
ways, though as discussed previously, most of these effects will only
flow to the extent that covered clearing agencies do not already comply
with the amendments. First, because the amendments result in general
consistency with the PFMI and requirements adopted by the CFTC and FRB,
consistency likely fosters efficiency by reducing the risk that covered
clearing agencies will be faced with conflicting or duplicative
regulation when clearing financial products across multiple regulatory
jurisdictions.
    Consistency across regulatory regimes in multiple markets may also
result in efficiency improvements. Fully integrated markets would allow
clearing agencies to more easily exploit economies of scale because
clearing agencies tend to have low marginal costs and, thus, could
provide clearance and settlement services over a larger volume of
transactions at a lower average cost. Differences in regulation, on the
other hand, may result in market fragmentation, allowing clearing
agencies to operate as local monopolists. The resulting potential for
segmentation of clearing and settlement businesses along jurisdictional
lines may lead to overinvestment in the provision of clearing services
and reductions in efficiency as clearing agencies open and operate
solely within jurisdictional boundaries. If market segmentation
precludes covered clearing agencies from clearing transactions for
customers located in another jurisdiction with a market too small to
support a local clearing agency, fragmentation may result in under-
provisioning of clearing and settlement services in these areas, in
turn reducing the efficiency with which market participants share risk.
    The amendments may also affect efficiency directly if they mitigate
covered clearing agencies' incentives to underinvest in risk management
and recovery and wind-down procedures. CCP default and liquidation is
likely a costly event, so to the extent that the rules mitigate the
risk of CCP default and prescribe rules for orderly recovery and wind-
down, they will produce efficiency benefits. Another direct effect on
efficiency may come if registered clearing agencies attempt to
restructure their operations in ways that would allow them to fall
outside of the scope of Rule 17Ad-22(e).
    Finally, price efficiency and the efficiency of risk sharing among
market participants may be affected by the amendments. On one hand, the
cost of a transaction includes costs related to counterparty default
that are typically unrelated to fundamental asset payoffs. Academic
research using credit default swap transaction data has revealed a
statistically significant, though economically small, relationship
between the credit risk of a counterparty and the spreads implicit in
transaction prices.\700\ Enhanced risk management by clearing agencies
may reduce this component of transaction costs. By reducing deviations
of prices from fundamental value, the amendments may increase price
efficiency. If lower transaction costs or reduced ambiguity facilitates
participation in cleared markets by investors who would benefit from
opportunities for risk-sharing in these markets,\701\ then this
transmission channel may result in more efficient allocation of risk.
On the other hand, the amendments may have adverse implications for
price efficiency in cleared markets if they drive up transaction costs
as higher costs of risk management enter asset prices. An increase in
transaction costs could cause certain market participants to avoid
trading altogether, reducing liquidity in cleared products and
opportunities for risk sharing among investors in these markets.
---------------------------------------------------------------------------

    \700\ See e.g., Navneet Arora, Priyank Gandhi & Francis
Longstaff, Counterparty Credit Risk and the Credit Default Swap
Market, 103 J. Fin. Econ. 280 (2012). Using transaction prices and
quotes by 14 different CDS dealers, the authors identified how
dealers' credit risk affects transaction prices. They observed a
relationship between spreads and credit risk implying that a 645-
basis-point increase in a dealer's credit spread would produce a
one-basis-point increase in transaction prices. They explain the
magnitude of this relationship by noting that their sample included
transactions that were mostly collateralized, which would diminish
the sensitivity of transaction prices to counterparty credit risk.
    \701\ If investors who might benefit from risk-sharing in
cleared markets are ambiguity-averse, then regulation that addresses
payoffs in times of financial strain may induce their participation.
See supra note 669 and accompanying text.
---------------------------------------------------------------------------

c. Capital Formation
    The implications for capital formation that flow from the
amendments to Rule 17Ad-22 and Rule 17Ab2-2 stem mainly from
incremental costs that result from compliance with more specific
standards and benefits in the form of more efficient risk sharing.
    In cases where current practice falls short of the amendments,
covered clearing agencies may have to invest in infrastructure or make
other expenditures to come into compliance, which may divert capital
from other uses. In line with our previous discussion of cost
allocation in the market for clearing services, these resources may
come from clearing members and their customers.\702\
---------------------------------------------------------------------------

    \702\ See supra Part III.B.1 (discussing the economic effects of
the rules on the market for clearing services).
---------------------------------------------------------------------------

    At the same time, the Commission believes that the standards
contemplated under the rules may foster capital formation. As mentioned
earlier, clearing agencies that are less prone to failure may help
reduce transaction costs in the markets they clear.\703\ Conceptually,
the component of transaction costs that reflects counterparty credit
risk insures one counterparty against the default of

another.\704\ Reductions in counterparty default risk allow the
corresponding portion of transaction costs to be allocated to more
productive uses by market participants who otherwise would bear these
costs.
---------------------------------------------------------------------------

    \703\ See supra Part III.B.1.a (discussing the economic effects
of the rules on systemic risk).
    \704\ See supra note 700.
---------------------------------------------------------------------------

    If, on balance, the adopted amendments cause transaction costs to
decrease in cleared markets, then the expected value of trade may
increase. Counterparties that are better able to diversify risk through
participation in cleared markets may be more willing to invest in the
real economy rather than choosing to engage in precautionary savings.
3. Effect of Amendments to Rule 17Ad-22 and Rule 17Ab2-2
    The discussion below outlines the costs and benefits considered by
the Commission as they relate to the rules being adopted today. These
specific costs and benefits are in addition to the more general costs
and benefits anticipated under the Commission's proposal discussed in
Part III.B.1 and include, in particular, the costs and benefits
stemming from the availability of QCCP status under the BCBS capital
framework. Many of the costs and benefits discussed below are difficult
to quantify. This is particularly true where clearing agency practices
are anticipated to evolve and adapt to changes in technology and other
market developments. The difficulty in quantifying costs and benefits
of the adopted rules is further exacerbated by the fact that in some
cases the Commission lacks information regarding the specific practices
of clearing agencies that could assist in quantifying certain costs.
For example, as noted in Part I.A.1.a.i(4), without detailed
information about the composition of illiquid assets held by clearing
agencies and their members, the Commission cannot provide reasonable
estimates of costs associated with satisfying substantive requirements
under Rules 17Ad-22(e)(7)(i) and (ii). Another example, discussed in
Part I.A.1.a.i(5), is testing and validation of financial risk models,
where the Commission is only able to estimate that costs will fall
within a range. In this case, the costs associated with substantive
requirements under the rules may depend on the types of risk models
employed by clearing agencies, which are, in turn, dictated by the
markets they serve. As a result, much of the discussion is qualitative
in nature, though where possible, the costs and benefits have been
quantified.
a. Rule 17Ad-22(e)
    The Commission recognizes that the scope of Rule 17Ad-22(e) is an
important determinant of its economic effect. Having considered the
anticipated costs and benefits associated with Rule 17Ad-22(e), the
Commission believes Rule 17Ad-22(e) should apply to a ``covered
clearing agency,'' as defined in Rule 17Ad-22(a)(5).\705\ In
particular, as discussed below, the Commission believes that an
important benefit resulting from the enhanced risk management
requirements in the rules is a reduction in the risk of a failure of a
covered clearing agency. For example, these benefits may be significant
due to the clearing agencies' size, exposure to, and interconnectedness
with market participants, and the effect their failure may have on
markets, market participants, and the broader financial system. For
complex risk profile clearing agencies, significant benefits may flow
as a result of their higher baseline default risk.
---------------------------------------------------------------------------

    \705\ See Part II.A.1.
---------------------------------------------------------------------------

    As an alternative, the Commission could have extended the scope of
Rule 17Ad-22(e) to cover all registered clearing agencies. The
Commission acknowledges, however, that clearing agencies are involved
in differing products and markets that carry varying levels of risk.
Further, the costs of compliance with the rules may represent barriers
to entry for clearing agencies. By continuing to apply Rule 17Ad-22(d)
to registered clearing agencies that are not covered clearing agencies,
the Commission believes that the scope of Rule 17Ad-22(e) appropriately
preserves the potential for the continuing development of the national
system for clearance and settlement and maintains innovation in the
operation of registered clearing agencies.\706\
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    \706\ The Commission notes that under Rule 17Ab2-2(a), a
registered clearing agency that is not involved in activities with a
more complex risk profile and is not a designated clearing agency
may apply for covered clearing agency status, which would subject
them to the requirements of Rule 17Ad-22(e). The Commission believes
that this may occur if the registered clearing agency believes such
status may credibly signal the quality of the services it provides
or if it is seeking to obtain QCCP status under the BCBS capital
framework.
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i. Rule 17Ad-22(e)(1): Legal Risk
    Because, as noted above, Rule 17Ad-22(e)(1) would require
substantially the same set of policies and procedures as Rule 17Ad-
22(d)(1),\707\ the Commission believes that Rule 17Ad-22(e)(1) would
likely impose limited material additional costs on covered clearing
agencies and produce limited benefits, in line with the general
economic considerations discussed in Part III.B.1.
---------------------------------------------------------------------------

