Ownership Limitations and Governance Requirements for Security-Based Swap Clearing Agencies, Security-Based Swap Execution Facilities, and National Securities Exchanges With Respect to Security-Based Swaps Under Regulation MC, 65882-65932 [2010-26315]
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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 242
[Release No. 34–63107; File No. S7–27–10]
RIN 3235–AK74
Ownership Limitations and
Governance Requirements for
Security-Based Swap Clearing
Agencies, Security-Based Swap
Execution Facilities, and National
Securities Exchanges With Respect to
Security-Based Swaps Under
Regulation MC
Securities and Exchange
Commission.
ACTION: Proposed rule.
AGENCY:
In accordance with Section
765 (‘‘Section 765’’) of Title VII (‘‘Title
VII’’) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of
2010 (‘‘Dodd-Frank Act’’), the Securities
and Exchange Commission (‘‘SEC’’ or
‘‘Commission’’) is proposing Regulation
MC under the Securities Exchange Act
of 1934 (‘‘Exchange Act’’) for clearing
agencies that clear security-based swaps
(‘‘security-based swap clearing
agencies’’) and for security-based swap
execution facilities (‘‘SB SEFs’’) and
national securities exchanges that post
or make available for trading securitybased swaps (‘‘SBS exchanges’’).
Regulation MC is designed to mitigate
potential conflicts of interest that could
exist at these entities. Specifically, the
Commission seeks to mitigate the
potential conflicts of interest through
conditions and structures relating to
ownership, voting, and governance of
security-based swap clearing agencies,
SB SEFs, and SBS exchanges.
DATES: Comments should be submitted
on or before November 26, 2010.
ADDRESSES: Comments may be
submitted by any of the following
methods:
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SUMMARY:
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/proposed.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number S7–27–10 on the subject line;
or
• Use the Federal eRulemaking Portal
(https://www.regulations.gov). Follow the
instructions for submitting comments.
Paper Comments
• Send paper comments in triplicate
to Elizabeth M. Murphy, Secretary,
Securities and Exchange Commission,
100 F St., NE., Washington, DC 20549–
1090.
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All submissions should refer to File
Number S7–27–10. This file number
should be included on the subject line
if e-mail is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s Internet Web site
(https://www.sec.gov/rules/
proposed.shtml). Comments are also
available for Web site viewing and
printing in the Commission’s Public
Reference Room, 100 F St., NE.,
Washington, DC 20549 on official
business days between the hours of
10 a.m. and 3 p.m. All comments
received will be posted without change;
the Commission does not edit personal
identifying information from
submissions. You should submit only
information that you wish to make
available publicly.
FOR FURTHER INFORMATION CONTACT:
Proposals relating to security-based
swap clearing agencies: Catherine
Moore, Senior Special Counsel, at (202)
551–5710; and Joseph P. Kamnik,
Special Counsel, at (202) 551–5710;
Office of Clearance and Settlement,
Division of Trading and Markets,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–7010; proposals relating to
security-based swap execution facilities
and national securities exchanges that
post or make available for trading
security-based swaps: Nancy BurkeSanow, Assistant Director, at (202) 551–
5621; Molly Kim, Special Counsel, at
(202) 551–5644; Steven Varholik,
Special Counsel, at (202) 551–5615;
Sarah Schandler, Attorney, at (202) 551–
7145; and Iliana Lundblad, Attorney, at
(202) 551–5871; Office of Market
Supervision, Division of Trading and
Markets, Securities and Exchange
Commission, 100 F Street, NE.,
Washington, DC 20549–7010.
SUPPLEMENTARY INFORMATION: The
Commission is proposing new
Regulation MC under the Exchange Act
relating to conflicts of interest with
respect to security-based swap clearing
agencies, SB SEFs, and SBS exchanges.
I. Introduction
On July 21, 2010, the President signed
the Dodd-Frank Act into law.1 The
Dodd-Frank Act was enacted to, among
other purposes, promote the financial
stability of the United States by
improving accountability and
transparency in the financial system.2
Title VII of the Dodd-Frank Act provides
1 The Dodd-Frank Wall Street Reform and
Consumer Protection Act (Pub. L. 111–203, H.R.
4173).
2 See Public Law 111–203, Preamble.
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the Commission and the Commodity
Futures Trading Commission (‘‘CFTC’’)
with the authority to regulate over-thecounter (‘‘OTC’’) derivatives in light of
the recent financial crisis, which
demonstrated the need for enhanced
regulation in the OTC derivatives
market. The Dodd-Frank Act is intended
to close loopholes in the existing
regulatory structure and to provide the
Commission and the CFTC with
effective regulatory tools to oversee the
OTC swaps market, which has grown
exponentially in recent years and is
capable of affecting significant sectors of
the U.S. economy.