    \707\ See supra note 179; supra Part II.C.1 (discussing the full
set of requirements under Rule 17Ad-22(e)(1)); supra Part III.A.2.a
(discussing current practices among registered clearing agencies
regarding legal risk); see also 17 CFR 240.17Ad-22(d)(1).
---------------------------------------------------------------------------

ii. Rule 17Ad-22(e)(2): Governance
    Each covered clearing agency has a board of directors that governs
its operations and oversees its senior management. Rule 17Ad-22(e)(2)
would establish more detailed requirements for governance arrangements
at covered clearing agencies relative to those imposed on registered
clearing agencies under Rule 17Ad-22(d)(8).\708\
---------------------------------------------------------------------------

    \708\ See supra Part II.C.2 (discussing the full set of
requirements under Rule 17Ad-22(e)(2)).
---------------------------------------------------------------------------

    The Commission understands that any covered clearing agency subject
to the rule has policies and procedures in place that clearly
prioritize the risk management and efficiency of the clearing agency.
However, the Commission believes that covered clearing agencies do not
already have in place policies and procedures with respect to other
requirements under Rule 17Ad-22(e)(2). Based on its supervisory
experience, the Commission believes that some covered clearing agencies
may need to update their policies and procedures to comply with Rule
17Ad-22(e)(2)(iv). These updates will entail certain basic compliance
costs, and covered clearing agencies may also incur assessment costs
related to analyzing current governance arrangements to determine the
extent to determine which they do not meet the requirements of the
amendments. The estimated costs in terms of paperwork are discussed in
Part IV. If, as a result of new policies and procedures, a covered
clearing agency is required to recruit new directors, the Commission
estimates a cost per director of $73,912.\709\
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    \709\ The Commission estimated a cost per director of $68,000 in
proposing Regulation MC. See Exchange Act Release No. 34-63107 (Oct.
14, 2010), 75 FR 65881, 65921 & n.215 (Oct. 26, 2010). The $73,912
estimate reflects this amount in 2015 dollars, using consumer price
inflation data provided by the Bureau of Labor Statistics.
---------------------------------------------------------------------------

    While there are potential costs associated with compliance, the
Commission believes that benefits would potentially accrue from these
requirements. Specifically, the Commission believes that enhanced
governance arrangements would further promote safety and efficiency at
the clearing agency--motives that may not be part of a clearing
agency's governance arrangements in the absence of regulation. Policies
and procedures required under Rule 17Ad-22(e)(2)

would also reinforce governance arrangements at covered clearing
agencies by requiring board members and senior management to have
appropriate experience and skills to discharge their duties and
responsibilities.
    Compliance with these requirements could reduce the risk that
insufficient internal controls within a covered clearing agency
endanger broader financial stability. While the benefits of compliance
are difficult to quantify, the Commission believes that they flow
predominantly from a reduced probability of covered clearing agency
default.
iii. Rule 17Ad-22(e)(3): Comprehensive Framework for the Management of
Risks
    The Commission believes that Rule 17Ad-22(e)(3) would aid covered
clearing agencies in implementing a systematic process to examine risks
and assess the probability and impact of those risks.\710\ Rule 17Ad-
22(e)(3)(i) specifies that a risk management framework include policies
and procedures reasonably designed to identify, measure, monitor, and
manage the range of risks that arise in or are borne by the covered
clearing agency. Critically, these policies and procedures would be
subject to review on a specified basis and approval by the board of
directors annually. A sound framework for comprehensive risk management
under regular review would have the benefits of providing covered
clearing agencies with a better awareness of the totality of risks they
face in the dynamic markets they serve. In addition, the requirement to
have policies and procedures that provide for an independent audit
committee of the board and that provide internal audit and risk
management functions with sufficient resources, authority, and
independence from management, as well as access to risk and audit
committees of the board, would reinforce governance arrangements
directly related to risk management at covered clearing agencies. A
holistic approach to risk management could help ensure that policies
and procedures that covered clearing agencies adopt pursuant to the
rules work in tandem with one another. For example, such an approach
could result in risk-based membership standards under Rule 17Ad-
22(e)(18) that are consistent with policies and procedures related to
the allocation of credit losses under Rule 17Ad-22(e)(13)(i). The
Commission believes ensuring that a covered clearing agency's risk
management activities fit within a unified framework could mitigate the
risk of financial losses to covered clearing agencies' members and
participants in the markets they serve.
---------------------------------------------------------------------------

    \710\ See supra Part II.C.3 (discussing the full set of
requirements under Rule 17Ad-22(e)(3)).
---------------------------------------------------------------------------

    Additionally, the rule extends requirements under Rules 17Ad-
22(d)(4) and 17Ad-22(d)(11) by requiring plans for recovery and orderly
wind-down.\711\ To the extent that covered clearing agencies do not
already have such plans in place, they would incur incremental costs to
develop such plans. Recovery and resolution planning can benefit both
clearing members and, more generally, participants in markets where
products are cleared. Many of the costs and benefits of such plans
depend critically on the specific recovery and wind-down tools that
covered clearing agencies choose to include in their rules. The
presence of such plans could reduce uncertainty over the allocation of
financial losses to clearing members in the event that a covered
clearing agency faces losses due to member default or for other reasons
that exceed its prefunded default resources. Further, recovery and
orderly wind-down plans that detail the circumstances under which
clearing services may be suspended or terminated may mitigate the risk
of market disruption in periods of financial stress. Market
participants who face the possibility that the assets they trade may no
longer be cleared and settled by a CCP may be unwilling to trade such
assets at times when risk sharing is most valuable. While the effects
are difficult to quantify, the Commission believes that recovery and
orderly wind-down plans ensure that a covered clearing agency is able
to remain resilient in times of market stress.
---------------------------------------------------------------------------

    \711\ See supra Part II.C.3.b.iii (discussing the requirements
for recovery and orderly wind-down plans under Rule 17Ad-
22(e)(3)(ii)).
---------------------------------------------------------------------------

    Based on its supervisory experience, the Commission believes that
all covered clearing agencies have an independent audit committee of
the board. The Commission further believes that most covered clearing
agencies already have policies or procedures that may be relevant to
issues arising in recovery and/or wind-down of clearing operations. As
a result, the benefits and costs associated with these requirements
will likely be limited to incremental changes associated with covered
clearing agencies' review of such policies and procedures and further
development of plans for recovery and orderly wind-down and to
registered clearing agencies that become covered clearing agencies.
iv. Rules 17Ad-22(e)(4) through (7): Financial Risk Management
(1) Rule 17Ad-22(e)(4): Credit Risk
    Rule 17Ad-22(e)(4) would establish requirements for credit risk
management by covered clearing agencies.\712\ Based on its supervisory
experience, the Commission believes that all entities that would be
covered clearing agencies are already in compliance with Rules 17Ad-
22(e)(4)(i) through (iv). Pursuant to Rule 17Ad-22(b)(3), registered
clearing agencies that provide CCP services currently maintain
additional financial resources to meet the ``cover one'' requirement,
and registered clearing agencies that would be complex risk profile
clearing agencies under the adopted rules currently maintain financial
resources to meet the ``cover two'' requirement.\713\ All covered
clearing agencies exclude resources that are not prefunded when
calculating this coverage.\714\ As a result, the Commission believes
little or no additional direct costs or benefits will result from these
requirements unless registered clearing agencies were to become covered
clearing agencies and include resources that are not prefunded towards
their resource requirements. The requirement to include only prefunded
resources when calculating the financial resources available to meet
the standards under Rules 17Ad-22(e)(4)(ii) and (iii) potentially
reduces the risk that covered clearing agencies request financial
resources from their members in times of financial stress, when members
are least able to provide these resources.
---------------------------------------------------------------------------

    \712\ See supra Part II.C.4 (discussing the full set of
requirements under Rule 17Ad-22(e)(4)).
    \713\ The Commission also notes that no covered clearing agency
would be systemically important in multiple jurisdictions unless and
until the Commission made such a determination pursuant to Rule
17Ab2-2. See supra Part II.D (discussing the determinations process
under Rule 17Ab2-2).
    \714\ See supra Part III.A.2.d.i (discussing current practices
regarding credit risk management at registered clearing agencies).
---------------------------------------------------------------------------

    While requiring ``cover two'' for complex risk profile clearing
agencies and for covered clearing agencies designated systemically
important in multiple jurisdictions would place additional requirements
on the affected clearing agencies, the Commission believes that the
requirement is appropriate because disruption to these entities due to
member default carries relatively higher expected costs than for other
covered clearing agencies. These relatively higher expected costs arise
from the fact that covered clearing agencies designated systemically
important in multiple jurisdictions are exposed to foreign financial
markets and

may serve as a conduit for the transmission of risk; for complex risk
profile clearing agencies, high expected costs may arise from discrete
jump-to-default price changes in the products they clear and higher
correlations in the default risk of members.\715\
---------------------------------------------------------------------------

    \715\ Cf. PFMI, supra note 2, at 43 (discussing Principle 4,
Explanatory Note 3.4.19).
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(4)(vi) and (vii) would also impose additional costs
by requiring additional measures to be taken with respect to the
testing of a covered clearing agency's financial resources and model
validation of a covered clearing agency's credit risk models. These
requirements do not currently exist as part of the standards applied to
registered clearing agencies.\716\ Covered clearing agencies may incur
additional costs under expanded and more frequent testing of total
financial resources if the formal requirement that results of monthly
testing be reported to appropriate decision makers is a practice not
currently used by covered clearing agencies. A range of costs for these
new requirements is discussed in Part I.A.1.a.i(5).
---------------------------------------------------------------------------

    \716\ Rule 17Ad-22(b)(4) requires a registered clearing agency's
policies and procedures be reasonably designed to provide for an
annual validation of its margin models and the related parameters
and assumptions. See 17 CFR 240.17Ad-22(b)(4).
---------------------------------------------------------------------------

    Frequent monitoring and stress testing of total financial
resources, model validations, and reporting of results of the
monitoring and testing to appropriate personnel within the clearing
agency could help rapidly identify any gaps in resources required to
ensure stability, even in scenarios not anticipated on the basis of
historical data. Moreover, the requirement to test and, when necessary,
update the assumptions and parameters supporting models of credit risk
will support the adjustment of covered clearing agency financial
resources to changing financial conditions, and mitigate the risk that
covered clearing agencies will strategically manage updates to their
risk models in support of cost reduction or profit maximization.
    The Commission believes that most covered clearing agencies will be
required to update their policies and procedures as a result of Rules
17Ad-22(e)(4)(viii) and (ix). Clearing members may experience benefits
from 17Ad-22(e)(4)(viii), which requires covered clearing agencies to
provide disclosure to members regarding the allocation of default
losses when these losses exceed the level of financial resource it has
available. As a result of this additional transparency, clearing
members may experience an improved ability to manage their expectations
of potential obligations against the covered clearing agency, which may
increase the likelihood of orderly wind-downs in the event of member
default. Crafting such allocation plans by covered clearing agencies
may entail certain compliance costs, as discussed further in Part
III.B.3.d. Further, covered clearing agencies may allocate default
losses in a number of ways that may themselves have implications for
participation, competition, and systemic risk.\717\ For example, if, as
a part of a default resolution plan, selective tear-up is contemplated
after a failed position auction, then clearing members who expect low
loss exposure in the tear-up may not have adequate incentives to
participate in the position auction, even if they are better able to
absorb losses than clearing members who expect high exposure in the
tear-up plan. This would increase the chances of a failed auction and
the chances of a protracted and more disruptive wind-down. Thus, the
total costs of any loss allocation plan may depend largely on the
particular choices embedded in covered clearing agencies' plans.
---------------------------------------------------------------------------

    \717\ See, e.g., Elliot, supra note 616 (discussing various
loss-allocation rules and CCP recovery and wind-down).
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(4)(ix) contains new provisions related to the
replenishment of financial resources that do not appear in Rule 17Ad-
22(d)(11). The Commission believes that the rules related to
replenishment of financial resources may reduce the potential for
systemic risk and contagion in cleared markets, as they facilitate
covered clearing agencies' prompt access to these resources in times of
financial stress.
(2) Rule 17Ad-22(e)(5): Collateral
    Rule 17Ad-22(e)(5) would require a covered clearing agency to have
policies and procedures reasonably designed to limit the assets it
accepts as collateral to those with low credit, liquidity, and market
risks, and to set and enforce appropriately conservative haircuts and
concentration limits. Collateral haircut and concentration limit models
would be subject to a not-less-than-annual review of their
sufficiency.\718\ Rule 17Ad-22(d)(3) currently requires registered
clearing agencies to have policies and procedures reasonably designed
to hold assets in a manner that minimizes risk of loss or risk of delay
in access to them and invest assets in instruments with minimal credit,
market, and liquidity risk.
---------------------------------------------------------------------------

    \718\ See supra Part II.C.5 (discussing the full set of
requirements under Rule 17Ad-22(e)(5)).
---------------------------------------------------------------------------

    By focusing on the nature of assets and not on accounts, the
Commission believes the adopted rule may allow covered clearing
agencies the ability to manage collateral more efficiently. In
particular, under the adopted rule, a covered clearing agency would
have the option of accepting collateral that is riskier than cash and
holding this collateral at commercial banks, potentially increasing
default risk exposure. On the other hand, the requirement to regularly
review concentration limits and haircuts mitigates the risk that a
covered clearing agency's collateral policies fail to respond to
changing economic conditions. Based on its supervisory experience, the
Commission understands that all registered clearing agencies that would
meet the definition of a covered clearing agency already conform to the
requirements under the adopted rule related to the nature of assets
they may accept as collateral and the haircuts and concentration limits
they apply to collateral assets, so the associated costs and benefits
that would result from these requirements would apply only if
registered clearing agencies not already in compliance were to become
covered clearing agencies.
    As a result of the rule, these covered clearing agencies and
registered clearing agencies that become covered clearing agencies may
experience additional costs as a result of the annual review
requirements for the sufficiency of collateral haircut and
concentration limit models. Based on its supervisory experience, the
Commission believes that many clearing agencies that require collateral
would need to develop policies and procedures to review haircuts and
concentration limits annually. Enforcement of the haircut requirement
would also require additional resources. A range of costs for these new
requirements is discussed in Part I.A.1.a.i(5). Adherence to these
requirements by these entrants could extend the benefits of prompt loss
coverage, incentive alignment, and systemic risk mitigation to a larger
volume of cleared transactions.
(3) Rule 17Ad-22(e)(6): Margin
    Rule 17Ad-22(e)(6) would require a covered clearing agency that
provides CCP services to have policies and procedures reasonably
designed to require it to cover credit exposures using a risk-based
margin system and to establish minimum standards for such a system. It
would require these policies and procedures to cover daily collection
of variation margin. The rule also

requires a set of policies and procedures generally designed to support
a reliable margin system. Among these are policies and procedures to
ensure the use of reliable price data sources and appropriate methods
for measuring credit exposure, which could improve margin system
accuracy. Finally, covered clearing agencies would be required to have
policies and procedures related to the testing and verification of
margin models.\719\ Rules 17Ad-22(a)(6) and (14) support these
requirements by addressing the means of verification for margin models
and the level of coverage required of a margin system against potential
future exposures, respectively. Based on its supervisory experience,
however, the Commission understands that all current covered clearing
agencies have policies and procedures that conform to the requirements
under Rules 17Ad-22(e)(6)(i) through (v) and (vii), and some will have
to update their policies and procedures to comply with Rule 17Ad-
22(e)(6)(vi).
---------------------------------------------------------------------------

    \719\ See supra Part II.C.6 (discussing the full set of
requirements under Rule 17Ad-22(e)(6)).
---------------------------------------------------------------------------

    Similar to Rules 17Ad-22(e)(4) and (7), covered clearing agencies
that do not already engage in backtesting of margin resources at least
once each day or engage in a monthly analysis of assumptions and
parameters, as well as registered clearing agencies that become covered
clearing agencies in the future, may incur incremental compliance costs
as a result of the adopted rule. Since margin plays a key role in
clearing agency risk management, however, requiring that margin be
periodically verified and modified as a result of changing market
conditions may mitigate the risks posed by covered clearing agencies to
financial markets in periods of financial stress. Further, periodic
review of model specification and parameters reduces the likelihood
that covered clearing agencies opportunistically update margin models
in times of low volatility and fail to update margin models in times of
high volatility. A range of costs for verification and modification of
margin models is discussed in Part I.A.1.a.i(5). Further, since risk-
based initial margin requirements may cause market participants to
internalize some of the costs borne by the CCP as a result of large or
risky positions,\720\ ensuring that margin models are well-specified
and correctly calibrated with respect to economic conditions will help
ensure that they continue to align the incentives of clearing members
with the goal of financial stability.
---------------------------------------------------------------------------