The Dodd-Frank Act provides that the
CFTC will regulate ‘‘swaps,’’ the
Commission will regulate ‘‘securitybased swaps,’’ and the CFTC and the
Commission will jointly regulate ‘‘mixed
swaps.’’ 3 The Dodd-Frank Act amends
the Exchange Act to require, among
other things, the following:
(1) Transactions in security-based swaps
must be cleared through a clearing
agency if they are of a type that the
Commission determines must be
cleared, unless an exemption from
mandatory clearing applies; (2)
transactions in security-based swaps
must be reported to a registered
security-based swap data repository or
3 Section 712(d) of the Dodd-Frank Act provides
that the Commission and the CFTC, in consultation
with the Board of Governors of the Federal Reserve
System (‘‘Federal Reserve’’), shall jointly further
define the terms ‘‘swap,’’ ‘‘security-based swap,’’
‘‘swap dealer,’’ ‘‘security-based swap dealer,’’ ‘‘major
swap participant,’’ ‘‘major security-based swap
participant,’’ ‘‘eligible contract participant,’’ and
‘‘security-based swap agreement.’’ These terms are
defined in Sections 721 and 761 of the Dodd-Frank
Act and, with respect to the term ‘‘eligible contract
participant,’’ in Section 1a(18) of the Commodity
Exchange Act (‘‘CEA’’), 7 U.S.C. 1a(18), as redesignated and amended by Section 721 of the
Dodd-Frank Act. Further, Section 721(c) of the
Dodd-Frank Act requires the CFTC to adopt a rule
to further define the terms ‘‘swap,’’ ‘‘swap dealer,’’
‘‘major swap participant,’’ and ‘‘eligible contract
participant,’’ and Section 761(b) of the Dodd-Frank
Act permits the Commission to adopt a rule to
further define the terms ‘‘security-based swap,’’
‘‘security-based swap dealer,’’ ‘‘major security-based
swap participant,’’ and ‘‘eligible contract
participant,’’ with regard to security-based swaps,
for the purpose of including transactions and
entities that have been structured to evade Title VII
of the Dodd-Frank Act. Finally, Section 712(a) of
the Dodd-Frank Act provides that the Commission
and CFTC, after consultation with the Federal
Reserve, shall jointly prescribe regulations
regarding ‘‘mixed swaps’’ as may be necessary to
carry out the purposes of Title VII. To assist the
Commission and CFTC in further defining the terms
specified above, and to prescribe regulations
regarding ‘‘mixed swaps’’ as may be necessary to
carry out the purposes of Title VII, the Commission
and the CFTC have requested comment from
interested parties. See Securities Exchange Act
Release No. 62717 (August 13, 2010), 75 FR 51429
(August 20, 2010) (File No. S7–16–10) (advance
joint notice of proposed rulemaking regarding
definitions contained in Title VII of the Dodd-Frank
Act) (‘‘Definitions Release’’).
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the Commission; and (3) if a securitybased swap is subject to a clearing
requirement, it must be traded on a
registered trading platform, i.e., a SB
SEF or SBS exchange, unless no facility
makes such security-based swap
available for trading.4
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II. Mandated Rulemaking on Mitigating
Conflicts of Interest
Section 765 of the Dodd-Frank Act
requires the Commission to adopt rules
to mitigate specified conflicts of
interest.5 Section 765(a) requires the
Commission to adopt rules, which rules
may include numerical limits on the
control of, or the voting rights with
respect to, any security-based swap
clearing agency, or on the control of any
SB SEF or SBS exchange, by specified
entities, such as a bank holding
company with total consolidated assets
of $50 billion or more,6 a nonbank
financial company,7 an affiliate of such
bank holding company or nonbank
financial company, a security-based
swap dealer,8 or a major security-based
4 See Section 761 of the Dodd-Frank Act, added
as Section 3(a)(77) of the Exchange Act, 15 U.S.C.
78(c)(a), which defines the term ‘‘security-based
swap execution facility’’ to mean ‘‘a trading system
or platform in which multiple participants have the
ability to execute or trade security-based swaps by
accepting bids and offers made by multiple
participants in the facility or system, through any
means of interstate commerce, including any
trading facility that (A) facilitates the execution of
security-based swaps between persons; and (B) is
not a national securities exchange.’’ See Public Law
111–203, Section 761. The Dodd-Frank Act amends
the CEA to provide for a similar regulatory
framework with respect to transactions in swaps
regulated by the CFTC.
5 See Public Law 111–203, Section 765.
6 The term ‘‘bank holding company’’ has the
meaning set forth in Section 2 of the Bank Holding
Company Act of 1956 (12 U.S.C. 1841) (‘‘Bank
Holding Company Act’’), and generally means any
company that has control over any bank or over any
company that is or becomes a bank holding
company by virtue of the Bank Holding Company
Act.
7 Under Section 765(a) of the Dodd-Frank Act, the
term ‘‘nonbank financial company’’ has the meaning
set forth in Section 102 of the Dodd-Frank Act, and
generally means a company, other than a bank
holding company, national securities exchange,
clearing agency, SB SEF, registered security-based
swap data repository, board of trade designated as
a contract market (‘‘DCM’’), derivatives clearing
organization, swap execution facility (‘‘SEF’’) or
registered swap data repository, that is
predominantly engaged in financial activities
(including through a branch in the U.S., if such
company is incorporated or organized in a country
other than the U.S.). See Public Law 111–203,
Section 102 for the complete definition.