    \720\ See, e.g., Philipp Haene & Andy Sturm, Optimal Central
Counterparty Risk Management (Swiss Nat'l Bank Working Paper, June
2009) (addressing the tradeoff between margin and default fund,
considering collateral costs, clearing member default probability,
and the extent to which margin requirements are associated with risk
mitigating incentives).
---------------------------------------------------------------------------

(4) Rule 17Ad-22(e)(7): Liquidity Risk
    Rule 17Ad-22(e)(7) would require a covered clearing agency to have
policies and procedures reasonably designed to effectively monitor,
measure, and manage liquidity risk.\721\ Parties to securities and
derivatives transactions rely on clearing agencies for prompt clearance
and settlement of transactions. Market participants in centrally
cleared and settled markets are often linked to one another through
intermediation chains in which one party may rely on proceeds from
sales of cleared products to meet payment obligations to another party.
If insufficient liquidity causes a clearing agency to fail to meet
settlement or payment obligations to its members, consequences could
include the default of a clearing member who may be depending on these
funds to make a payment to another market participant, with losses then
transmitted to others that carry exposure to this market participant if
the market participant is depending on payments from the clearing
members to make said payments to others. Therefore, the benefits
related to liquidity risk management generally flow from the reduced
risk of systemic risk transmission by covered clearing agencies as a
result of liquidity shortfalls, either in the normal course of
operation or as a result of member default.
---------------------------------------------------------------------------

    \721\ See supra Part II.C.7 (discussing the full set of
requirements under Rule 17Ad-22(e)(7)).
---------------------------------------------------------------------------

    Enhanced liquidity risk management may produce additional benefits.
Clearing members would face less uncertainty over whether a covered
clearing agency has the liquidity resources necessary to make prompt
payments which would reduce any need to hedge the risk of nonpayment.
Potential benefits from enhanced liquidity risk management may also
extend beyond members of covered clearing agencies or markets for
centrally cleared and settled securities. Clearing members are often
members of larger financial networks, and the ability of a covered
clearing agency to meet payment obligations to its members can directly
affect its members' ability to meet payment obligations outside of the
cleared market. Thus, management of liquidity risk may mitigate the
risk of contagion between asset markets.
    Based on its supervisory experience, the Commission believes that
some covered clearing agencies would need to create new policies and
procedures, or update existing policies and procedures, to meet
requirements under the various subsections of Rule 17Ad-22(e)(7). These
actions would entail compliance costs, as described in Part III.B.3.d.
Further, the Commission believes that for some covered clearing
agencies the adopted requirements would require them to establish new
practices. The cost of adherence to the rule would likely be passed on
to market participants in cleared markets, as discussed in more detail
below.
    Under Rule 17Ad-22(e)(7)(i), a covered clearing agency would be
required to have policies and procedures reasonably designed to require
maintaining sufficient resources to achieve ``cover one'' for liquidity
risk. This requirement mirrors the ``cover one'' requirement for credit
risk in Rule 17Ad-22(e)(4)(iii). Based on its supervisory experience,
the Commission believes that many covered clearing agencies do not
currently meet a ``cover one'' requirement for liquidity and thus will
likely incur costs to comply with this rule. As discussed earlier,
whether covered clearing agencies choose to gather liquidity directly
from members or instead choose to rely on third-party arrangements, the
costs of liquidity may be passed on to other market participants,
eventually increasing transaction costs.\722\ The requirement may,
however, reduce the procyclicality of covered clearing agencies'
liquidity demands, which may reduce costs to market participants in
certain situations. For instance, the requirement would reduce the
likelihood that a covered clearing agency would have to call on its
members to contribute additional liquidity in periods of financial
stress, when liquidity may be most costly.
---------------------------------------------------------------------------

    \722\ See supra Part III.B.1.d (discussing the effect of the
rules on concentration in the market for clearing services and among
clearing members).
---------------------------------------------------------------------------

    Under Rule 17Ad-22(e)(7)(ii), a covered clearing agency would be
required to have policies and procedures reasonably designed to ensure
that it meets the minimum liquidity resource requirement in Rule 17Ad-
22(e)(7)(i) with qualifying liquid resources.\723\ Qualifying liquid
resources would include cash held at the central bank or at a
creditworthy commercial bank, assets that are readily converted into
cash pursuant to committed lines of credit, committed foreign exchange
swaps, committed

repurchase agreements or other highly reliable prearranged funding
agreements, or assets that may be pledged to a central bank in exchange
for cash (if the covered clearing agency has access to routine credit
at a central bank). The Commission notes that the adopted rules allow
covered clearing agencies some measure of flexibility, subject to their
obligations and responsibilities as SROs under the Exchange Act, to
manage their qualifying liquid resources and that covered clearing
agencies would be able to use creditworthy commercial bank services
where appropriate.
---------------------------------------------------------------------------

    \723\ See Rule 17Ad-22(a)(14), infra Part VI (defining
``qualifying liquid resources'').
---------------------------------------------------------------------------

    Based on its supervisory experience, the Commission believes that
some covered clearing agencies currently do not meet the liquidity
requirements with qualifying liquid resources. As an alternative to the
adopted rules, the Commission could have restricted the definition of
qualifying liquid resources to assets held by covered clearing
agencies. These covered clearing agencies and the markets they serve
would benefit from the adopted minimum requirements for liquidity
resources in terms of the reduced risk of liquidity shortfalls and
associated contagion risks described above. However, qualifying liquid
resources may be costly for covered clearing agencies to maintain on
their own balance sheets. Such resources carry an opportunity cost.
Assets held as cash are, by definition, not available for investment in
less liquid assets that may be more productive uses of capital. This
cost may ultimately be borne by clearing members who contribute liquid
resources to covered clearing agencies to meet minimum requirements
under Rule 17Ad-22(e)(7)(ii) and their customers.
    The Commission notes that, under the adopted rules, covered
clearing agencies have flexibility, subject to their obligations and
responsibilities as SROs under the Exchange Act, to meet their
qualifying liquid resource requirements in a number of ways. In perfect
capital markets, maintaining on-balance-sheet liquidity resources
should be no more costly than entering into committed lines of credit
or prearranged funding agreements backed by less-liquid assets that
would allow these assets to be converted into cash. However, market
frictions, such as search frictions, may enable banks to obtain
liquidity at lower cost than other firms. In the presence of such
frictions, obtaining liquidity using committed and uncommitted funding
arrangements provided by banks may prove a less costly option for some
covered clearing agencies than holding additional liquid resources on
their balance sheets. In particular, the Commission believes that
requiring covered clearing agencies to enter into committed or
uncommitted funding arrangements would decrease the costs that would be
experienced by them in the event they sought to liquidate securities
holdings during periods of market disruptions and increase the
likelihood that they meet funding obligations to market participants by
reducing the risk of delay in converting non-cash assets into cash.
    The Commission notes that committed or uncommitted funding
arrangements would only count towards minimum requirements to the
extent that covered clearing agencies had securities available to post
as collateral, so use of these facilities may require covered clearing
agencies to require their members to contribute more securities. If
these securities are costly for clearing members to supply, then
additional required contributions to meet minimum requirements under
Rule 17Ad-22(e)(7)(ii) may impose costs on clearing members and their
customers. Similarly, prearranged funding arrangements may entail
implicit costs to clearing members. Prearranged funding arrangements
could impose costs on clearing members if they are obligated to
contribute securities towards a collateral pool that the covered
clearing agency would use to back borrowing. Alternatively, clearing
members may be obligated under a covered clearing agency's rules to act
as counterparties to repurchase agreements. Under the latter scenario,
clearing members would bear costs associated with accepting securities
in lieu of cash. Additionally, the Commission notes certain explicit
costs specifically associated with these arrangements outlined below.
    Counterparties to committed arrangements allowable under Rule 17Ad-
22(a)(14) charge covered clearing agencies a premium to provide firm
liquidity commitments and additional out-of-pocket expenses will be
incurred establishing and maintaining committed liquidity arrangements.
The Commission estimates that the total cost of committed funding
arrangements will be approximately 30 basis points per year, including
upfront fees, legal fees, commitment fees, and collateral agent
fees.\724\ Furthermore, the Commission is aware of other potential
consequences of these arrangements. In some instances, they may cause
entities outside of a covered clearing agency to bear risks ordinarily
concentrated within the covered clearing agency, while, in others,
these arrangements may result in increased exposure of covered clearing
agencies to certain members.\725\ Financial intermediaries that
participate in committed credit facilities may be those least able to
provide liquidity in times of financial stress, so these commitments
may represent a route for risk transmission.\726\ Finally, the
Commission notes that covered clearing agencies may face constraints in
the size of credit facilities available to them. Recent market
statistics have estimated the total size of the committed credit
facility market in the U.S. at $2.3 trillion with 15 of 3,740
facilities exceeding $10 billion in size.\727\ Given the volume of
activity at covered clearing agencies, it is possible that they may
only be able to use committed credit facilities to meet a portion of
their liquidity requirements under Rule 17Ad-22(e)(7)(ii).
---------------------------------------------------------------------------

    \724\ See Letter from Kim Taylor, President, CME Clearing, to
Melissa Jurgens, Office of the Secretariat, CFTC (Sept. 16, 2013),
at 13 & n.48 (noting CME's assumption that the cost of committed
liquidity or committed repurchase facilities is approximately $3
million for every $1 billion of required committed facilities,
including upfront fees, commitment fees, legal fees, and collateral
agent fees).
    \725\ See id. at 11.
    \726\ See Letter from Robert C. Pickel, CEO, ISDA to Secretary,
CFTC (Sept. 16, 2013), at 4 (discussing collateral and liquidity
requirements); see also Craig Pirrong, Clearing and Collateral
Mandates: A New Liquidity Trap?, 24 J. Applied Corp. Fin. 67 (2012).
    \727\ These estimates are based on the number of deals issued in
2015 as reported by the DealScan database from Thomson Reuters
Markets LLC. Suspended and cancelled deals were omitted. U.S. deals
were defined based on the country of the borrower's principal
executive offices, as reported in DealScan, due to data
availability. In cases of multiple facilities within the deal, the
loan deal date is the earliest facility date. Estimates for
corporate borrowers refer to non-financial private sector borrowers.
---------------------------------------------------------------------------

    A covered clearing agency may alternatively use a prearranged
funding arrangement determined to be highly reliable in extreme but
plausible market conditions to raise liquid resources backed by non-
cash assets but that does not require firm commitments from liquidity
providers. This strategy would avoid certain of the explicit fees
associated with firm commitments, while incurring costs related to the
annual review and maintenance of such arrangements. Based on its
supervisory experience and discussions with market participants, the
Commission believes the cost associated with commitment fees to be
between 5 and 15 basis points per year. Given the 30 basis point cost
associated with committed funding arrangements, mentioned above,
uncommitted facilities could entail

costs of between 15 and 25 basis points.\728\ Prearranged funding
arrangements may ultimately prove less costly than holding cash and may
be more widely available than committed arrangements, while still
reducing the likelihood of delay faced by covered clearing agencies
that attempt to market less-liquid assets. As mentioned above in the
context of committed credit facilities, the Commission acknowledges
that financial institutions who offer to provide liquidity to covered
clearing agencies on an uncommitted basis may be least able to do so in
times of financial stress, when access to liquidity is most needed by
the covered clearing agency. Without a commitment in place,
counterparties retain the option to fail to provide liquidity during
stressed conditions, when liquidity is most valuable to clearing
agencies and the markets they serve. To the extent covered clearing
agencies may establish requirements for clearing members to provide
liquidity to ensure compliance with the Commission's adopted rules, the
costs experienced by members indirectly may exceed those associated
with committed credit facilities.
---------------------------------------------------------------------------

    \728\ Subtracting the lower bound of commitment fees (5 basis
points) from the estimated total cost of a committed facility (30
basis points) yields an estimate of the upper bound of the fees
associated with an uncommitted facility (30-5 = 25 basis points). We
estimate the lower bound of fees associated with an uncommitted
facility analogously (30-15 = 15 basis points).
---------------------------------------------------------------------------

    Finally, covered clearing agencies that have access to routine
credit at a central bank could meet the qualifying liquid resources
requirement with assets that are pledgeable to a central bank, if that
jurisdiction permits such pledges or the transactions by the covered
clearing agency. The Commission notes that this may represent the
lowest cost option for covered clearing agencies, but understands that
this latter provision would represent an advantage only if and when a
covered clearing agency receives the benefit of access to routine
central bank borrowing. The Commission anticipates that at such future
time access to routine credit at a central bank would provide covered
clearing agencies with additional flexibility, subject to their
obligations and responsibilities as SROs under the Exchange Act, with
respect to resources used to comply with the liquidity risk management
requirements of Rules 17Ad-22(e)(7)(i) and (ii).
    The total cost of maintaining qualifying liquid resources pursuant
to Rules 17Ad-22(e)(7)(i) and (ii) is composed of the cost of each
liquidity source including assets held by covered clearing agencies,
committed credit facilities and prearranged funding agreements,
multiplied by the quantity of each of these liquidity sources held by
covered clearing agencies. The Commission is unable to quantify the
cost of cash held by clearing agencies and securities required to back
credit facilities since such estimates would require detailed
information about additional required contributions of clearing members
under the adopted rules, as well as clearing members' best alternative
to holding cash and securities.\729\ As mentioned above, however, the
Commission has limited information about the costs associated with
committed and uncommitted credit facilities. Based on this information,
we are able to quantify the costs associated with committed credit
facilities that will result from the requirement to maintain qualifying
liquid resources. The Commission estimates that the cost of compliance
with the adopted rules will be between $122 million and $204 million
per year as a result of the requirement to enter into prearranged
funding agreements for non-cash assets used to meet liquidity
requirements under Rules 17Ad-22(e)(7)(i) and (ii). This analysis
assumes that covered clearing agencies will enter into such agreements
at arm's length on an uncommitted basis. Based on staff discussions
with market participants, the Commission understands that alternative
arrangements between covered clearing agencies and their members may be
obtained at lower cost, though these arrangements may come with
increased wrong-way risk.\730\
---------------------------------------------------------------------------

    \729\ Covered clearing agencies may choose to allocate the costs
associated with increased liquidity requirements based on a number
of factors related to the markets they serve and their membership.
See, e.g., Exchange Act Release No. 34-70999 (Dec. 5, 2013), 78 FR
75400 (Dec. 11, 2013) (Commission order approving NSCC rule change
to institute supplemental liquidity deposits to its clearing fund
designed to increase liquidity resources to meet its liquidity
needs).
    \730\ To produce this range, the Commission used a combination
of publicly available information from SRO rule filings, comment
letters, and 2015 annual financial statements, and non-public
information gathered as a result of its regulatory role. For each
covered clearing agency, the Commission assumed that the covered
clearing agency's guaranty fund represents the sole source of
liquidity used to satisfy its minimum liquidity requirements under
the adopted rules. To compute the level of qualifying liquid
resources currently held by each covered clearing agency, the
Commission assumed that cash in the covered clearing agency's
guaranty fund remains fixed at current levels and added to this any
amount from credit facilities that could be backed by the value of
securities held in the covered clearing agency's guaranty funds.
    Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
the ``cover one'' guaranty fund requirement over all covered
clearing agencies results in the total shortfall relative to minimum
requirements under Rules 17Ad-22(e)(7)(i) and (ii). The Commission
further assumed that covered clearing agencies would cover this
shortfall using prearranged funding agreements backed by additional
securities posted to guaranty funds by clearing members. Finally,
the Commission multiplied the total prearranged funding amount by
between 0.15% and 0.25% to arrive at a range of ongoing costs.
    This range estimate has been updated since the proposal. While
it relies on the same methodology, this estimate relies on more
recent financial information from covered clearing agencies. Cf. CCA
Standards proposing release, supra note 5, at 29600.
---------------------------------------------------------------------------

    U.S. Treasury securities would not fall under the definition of
qualifying liquid resources. The Commission understands that U.S.
Treasury markets represent some of the largest and most liquid markets
in the world, see Part III.A.2.k, and that, in ``flights to quality''
and ``flights to liquidity'' in times of financial stress, U.S.
Treasuries trade at a premium to other assets.\731\ If, as an
alternative to the adopted rules, the Commission included U.S.
government securities in the definition of qualifying liquid resources,
the Commission estimates the cost of complying with requirements under
Rule 17Ad-22(e)(7)(i) and (ii) would be reduced by between $32 million
and $204 million per year.\732\ The Commission believes,

however, that there are benefits to including government securities
only if prearranged funding agreements exist. In particular, given the
quantity of these securities financed by the largest individual
dealers, fire-sale conditions could materialize if collateral is
liquidated in a disorderly manner, which could prevent covered clearing
agencies from meeting payment obligations.\733\
---------------------------------------------------------------------------