8 Pursuant to Section 761 of the Dodd-Frank Act,
the term ‘‘security-based swap dealer’’ is added as
Section 3(a)(71) of the Exchange Act, 15 U.S.C
78c(a), and generally means any person who (A)
holds themselves out as a dealer in security-based
swaps; (B) makes a market in security-based swaps;
(C) regularly enters into security-based swaps with
counterparties as an ordinary course of business for
its own account; or (D) engages in any activity
causing it to be commonly known in the trade as
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swap participant (collectively,
‘‘Specified Entities’’).9
Section 765(b)—captioned
‘‘Purposes’’—provides that the
Commission shall adopt such rules if it
determines they are necessary or
appropriate to improve the governance
of, or to mitigate systemic risk, promote
competition or mitigate conflicts of
interest in connection with a securitybased swap dealer’s or major securitybased swap participant’s conduct of
business with, a security-based swap
clearing agency, SB SEF, or SBS
exchange and in which such securitybased swap dealer or major securitybased swap participant has a material
debt or equity investment.10 Section
765(b) sets forth a number of underlying
policy objectives for the Commission’s
rulemaking—improving governance,
mitigating systemic risk, promoting
competition, and mitigating conflicts of
interest with respect to security-based
swap clearing agencies, SB SEFs, and
SBS exchanges. In considering proposed
rules to mitigate conflicts of interest, the
Commission is mindful that, in some
instances, certain of these diverse policy
objectives may be in tension with
others. For example, as described in
Section III.A.2.a below, with respect to
security-based swap clearing agencies,
the statutory objective of promoting
competition, which may be furthered
through enhanced access to cleared
products and clearing venues, may to
some extent be in tension with the
objective of minimizing systemic risk
through effective risk management of
the clearing agency.
Section 765(c) of the Dodd-Frank Act
also provides that in adopting rules
a dealer or market maker in security-based swaps.
See Public Law 111–203, Section 761 for the
complete definition. See also Definitions Release,
75 FR 51429, supra note 3.
9 Pursuant to Section 761 of the Dodd-Frank Act,
the term ‘‘major security-based swap participant’’ is
added as Section 3(a)(67) of the Exchange Act, 15
U.S.C 78c(a), and generally means any person
(A) who is not a security-based swap dealer; and
(B)(I) who maintains a substantial position in
security-based swaps for any of the major securitybased swap categories, as such categories are
determined by the Commission, excluding positions
held for hedging or mitigating commercial risk; (II)
whose outstanding security-based swaps create
substantial counterparty exposure that could have
serious adverse effects on the financial stability of
the U.S. banking system or financial markets; or (III)
that is a financial entity that (a) is highly leveraged
relative to the amount of capital such entity holds
and that is not subject to capital requirements
established by an appropriate Federal banking
regulator; and (b) maintains a substantial position
in outstanding security-based swaps in any major
security-based swap category, as such categories are
determined by the Commission. See Public Law
111–203, Section 761 for the complete definition.
See also Definitions Release, 75 FR 51429, supra
note 3.
10 See Public Law 111–203, Section 765(b).
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65883
under Section 765, the Commission
shall consider any conflicts of interest
arising from the amount of equity
ownership and voting by a single
investor; the ability of owners to vote,
cause the vote of, or withhold votes
entitled to be cast on any matters by the
holders of the ownership interest; and
the governance arrangements of any
derivatives clearing organization that
clears swaps, or swap execution facility
or board of trade designated as a
contract market that posts swaps or
makes swaps available for trading.11
The Commission is cognizant that the
proposed rules discussed herein, as well
as other proposals that the Commission
may consider in the coming months to
implement the Dodd-Frank Act, if
adopted, could significantly affect—and
be significantly affected by—the nature
and scope of the security-based swaps
market in a number of ways. For
example, the Commission recognizes
that if the measures proposed in this
release are adopted and are too onerous
for new entrants, they could hinder the
further development of a market for
security-based swaps by unduly
discouraging competition and the
formation of new security-based swap
clearing agencies and of new SB SEFs or
SBS exchanges. On the other hand, if
the Commission adopts rules that are
too permissive, conflicts of interest may
be inadequately mitigated and such
conflicts may incentivize restricting
access to centralized clearing and lack
of transparency in the trading of
security-based swaps as described in
detail in Section III below. The
Commission is also mindful that the
further development of the securitybased swaps market may alter the
calculus for future regulation of
conflicts of interest. As commenters
review the instant proposals, they are
urged to consider generally the role that
regulation may play in fostering or
limiting the development of the market
for security-based swaps (or, vice versa,
the role that market developments may
play in changing the nature and
implications of regulation) and
specifically to focus on this issue with
respect to the proposals to mitigate
conflicts of interest for security-based
swap clearing agencies, SB SEFs, and
SBS exchanges.
11 See Public Law 111–203, Section 765(c).
Although this provision refers to swaps and to
entities regulated by the CFTC, the Commission
believes that the Congress intended it to refer to
security-based swaps and to security-based swap
clearing agencies, SB SEFs, and SBS exchanges,
because Section 765 pertains to transactions in
security-based swaps and persons and entities
related thereto.
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The Commission must adopt the rules
required by Section 765 of the DoddFrank Act by January 17, 2011, which is
180 days after enactment of the DoddFrank Act.12 The Commission therefore
is proposing Regulation MC under the
Exchange Act to mitigate conflicts of
interest with respect to security-based
swap clearing agencies, SB SEFs, and
SBS exchanges.
This proposed rulemaking is among
the first that the Commission has
considered in connection with its
mandates under the Dodd-Frank Act,
and the Commission is mindful of the
considerations raised by this timing. In
particular, under the prescribed
timeframes of the Dodd-Frank Act, the
Commission must propose rules
required by Section 765 before it has the
opportunity to consider proposed rules
that also are likely to affect the
development of security-based swap
clearing agencies, SB SEFs, and SBS
exchanges, as well as the security-based
swaps market overall. The Commission
also notes that the market for securitybased swaps is in a nascent stage of
development compared to the markets
for equity securities and listed options
and that the market for security-based
swaps could develop further as the
Dodd-Frank Act is fully implemented
and these transactions continue to move
to central clearing and trading on
organized markets.
III. Discussion of Potential Conflicts of
Interest
A. Security-Based Swap Clearing
Agencies
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1. Current Regulatory Structure
Credit market events from the last few
years have demonstrated that a securitybased swaps market operating without
meaningful regulation 13 and central
counterparties 14 can pose systemic
12 Section 726 of the Dodd-Frank Act similarly
requires the CFTC to adopt rules designed to
mitigate conflicts of interest with respect to entities
under its jurisdiction that clear or trade swaps. See
Public Law 111–203, Section 726. The Commission
preliminarily believes that an entity that registers
with the Commission as either a security-based
swap clearing agency or a SB SEF is likely to
register also with the CFTC as a derivatives clearing
organization or swap execution facility,
respectively. As a result, the Commission staff and
the CFTC staff have consulted and coordinated with
one another regarding their respective agencies’
proposed rules to mitigate conflicts of interest.
13 See, generally, Policy Objectives for the OTC
Derivatives Market, The President’s Working Group
on Financial Markets (November 14, 2008)
(available at https://www.ustreas.gov/press/releases/
reports/policyobjectives.pdf).
14 See The Role of Credit Derivatives in the U.S.
Economy before the H. Agric. Comm., 110th Cong.
(2008) (Statement of Erik Sirri, Director of the
Division of Trading and Markets, Commission)
(available at https://agriculture.house.gov/testimony/
110/110-49.pdf).
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risks. In November 2008, under the
auspices of the President’s Working
Group on Financial Markets, the
Secretary of the Department of the
Treasury, the Chairs of the Board of
Governors of the Federal Reserve, the
Office of the Comptroller of the
Currency, the CFTC, and the
Commission established as a policy
objective for the OTC derivatives market
that regulators and prudential
supervisors require participants in a
central counterparty (‘‘CCP’’)
arrangement to clear all eligible
contracts through that CCP.15 In
furtherance of this policy objective, the
Commission, the Federal Reserve, and
the CFTC signed a Memorandum of
Understanding that established a
framework for consultation and
information sharing on issues related to
central counterparties for the OTC
derivatives market.16
The Commission has taken steps to
help foster the prompt development of
CCPs. In particular, the Commission
acted to authorize the clearing of OTC
security-based swaps by permitting
certain clearing agencies to clear credit
default swaps (‘‘CDS’’) on a temporary
conditional basis.17 Today, a significant
volume of CDS transactions is cleared
centrally and the Commission monitors
15 See supra note 13. See also Policy Statement
on Financial Market Developments, The President’s
Working Group on Financial Markets (March 13,
2008) (available at https://www.treas.gov/press/
releases/reports/
pwgpolicystatemktturmoil_03122008.pdf) and
Progress Update on March Policy Statement on
Financial Market Developments, The President’s
Working Group on Financial Markets (October
2008) (available at https://www.treas.gov/press/
releases/reports/q4progress%20update.pdf).
16 See Memorandum of Understanding Between
the Board of Governors of the Federal Reserve
System, the U.S. Commodity Futures Trading
Commission, and the U.S. Securities and Exchange
Commission Regarding Central Counterparties for
Credit Default Swaps (November 14, 2008)
(available at https://www.treas.gov/press/releases/
reports/finalmou.pdf).