    \731\ See Alessandro Beber, Michael W. Brandt & Kenneth A.
Kavajecz, Flight-to-Quality or Flight-to-Liquidity? Evidence from
the Euro-Area Bond Market, 22 Rev. Fin. Stud. 925 (2009)
(decomposing sovereign yield spreads into credit and liquidity
components and showing that credit quality matters for bond
valuation but that, in times of market stress, investors chase
liquidity, not quality); Markus K. Brunnermeier & Lasse Heje
Pedersen, Market Liquidity and Funding Liquidity, 22 Rev. Fin. Stud.
2201 (2009) (showing, in a theoretical model, how with low wealth
shocks, demand for illiquid assets falls off more sharply than
demand for liquid assets); Francis A. Longstaff, The Flight-to-
Liquidity Premium in U.S. Treasury Bond Prices, 77 J. Bus 511 (2004)
(estimating the liquidity premium associated with U.S. Treasuries
relative to close substitutes); Dimitri Vayanos Flight to Quality,
Flight to Liquidity, and the Pricing of Risk (NBER Working Paper No.
10327, Feb. 2004) (showing, in a theoretical model, that during
volatile times, assets' liquidity premia increase), available at
http://www.nber.org/papers/w10327.pdf.
    \732\ The Commission re-estimated the level of prearranged
funding agreements required to meet requirements under Rules 17Ad-
22(e)(7)(i) and (ii) using the data and methodology described in
note 730, except in this case the Commission assumed that all non-
defaulting member resources applied to funding obligations were a
mix of cash and U.S. Treasuries for a lower bound, and assumed that
all resources applied to funding obligations were a mix of cash and
U.S. Treasuries for an upper bound.
    Taking the sum of these current qualifying liquid resources over
all covered clearing agencies and subtracting this from the sum of
cover one guaranty fund requirement over all covered clearing
agencies results in the total shortfall relative to minimum
requirements under Rules 17Ad-22(e)(7)(i) and (ii) if U.S.
government and agency securities were considered qualifying liquid
resources. As above, the Commission further assumed that covered
clearing agencies would cover this shortfall using prearranged
funding agreements backed by additional securities posted to
guaranty funds by clearing members and multiplied this amount by
between 0.15% and 0.25% to arrive at a range of ongoing costs.
    As above, this range estimate has been updated since the
proposal. While it relies on the same methodology, this estimate
relies on more recent financial information from covered clearing
agencies. Cf. CCA Standards proposing release, supra note 5, at
29601.
    \733\ See Brian Begalle et al., The Risk of Fire Sales in the
Tri-Party Repo Market, at 19 & n.37 (FRBNY Staff Report No. 616, May
2013), available at http://www.newyorkfed.org/research/staff_reports/sr616.pdf.
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(7)(iii) requires a covered clearing agency to
establish implement, maintain and enforce written policies and
procedures reasonably designed to ensure it uses accounts and services
at a Federal Reserve Bank or other relevant central bank, when
available and where determined to be practical by the board of
directors, to enhance its management of liquidity risk.\734\ The
Commission believes that it may be beneficial for covered clearing
agencies to use central bank account services because doing so would
reduce exposure to commercial bank default risk. Moreover, for some
covered clearing agencies, central bank services may represent the
lowest-cost admissible funding arrangement under the adopted rule. The
Commission understands, however, that central bank services may not be
practical because direct access to central bank accounts and services
may not be available to all clearing agencies or members in all
circumstances.
---------------------------------------------------------------------------

    \734\ See Rule 17Ad-22(e)(7)(iii), infra Part VI.
---------------------------------------------------------------------------

    Rules 17Ad-22(e)(7)(iv) and (v) address relations between covered
clearing agencies and their liquidity providers. The Commission
believes that a key benefit of these adopted rules would be an
increased level of assurance that liquidity providers would be able to
supply liquidity to covered clearing agencies on demand. Such assurance
is especially important because of the possibility that covered
clearing agencies may rely on outside liquidity providers to convert
non-cash assets into cash using prearranged funding arrangements or
committed facilities, pursuant to Rule 17Ad-22(e)(7)(ii) and the
definition of qualifying liquid resources in Rule 17Ad-22(a)(14). The
required policies and procedures would ensure the covered clearing
agency undertakes due diligence to confirm that it has a reasonable
basis to believe each of its liquidity providers understand the
liquidity risk borne by the liquidity provider, and that the liquidity
provider would have the capacity to provide liquidity under commitments
to the covered clearing agency. Finally, covered clearing agencies
would be required, under the adopted rule, to maintain and test the
covered clearing agency's procedures and operational capacity for
accessing liquidity under their agreements. The Commission believes
that, besides the costs associated with new or updated policies and
procedures discussed in Part IV.C, covered clearing agencies and
liquidity providers may experience costs associated with the adopted
rules as a result of the requirement to test liquidity resources, such
as, for example, fees associated with conducting test draws on a
covered clearing agency's credit lines. Costs associated with ongoing
monitoring and compliance related to testing are included in the
Commission's estimate of quantifiable costs presented in Part
III.B.3.d.
    Rules 17Ad-22(e)(7)(vi) and (vii) may impose costs on covered
clearing agencies as a result of requirements for testing the
sufficiency of liquidity resources and validating models used to
measure liquidity risk. The testing and model validation requirements
of these adopted rules are similar to requirements for testing and
model validation for credit risk in Rules 17Ad-22(e)(4)(vi) and (vii),
and the Commission believes that these adopted rules would yield
similar benefits. Frequent monitoring and testing liquidity resources
could help rapidly identify any gaps in resources required to meet
payment obligations. Moreover, the requirement to test and, when
necessary, update the assumptions and parameters supporting models of
liquidity risk will support the adjustment of covered clearing agency
liquidity resources to changing financial conditions and mitigate the
risk that covered clearing agencies will strategically manage updates
to their liquidity risk models in support of cost-reduction or profit-
maximization.
    Rule 17Ad-22(e)(7)(viii) addresses liquidity shortfalls at a
covered clearing agency, and the Commission believes the adopted rule
would reduce ambiguity related to settlement delays in the event of
liquidity shocks. Among other things, by requiring procedures that seek
to avoid delay of settlement payments, this adopted rule would require
covered clearing agencies to address liquidity concerns in advance
rather than relying on strategies of delaying accounts payable in the
event of liquidity shocks. As discussed previously, effective liquidity
risk management by covered clearing agencies that serves to eliminate
uncertainty on the part of clearing members that payments by the
covered clearing agency will be made on time may allow these clearing
members to allocate their liquidity resources to more efficient uses
than holding precautionary reserves.\735\ The Commission believes the
rule may reduce some of the flexibility covered clearing agencies have
in the absence of the rule, which could impose additional costs on
these clearing agencies as discussed in Part III.B.1.b.
---------------------------------------------------------------------------

    \735\ See supra Part III.B.2.b.
---------------------------------------------------------------------------

    Rule 17Ad-22(e)(7)(ix) would require a covered clearing agency to
have policies and procedures reasonably designed to describe its
process for replenishing any liquid resources that it may employ during
a stress event.\736\ The ability to replenish liquidity resources is
critical to ensure that covered clearing agencies are able to continue
operations after a stress event. Beyond the general benefits associated
with liquidity risk management noted earlier, this adopted rule would
yield particular benefits insofar as it would reduce uncertainty about
covered clearing agency liquidity resources at precisely those times
when information about liquidity may be most important to market
participants.
---------------------------------------------------------------------------

    \736\ See Rule 17Ad-22(e)(7)(ix), infra Part VI.
---------------------------------------------------------------------------

    Finally, Rule 17Ad-22(e)(7)(x) would require a covered clearing
agency that provides CCP services and is either systemically important
in multiple jurisdictions or is a clearing agency involved in
activities with a more complex risk profile to conduct a feasibility
analysis for ``cover two.'' \737\ The primary cost associated with this
rule will be an annual analysis by the affected covered clearing
agencies. Costs associated with a feasibility study would likely
include the cost of staffing and consulting, which will depend on the
scope of products cleared and the particular approach taken by each
covered clearing agencies. The costs associated with this requirement
are included in Part III.B.3.d.
---------------------------------------------------------------------------

    \737\ See Rule 17Ad-22(e)(7)(x), infra Part VI.