17 The Commission authorized five entities to
clear credit default swaps. See Securities Exchange
Act Release Nos. 60372 (July 23, 2009), 74 FR 37748
(July 29, 2009) and 61973 (April 23, 2010), 75 FR
22656 (April 29, 2010) (CDS clearing by ICE Clear
Europe Limited); 60373 (July 23, 2009), 74 FR
37740 (July 29, 2009) and 61975 (April 23, 2010),
75 FR 22641 (April 29, 2010) (CDS clearing by
Eurex Clearing AG); 59578 (March 13, 2009), 74 FR
11781 (March 19, 2009), 61164 (December 14,
2009), 74 FR 67258 (December 18, 2009) and 61803
(March 30, 2010), 75 FR 17181 (April 5, 2010) (CDS
clearing by Chicago Mercantile Exchange Inc.);
59527 (March 6, 2009), 74 FR 10791 (March 12,
2009), 61119 (December 4, 2009), 74 FR 65554
(December 10, 2009) and 61662 (March 5, 2010), 75
FR 11589 (March 11, 2010) (CDS clearing by ICE
Trust US LLC); 59164 (December 24, 2008), 74 FR
139 (January 2, 2009) (temporary CDS clearing by
LIFFE A&M and LCH.Clearnet Ltd.) (collectively,
‘‘CDS Clearing Exemption Orders’’). LIFFE A&M and
LCH.Clearnet Ltd. allowed their order to lapse
without seeking renewal.
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the activities of these clearing
agencies.18
The Exchange Act does not impose
specific requirements regarding the
ownership structure of a clearing
agency. As a result, clearing agencies
may operate under a variety of
appropriate organizational structures
provided that they have the capacity to
meet the standards in Section 17A of the
Exchange Act.19 Certain clearing
agencies registered with the
Commission are owned either by
participants or by securities
exchanges.20 Other clearing agencies,
such as the security-based swap clearing
agencies that, once registered, would be
required to comply with proposed
Regulation MC, are subsidiaries of or
partly-owned by publicly traded
companies.21 These entities are not
wholly-owned by participants or
exchanges and may have different
governance related issues than the
securities clearing agencies currently
registered with the Commission.
Upon the effective date of Title VII of
the Dodd-Frank Act, clearing agencies
that clear and settle security-based swap
transactions will be subject to a number
of regulatory obligations that are
intended to promote the policy
objectives of the Dodd-Frank Act,
including increased clearing of securitybased swaps and effective risk
management. Accordingly, securitybased swap clearing agencies will be
required to be registered with, and
regulated by, the Commission under
Section 17A.22 In addition, all registered
18 To date most cleared CDS transactions have
cleared at ICE Trust US LLC (‘‘ICE Trust’’) or ICE
Clear Europe Limited (‘‘ICE Clear Europe’’). As of
October 8, 2010, ICE Trust had cleared
approximately $7.1 trillion notional amount of CDS
contracts based on indices of securities and
approximately $490 billion notional amount of CDS
contracts based on individual reference entities or
securities. As of October 8, 2010, ICE Clear Europe
had cleared approximately Ö3.09 trillion notional
amount of CDS contracts based on indices of
securities and approximately Ö560 billion notional
amount of CDS contracts based on individual
reference entities or securities. See https://
www.theice.com/marketdata/reports/
ReportCenter.shtml.
19 See 78q–1(b)(3)(A).
20 The Depository Trust and Clearing Corporation
(‘‘DTCC’’) is participant-owned and has three
separate subsidiaries that are registered clearing
agencies which function as quasi-utilities. The
Options Clearing Corporation is owned by five
unaffiliated options exchanges.
21 These clearing agencies include ICE Trust US
LLC, ICE Clear Europe Limited, Eurex Clearing AG,
and Chicago Mercantile Exchange Inc.
22 Section 763(b) of the Dodd-Frank Act adds new
Section 17A(k) to the Exchange Act, which
authorizes the Commission to exempt,
conditionally or unconditionally, a security-based
swap clearing agency from registration if the
Commission determines it is subject to comparable,
comprehensive supervision and regulation by the
CFTC or appropriate government authorities in the
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clearing agencies must comply with the
standards in Section 17A, which
include, but are not limited to,
maintaining rules for promoting the
prompt and accurate clearance and
settlement of securities transactions,
assuring the safeguarding of securities
and funds which are in the custody or
control of the clearing agency or for
which it is responsible, fostering
cooperation and coordination with
persons engaged in the clearance and
settlement of securities transactions,
removing impediments to and
perfecting the mechanism of a national
system for the prompt and accurate
clearance and settlement of securities
transactions, and, in general, protecting
investors and the public interest.23 A
registered clearing agency is also
required to provide fair access to
clearing and to have the capacity to
facilitate the prompt and accurate
clearance and settlement of securities
transactions and derivative agreements,
contracts, and transactions for which it
is responsible, as well as to safeguard
securities and funds in its custody or
control or for which it is responsible.24
Pursuant to Section 765 of the DoddFrank Act, the Commission must
identify the nature and sources of any
conflicts of interest relating to the voting
interests in and governance of a
security-based swap clearing agency
that may interfere with achieving the
policy objectives described above or
with the clearing agency complying
with the regulatory mandates of Section
17A of the Exchange Act described
above, including the obligation to adopt
rules consistent with the protection of
investors and the public interest.
2. Sources of Conflicts of Interest
The Commission’s experience in
monitoring the activities of the clearing
agencies engaged in clearing CDS has
provided it with insight into the
potential sources of conflicts of interest
that may exist at security-based swap
clearing agencies. Since shortly after the
enactment of the Dodd-Frank Act, the
Commission staff and staff from the
CFTC have met with interested persons
to learn more about potential conflicts.
Moreover, on August 20, 2010, the staff
of the Commission and CFTC held a
joint public roundtable in part to gain
further insight into the sources of
conflicts of interest at security-based
swap clearing agencies, SB SEFs, and
home country of the security-based swap clearing
agency. See Public Law 111–203, Section 763(b).
23 See 15 U.S.C. 78q–1(b)(3)(F). Section 17A of
the Exchange Act also includes standards that help
to mitigate conflicts of interest. See infra Section
IV.C. for a discussion of these standards.
24 15 U.S.C. 78q–1(b)(3)(A), (B), and (F).
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SBS exchanges, as well as methods for
mitigating conflicts of interest
(‘‘Conflicts Roundtable’’).25 Panelists
from this roundtable included industry
and non-industry participants.26
Drawing on these experiences, the
Commission has reviewed the potential
for conflicts of interest at security-based
swap clearing agencies in accordance
with Section 765 of the Dodd-Frank Act
and has identified those conflicts that
could affect access to clearing agency
services, products eligible for clearing,
and risk management practices of the
clearing agencies. Preliminarily, the
Commission believes that the most
significant conflicts of interest that may
have an adverse effect on statutory goals
in Section 765 of the Dodd-Frank Act
are those that arise when a small
number of participants,27 including
participants that are Specified Entities
and including related persons of the
participants,28 exercise undue control or
influence over a security-based swap
clearing agency.
The Commission has identified three
key areas where it believes a conflict of
interest of participants who exercise
undue control or influence over a
security-based swap clearing agency
could adversely affect the central
clearing of security-based swaps. First,
participants could limit access to the
security-based swap clearing agency,
either by restricting direct participation
in the security-based swap clearing
agency or restricting indirect access by
controlling the ability of nonparticipants to enter into correspondent
clearing arrangements.29 Second,
participants could limit the scope of
products eligible for clearing at the
security-based swap clearing agency,
particularly if there is a strong economic
incentive to keep a product traded in
25 See Securities Exchange Act Release No. 62725,
75 FR 51305 (August 19, 2010). The Commission
solicited comments on the Conflicts Roundtable
(comments received by the Commission are
available at https://sec.gov/cgi-bin/rulingcomments?ruling=4-609&rule_path=/comments/4609&file_num=4609&action=Show_Form&title=SEC%2DCFTC
Roundtable on Swaps and Security%2DBased
Swaps%3A Notice of roundtable discussion and
request for comment).
26 The transcript of the Conflicts Roundtable is
available on the CFTC’s Web site at https://cftc.gov/
ucm/groups/public/@newsroom/documents/file/
derivative9sub082010.pdf.
27 The term ‘‘participant’’ when used with respect
to a clearing agency has the meaning set forth in
Section 3(a)(24) of the Exchange Act, 15 U.S.C
78c(a), and shall include Specified Entities. See
proposed Rule 700(o) under Regulation MC.
28 See infra Section IV.A.3. for a discussion of
‘‘related person’’ in the context of a security-based
swap clearing agency.
29 See, generally, Matthew Leising and Shannon
D. Harrington, ‘‘Wall Street Dominance of Swaps
Must End, Brokers Say (Update 1),’’ Bloomberg
(March 16, 2010).
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the OTC market for security-based
swaps. Third, participants could use
their influence to lower the risk
management controls of a security-based
swap clearing agency in order to reduce
the amount of collateral they would be
required to contribute and liquidity
resources they would have to expend as
margin or guaranty fund to the securitybased swap clearing agency.
Each of these potential conflicts of
interest could limit the benefits of a
security-based swap clearing agency in
the security-based swaps market, and
even potentially cause substantial harm
to that market and the broader financial
markets, as described below. Conflicts
of interest in these areas could also
potentially undermine the mandatory
clearing requirement in Section 763 of
the Dodd-Frank Act, thereby affecting
transparency, investor protection, risk
management, efficiency, and
competition in the security-based swaps
market.30
a. Limitations on Open Access to
Security-Based Swap Clearing Agencies
The Commission believes that the
increased use of central clearing for
security-based swaps should help to
promote robust risk management, foster
greater efficiencies, improve investor
protection, and promote transparency in
the market for security-based swaps. For
these reasons, the Commission has
encouraged the use of central clearing
for security-based swaps.31 A
consequence of increased use of central
clearing services, however, is that
participants that control or influence a
security-based swap clearing agency
may gain a competitive advantage in the
security-based swaps market by
restricting access to the clearing agency.