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

(5) Testing and Validation of Risk Models
    Rules 17Ad-22(e)(4) through (7) include requirements for covered
clearing agencies to have policies and procedures reasonably designed
to test and validate models related to financial risks. Covered
clearing agencies may incur additional costs under expanded and more
frequent testing of financial resources if the requirements for testing
and validation do not conform to practices currently used by covered
clearing agencies.\738\ These costs are composed of two portions. The
first encompasses startup costs related to collection and storage of
data elements necessary to implement testing and validation, along with
investments in software tools and human capital to support these
functions. The second portion of costs includes the ongoing, annual
costs of conducting testing and validation under the adopted rules.
---------------------------------------------------------------------------

    \738\ The Commission notes that while the stress testing
provisions in Rules 17Ad-22(e)(4) through (7) include new
requirements for covered clearing agencies, Rule 17Ad-22(b)(4)
requires registered clearing agencies that provide CCP services for
security-based swaps to have policies and procedures for a general
margin model validation requirement. See supra note 716.
---------------------------------------------------------------------------

    Based on its supervisory experience and discussions with industry
participants, the Commission believes that startup costs to support
testing and validation of credit risk, margin, and liquidity risk
models at covered clearing agencies could fall in the range of $5
million to $25 million for each covered clearing agency. This range
primarily reflects investments in information technology to process
data already available to covered clearing agencies for stress testing
and validation purposes. The range's width reflects differences in
markets served by, as well as the scope of operations of, each covered
clearing agency. Based on its supervisory experience and discussions
with industry participants, the Commission estimates a lower bound of
$1 million per year for ongoing costs related to testing of risk
models.
    Should each covered clearing agency choose to hire external
consultants for the purposes of performing model validation required
under Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) through written policies
and procedures, the Commission estimates the ongoing cost associated
with hiring such consultants would be approximately $4,509,120 in the
aggregate.\739\
---------------------------------------------------------------------------

    \739\ This figure was calculated as follows: 2 Consultants for
40 hours per week at $653 per hour = $52,240 x 12 weeks = $644,160
per clearing agency x 7 covered clearing agencies = $4,509,120. The
$671 per hour figure for a consultant was calculated using
www.payscale.com, modified by Commission staff to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses,
firm size, employee benefits, and overhead.
     The Commission previously estimated that ongoing costs
associated with hiring external consultants to fulfill the
requirements of Rule 17Ad-22(b)(4) would be approximately $3.9
million per year. See Clearing Agency Standards adopting release,
supra note 5, at 66261.
---------------------------------------------------------------------------

    The Commission acknowledges that it could have, as an alternative,
rules that would require testing and validation of financial risk
models at covered clearing agencies at different frequencies. For
example, the Commission could have required backtesting of margin
resources less frequently than daily. Such a policy could imply less
frequent adjustments in margin levels that may result in over- or
under-margining. The Commission believes that the frequencies of
testing and validation of financial risk models that it has adopted are
appropriate given the risks faced by covered clearing agencies and
current market practices related to frequency of meetings of risk
management committees and boards of directors at covered clearing
agencies.
v. Rules 17Ad-22(e)(8) Through (10): Settlement and Physical Delivery
    Rules 17Ad-22(e)(8) through (10) require covered clearing agencies
to have policies and procedures reasonably designed to address
settlement risk. Many of the issues raised by settlement are similar to
those raised by liquidity. Uncertainty in settlement may make it
difficult for clearing members to fulfill their obligations to other
market participants within their respective financial networks if they
hold back precautionary reserves, as discussed above. Based on its
supervisory experience, the Commission believes that the benefits and
costs for the majority of covered clearing agencies will likely be
limited. Registered clearing agencies that become covered clearing
agencies in the future, by contrast, may bear more significant costs as
a result of the enhanced standards.
    Settlement finality is important to market participants for a
number of reasons. Reversal of transactions can be costly to
participants. For example, if transactions are reversed, buyers and
sellers of securities may be exposed to additional market risk as they
attempt to reestablish desired positions in cleared products.
Similarly, reversal of transactions may render participants expecting
to receive payment from the covered clearing agency unable to fulfill
payment obligations to their counterparties, exposing these additional
parties to the transmitted credit risk. Finally, settlement finality
can help facilitate default management procedures by covered clearing
agencies since they improve transparency of members' positions. Unless
settlement finality is established by covered clearing agencies, market
participants may attempt to hedge reversal risk for themselves. This
could come at the cost of efficiency if it means that, on the margin,
participants are less likely to use cleared products as collateral in
other financial transactions.
    In addition, settlement in central bank money, where available and
determined to be practical by the board of directors of the covered
clearing agency, as the adopted rules would require, greatly reduces
settlement risk related to payment agents. Using central bank accounts
to effect settlement rather than settlement banks removes a link from
the intermediation chain associated with clearance and settlement. As a
result, a covered clearing agency would be less exposed to the default
risk of its settlement banks. In cases where settlement banks maintain
links to other covered clearing agencies, for example as liquidity
providers or as members, reducing exposure to settlement bank default
risk may be particularly valuable.
    As in the case of Rule 17Ad-22(e)(7)(iii), the Commission
acknowledges there may be circumstances where it is appropriate for
covered clearing agencies to use commercial banks for conducting money
settlements even when comparable services are available from a central
bank. Accordingly, the Commission believes it is appropriate to allow
covered clearing agencies flexibility, subject to their obligations and
responsibilities as SROs under the Exchange Act, to also use commercial
bank account services to effect settlement, subject to a requirement
that covered clearing agencies monitor and manage the risks associated
with such arrangements.
vi. Rule 17Ad-22(e)(11): CSDs
    CSDs play a key role in modern financial markets. For many issuers,
many transactions in their securities involve no transfer of physical
certificates.
    Paperless trade generally improves transactional efficiency. Book-
entry transfer of securities may facilitate conditional settlement
systems required by Rule 17Ad-22(e)(12). For example, book-entry
transfer in a delivery versus payment system allows securities to be
credited to an account immediately upon debiting the account for the
payment amount. Institutions and individuals may elect to no longer
hold and exchange certificates that represent

their ownership of securities. An early study showed that the creation
of DTC resulted in a 30-35% reduction in the physical movement of
certificates.\740\ Among other benefits, to the extent that delays in
exchanging paper certificates result in settlement failures,
immobilization and dematerialization of shares reduces the frequency of
these failures.\741\
---------------------------------------------------------------------------

    \740\ See Neal L. Wolkoff & Jason B. Werner, The History of
Regulation of Clearing in the Securities and Futures Markets, and
Its Impact on Competition, 30 Rev. Banking & Fin. L. 313, 323
(2010).
    \741\ See Commission, Study of Unsafe and Unsound Practices of
Brokers and Dealers, H.R. Doc. No. 231, 92nd Cong., 1st Sess. 13, at
168 (1971) (suggesting that the delivery and transfer process for
paper certificates were a principal cause of failures to deliver and
receive during the ``paperwork crisis'' of the late 1960s).
---------------------------------------------------------------------------

    For markets to realize the transactional benefits of paperless
trade, however, requires confidence that CSDs can correctly account for
the number of securities in their custody and for the book entries that
allocate these securities across participant accounts. To realize these
benefits, the rules also require covered CSDs to establish, implement,
maintain and enforce written policies and procedures reasonably
designed to ensure the integrity of securities issues, minimize the
risks associated with transfer of securities, and protect assets
against custody risk. Based on its supervisory experience, the
Commission believes that registered CSDs already have infrastructure in
place to meet these requirements. However, CSDs may face incremental
compliance costs in instances where they must modify their rules to
implement appropriate controls. Compliance costs may be higher for
potential new CSDs that are determined to be covered clearing agencies
in the future.
vii. Rule 17Ad
22(e)(12): Exchange-of-Value Settlement Systems
    Clearance and settlement of transactions between two parties to a
trade involves an exchange of one obligation for another. Regarding
transactions in securities, these claims can be securities or payments
for securities. A particular risk associated with transactions is
principal risk, which is the risk that only one obligation is
successfully transferred between counterparties. For example, in a
purchase of common stock, a party faces principal risk if, despite
successfully paying the counterparty for the purchase, the counterparty
may fail to deliver the shares.
    The adopted requirements under Rule 17Ad-22(e)(12) are
substantially the same as those in Rule 17Ad-22(d)(13).\742\ As a
result, covered clearing agencies that have been in compliance with
Rule 17Ad-22(d)(13) face no substantially new requirements under Rule
17Ad-22(e)(12). The Commission expects the adopted rule would likely
impose limited material additional costs on covered clearing agencies.
It would also produce benefits in line with the general economic
considerations discussed in Part III.B.1. The economic effects may
differ for registered clearing agencies that become covered clearing
agencies in the future.
---------------------------------------------------------------------------