If that occurred, financial institutions
and marketplaces that do not have
access to central clearing would have
limited ability to trade in or list
security-based swaps. This problem
would continue to exist after the
mandatory clearing requirement under
Section 763 of the Dodd-Frank Act
becomes effective, because financial
institutions may be required either to
submit security-based swaps for central
30 See Public Law 111–203, Section 763(a).
Section 763(a) of the Dodd-Frank Act adds new
Section 3C to the Exchange Act, which requires
clearing for certain security-based swaps.
Specifically, Section 3C(a)(1) provides that ‘‘It shall
be unlawful for any person to engage in a securitybased swap unless that person submits such
security-based swap for clearing to a clearing
agency that is registered under the Exchange Act or
a clearing agency that is exempt from registration
under the Exchange Act if the security-based swap
is required to be cleared.’’
31 See CDS Clearing Exemption Orders, supra
note 17.
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clearing or face heightened capital or
margin requirements associated with
bilateral agreements.
Market participants generally obtain
access to a clearing agency in one of two
ways: (1) Directly, by becoming a
participant in a clearing agency or (2)
indirectly, by entering into a
correspondent clearing arrangement
with a participant in a clearing
agency.32 There are several ways that
both direct and indirect access to a
security-based swap clearing agency
could be restricted if persons who make
decisions for or act on behalf of the
clearing agency have a conflict of
interest because of their incentives to
further their own business interests
outside of the security-based swap
clearing agency. Participants may seek
to limit the number of other direct
participants in a security-based swap
clearing agency in order to limit
competition and increase their ability to
maintain higher profit margins. A
security-based swap clearing agency
that is controlled by a limited number
of participants might also adopt policies
and procedures that are designed to
unduly restrict access, or have the effect
of unduly restricting access, to the
clearing agency by other participants in
ways that are unrelated to sound risk
management practices.33 At the same
time, affording greater access to the
clearing agency at some point may come
at the expense of sound risk
management practices.
The Commission recognizes that
security-based swap clearing agencies
must establish reasonable participation
standards in order to ensure the
participants in the clearing agency do
not expose it to unacceptable risk or
otherwise adversely affect the
performance of the clearing agency,
particularly during periods of market
stress. However, participant standards
may have the effect of restricting access
to the clearing agency. On the one hand,
panelists at the Conflicts Roundtable
and others have raised the concern that
participation requirements could be
unnecessarily restrictive and primarily
designed to limit the number of entities
that are permitted to become direct
participants in the clearing agency.34
32 Correspondent clearing is an arrangement
between a current participant of a clearing agency
and a non-participant that desires to use the
clearing agency for clearance and settlement
services.
33 An example of such restrictive policies and
procedures would be a clearing agency establishing
prohibitively high participation standards so that
only the largest financial institutions qualify as
participants.
34 See, generally, Swaps and Derivatives Market
Association, ‘‘Lessening Systemic Risk: Removing
Final Hurdles to Clearing OTC Derivatives’’
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While appropriate participation
standards are necessary for the sound
operation of the security-based swap
clearing agency, unduly high standards
may needlessly exclude persons who
are otherwise qualified to clear securitybased swaps. On the other hand, some
panelists at the Conflicts Roundtable
also suggested that increasing access can
come at the expense of sound risk
management practices.35
Access could also be restricted by the
way that clearing members determine
executable end-of-day settlement prices.
Since there is currently no exchange or
other venue that publishes securitybased swap prices, the Commission has
required security-based swap clearing
agencies to publish end-of-day
settlement prices and any other prices
with respect to cleared security-based
swaps that the security-based swap
clearing agency may use to calculate
mark-to-market requirements.36 To
ensure that end-of-day settlement prices
are reliable and consistent, a securitybased swap clearing agency may require
that the price submission be
executable.37 The security-based swap
clearing agency, however, might not
permit an entity to rely on a third party
to provide an executable end-of-day
settlement price. This could potentially
prevent all but the largest dealer firms
from having direct access to the clearing
agency as they may be the only firms
that have the processes to determine
executable end-of-day settlement
prices.38
(available at https://media.ft.com/cms/fe51a53878d7-11df-a312-00144feabdc0.pdf) (‘‘SDMA
Letter’’). See also Public Roundtable on Governance
and Conflicts of Interest in the Clearing and Listing
of Swaps, comments of Darrell Duffie (‘‘[W]e want
to be very careful that the members of a central
clearing counterparty that determine what gets
cleared * * * are the members that have * * * the
right social incentives to create competition.’’)
(available at https://cftc.gov/ucm/groups/public/
@newsroom/documents/file/derivative9
sub082010.pdf at 62).
35 See supra note 25.
36 See, e.g., CDS Clearing Exemption Orders,
supra note 17.
37 As part of their internal processes, securitybased swap clearing agencies generally calculate
end-of-day settlement prices for each product in
which they hold a cleared interest each business
day. See, e.g., Letter from Kevin McClear, ICE Trust,
to Elizabeth Murphy, Secretary, Commission,
December 4, 2009, and letter from Ann K. Shuman,
Managing Director and Deputy General Counsel,
CME, to Elizabeth Murphy, Secretary, Commission,
December 14, 2009. One method for calculating an
end-of-day settlement price for open positions is
based on prices submitted by participants. As part
of this mark-to-market process, the security-based
swap clearing agency may periodically require
participants to execute certain security-based swap
trades at the applicable end-of-day settlement price.