    \742\ See supra Part II.C.13 (discussing the full set of
requirements under Rule 17Ad-22(e)(13)); supra Part III.A.2.g
(discussing current practices among registered clearing agencies
regarding exchange-of-value settlement systems); see also 17 CFR
240.17Ad-22(d)(13).
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viii. Rule 17Ad-22(e)(13): Participant-Default Rules and Procedures
    Rule 17Ad-22(e)(13) requires covered clearing agencies to have
policies and procedures for participant default with additional
specificity relative to current requirements for registered clearing
agencies under Rule 17Ad-22(d)(11). In particular, Rule 17Ad-22(e)(13)
requires policies and procedures that address the testing and review of
default procedures.
    Based on its supervisory experience, the Commission believes all
covered clearing agencies currently test and review default procedures
at least annually, so the costs of this requirement would apply only to
registered clearing agencies that may become covered clearing agencies
in the future. The Commission also believes that broad-based
participation in the testing of default procedures could reduce
disruption to cleared markets in the event of default. However, to the
extent that testing of these procedures requires participation by
members of covered clearing agencies, members' customers, and other
stakeholders, these parties may bear costs under the rules. The
Commission is unable to quantify the economic effects of participation
in these tests at this time.
    As an alternative to the rules, the Commission could have adopted
more prescriptive requirements for default procedures at covered
clearing agencies. The Commission believes that differences in cleared
assets and in the characteristics of clearing members supports allowing
each covered clearing agency flexibility, subject to its obligations
and responsibilities as an SRO under the Exchange Act, to determine its
own default procedures pursuant to Rule 17Ad-22(e)(13).
ix. Rule 17Ad-22(e)(14): Segregation and Portability
    Rule 17Ad-22(e)(14) applies only to a covered clearing agency that
is either a security-based swap clearing agency or a complex risk
profile clearing agency. It requires such a covered clearing agency to
establish, implement, maintain and enforce written policies and
procedures reasonably designed to enable the segregation and
portability of positions of a participant's customers and the
collateral provided to the covered clearing agency with respect to
those positions, and effectively protect such positions and related
collateral from the default or insolvency of that participant.\743\
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    \743\ See supra Part II.B.14.a (discussing applicability of Rule
17Ad-22(e)(14) and the existing rules for the cash securities and
listed options markets applicable to broker-dealers which already
promote segregation and portability to protect customer positions
and funds in those markets).
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    Segregation and portability of customer positions serves a number
of useful purposes in certain cleared markets. In the normal course of
business, the ability to efficiently identify and move an individual
customer's positions and collateral between clearing members enables
customers to easily terminate a relationship with one clearing member
and initiate a relationship with another. This may facilitate
competition between clearing members by ensuring customers are free to
move their accounts from one clearing member to another based on their
preferences, without being unduly limited by operational barriers.\744\
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    \744\ See, e.g., Paul Klemperer, Competition When Consumers Have
Switching Costs: An Overview with Applications to Industrial
Organization, Macroeconomics, and International Trade, 62 Rev. Econ.
Stud. 515 (1995) (presenting an overview of switching costs and
their effects on competition).
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    Segregation and portability may be especially important in the
event of participant default. By requiring that customer collateral and
positions remain segregated, covered clearing agencies can facilitate,
in the event of a clearing member's insolvency, the recovery of
customer collateral and the movement of customer positions to one or
more other clearing members. Further, portability of customer positions
may facilitate the orderly wind down of a defaulting member if customer
positions may be moved to a non-defaulting member. Porting of positions
in a default scenario may yield benefits for customers if the
alternative is closing-out positions at one clearing

member and reestablishing them at another clearing member. The latter
strategy would cause customers to bear transactions costs, which might
be especially high in times of financial stress.
    The Commission notes that, in its view, for those clearing agencies
to which Rule 17Ad-22(e)(14) applies, these adopted rules are flexible
in their approach to implementing segregation and portability
requirements. The most efficient means of implementing these
requirements may depend on the products that a covered clearing agency
clears as well as other business practices at a covered clearing
agency. For example, a clearing agency's decision whether or not to
collect margin on a gross or net basis may bear on its decision to port
customer positions and collateral on an individual or omnibus basis,
and while an individual account structure may provide a higher degree
of protection from a default by another customer, it may be
operationally and resource intensive for a covered clearing to
implement and may reduce the efficiency of its operations. Moreover,
some clearing agencies may already employ the LSOC model for
segregation and portability of customer positions in security-based
swaps because of existing CFTC requirements for swaps.
    As a result, the costs and benefits of Rule 17Ad-22(e)(14) will
depend on specific rules implemented by covered clearing agencies as
well as how much these rules differ from current practice. Based on its
supervisory experience, the Commission believes that the current
practices at covered clearing agencies to which the rule would apply
already meet segregation requirements under the rule, so any costs and
benefits for covered clearing agencies would flow from implementing
portability requirements, though the rule potentially raises a barrier
to entry for security-based swap clearing agencies or clearing agencies
involved in activities with a more complex risk profile that seek to
become covered clearing agencies.
x. Rule 17Ad-22(e)(15): General Business Risk
    While Rules 17Ad-22(e)(4) and 17Ad-22(e)(7) require that covered
clearing agencies have policies and procedures reasonably designed to
address credit risk and liquidity risk, Rule 17Ad-22(e)(15) requires
that covered clearing agencies have policies and procedures reasonably
designed to address general business risk. The Commission believes that
general business losses experienced by covered clearing agencies
represent a distinct risk to cleared markets, given limited competition
and specialization of clearing agencies. In this regard, the loss of
clearing services due to general business losses would likely result in
major market disruption. The rule requires a covered clearing agency to
have policies and procedures reasonably designed to mitigate the risk
that business losses result in the disruption of clearing services.
Under these policies and procedures covered clearing agencies would
hold sufficient liquid resources funded by equity to cover potential
general business losses, which at a minimum would constitute six months
of operating expenses. The Commission believes that the benefits of
such policies and procedures would flow primarily from covered clearing
agencies that would be required to increase their holdings of liquid
net assets funded by equity, enabling them to sustain their operations
for sufficient time and achieve orderly wind-down if such action is
eventually necessary.
    The Commission could have adopted a higher or lower minimum level
of resources, for example, corresponding to one quarter of operating
expenses or one year of operating expenses. The Commission believes,
however, that the rules, as adopted, afford covered clearing agencies
sufficient flexibility, subject to their obligations and
responsibilities as SROs under the Exchange Act, to determine the level
of resources to hold while maintaining a minimum standard that supports
continued operations in the event of general business losses. As
another alternative, the Commission could have allowed covered clearing
agencies additional flexibility to determine the nature of the
financial resources held to mitigate the effects of general business
risk or the means by which these resources are funded. The Commission
believes, however, that by specifying that these resources be liquid in
nature, the rule would limit any delays by covered clearing agencies
that suffer business losses from paying expenses required for continued
operations. Additionally, by specifically requiring that a covered
clearing agency draw liquid net resources from members as equity
capital, the rules may also encourage members to more closely monitor
the business operations of a covered clearing agency, which may reduce
the likelihood of losses.
    Based on its supervisory experience, the Commission believes that
certain covered clearing agencies would be required to establish and
maintain policies and procedures providing for specified levels of
equity capital and higher levels of liquid net assets as a result of
Rule 17Ad-22(e)(15).\745\ However, the Commission believes that based
on current market practices, covered clearing agencies may not bear
substantial costs to implement these policies and procedures. Table 2
contains summary information from five registered clearing agencies
obtained from quantitative disclosures made by these registered
clearing agencies pursuant to the PFMI.\746\ These disclosures suggest
that all five of these registered clearing agencies each currently hold
more net liquid assets funded by equity than would be required to cover
six months of operating expenses. While similar quantitative
disclosures are not currently published by DTC, DTC does publish an
annual disclosure framework pursuant to the PFMI,\747\ which states
that as of June 30, 2014, DTC maintained liquid net assets funded by
equity in an amount exceeding six months of its projected operating
expenses.\748\ This analysis suggests that based on available
information about liquid net assets funded by equity operating
expenses, covered clearing agencies would not be required to raise
additional equity capital to implement these policies and procedures
with respect to net liquid assets.
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    \745\ Additional equity capital may be raised through share
issuance or by retaining earnings.
    \746\ See supra note 41.
    \747\ See id.
    \748\ See The Depository Trust Company Disclosure under the
Principles for Financial Market Infrastructures (Dec. 2015), at 80,
available at http://www.dtcc.com/legal/policy-and-compliance.

    Table 2--Net Liquid Assets Funded by Equity and Operating Expenses at Registered Clearing Agencies \749\
----------------------------------------------------------------------------------------------------------------
                                                              FICC       ICC       ICEEU       NSCC       OCC
----------------------------------------------------------------------------------------------------------------
Value of liquid net assets funded by equity..............        214         53        358        321        247

Six months of current operating expenses.................         77         23        138        144        243
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    However, the Commission acknowledges that policies and procedure
adopted by covered clearing agencies pursuant to Rule 17Ad-22(e)(15)
may nevertheless result in certain costs for covered clearing agencies.
First, covered clearing agencies would incur ongoing costs to
implement, maintain, and enforce policies and procedures under Rule
17Ad-22(e)(15). To the extent that maintenance and enforcement of these
policies and procedures indicate that additional capital is required to
manage a covered clearing agency's general business risks, it may
determine that it needs to increase liquid net assets. Second, as a
result of these new policies and procedures, covered clearing agencies