This is designed to ensure that participants’
submitted prices reflect their best assessment of the
value of their open positions on a daily basis. Id.
38 See SDMA Letter, supra note 34.
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In situations where direct access is
limited by reasonable participation
standards, non-participant firms may be
able to access the security-based swap
clearing agency through correspondent
clearing arrangements with direct
participants. Correspondent clearing is
common in securities markets as well as
in futures markets. However, the nonparticipant firms ultimately would be
required to enter into a correspondent
clearing arrangement with a participant
in order to have the transactions
submitted to the security-based swap
clearing agency. Thus, the success of
correspondent clearing arrangements
depends on the willingness of securitybased swap participants to enter into
such arrangements with non-participant
firms that may act as direct competitors
to the participants. Given that current
participants may have an incentive to
restrict access to potential competitors,
correspondent clearing arrangements
may not be readily established while
only the large dealer firms are direct
participants in the security-based swap
clearing agency.
In addition, procedural barriers may
prohibit a firm from having indirect
access to a security-based swap clearing
agency. For example, although there are
no overt restrictions on indirect access
at the currently exempted securitybased swap clearing agencies, many of
the processing platforms by which
participants submit transactions to the
security-based swap clearing agency do
not have the functionality to allow a
non-participant firm to submit a trade
with a customer to the security-based
swap clearing agency through a
correspondent arrangement with a
direct member.
Prohibitively burdensome or
restrictive direct participation standards
and lack of availability of correspondent
clearing arrangements effectively deny
non-participant firms access to the
security-based swap clearing agency’s
services and, accordingly, create a
substantial competitive advantage for
those firms that are direct participants
in the security-based swap clearing
agency. As previously noted, this
competitive advantage would become
even more significant after the
mandatory clearing requirement for
security-based swaps in the Dodd-Frank
Act becomes effective.
b. Limitations on the Scope of Products
Eligible for Clearing
As discussed above, Congress found
and the Commission believes that
increased use of central clearing would
provide significant benefits to the
security-based swaps market and
mitigate systemic risk, particularly
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during times of financial crisis. Central
clearing of security-based swaps likely
would result in lower spreads and lower
transaction costs for end-users. A
participant in a security-based swap
clearing agency might, however, derive
greater revenues from its activities in
the OTC market for security-based
swaps than it would from sharing in the
profits of a security-based swap clearing
agency in which it holds a financial
interest. As a result, the increased use
of central clearing may be contrary to
the economic interests of some
participants to a security-based swap
clearing agency. Such participants or
their related persons could therefore
seek to have the security-based swap
clearing agency limit the types of
security-based swaps that are eligible for
clearing at a security-based swap
clearing agency over which they
exercise influence or control.39
A further incentive for a clearing
agency controlled by participants to
restrict the products that are eligible for
clearing at the security-based swap
clearing agency may be to control a
security-based swap’s price
transparency. Trading in the OTC
derivatives market is currently
dominated by a small number of firms.40
Prior to the use of clearing agencies to
clear security-based swaps, end-users
had to transact directly with a small
number of firms to trade in securitybased swaps without the benefit of
publicly available pricing data.
Security-based swap clearing agencies
provide greater price transparency by
making certain price data available to
the public and thereby helping to
reduce the information asymmetry that
benefits firms in the OTC market.41
39 Representative Barney Frank, who chaired the
conference committee that reconciled the House
Bill and the Senate Bill, referred to this specific
concern when discussing the amendment adding
Section 765 to the Dodd-Frank Act. Chairman Frank
stated, ‘‘The purpose of this in part is to get many
more derivatives cleared. But the clearing houses
have the right to refuse them if they say the
transactions aren’t suitable for clearing. We believe
that some banks have an interest in not having them
cleared. So we don’t want entities that have an
interest and [sic] there being no clearing, owning
the clearing houses. That’s why this is an important
amendment to us, and it was passed after
considerable debate on the House floor.’’ HouseSenate Conf. Comm. Holds Markup on HR 4173,
Financial Regulatory Overhaul Bill, June 24, 2010,
reprinted in CQ Congressional Transcripts, 111th
Cong. 182 (2010) (statement of Barney Frank,
Chairman, House Comm. on Fin. Serv.).
40 See Office of the Comptroller of the Currency,
Quarterly Report on Bank Trading and Derivatives
Activities, First Quarter 2010. (‘‘Derivatives activity
in the U.S. banking system continues to be
dominated by a small group of large financial
institutions. Five large commercial banks represent
97% of the total banking industry notional amounts
* * *.’’)
41 See Darrell Duffie, Ada Li, and Theo Lubke,
‘‘Policy Perspectives on OTC Derivatives Market
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Publicly available pricing data may
result in reducing the spreads and
reduce the profit per trade for firms that
have dominated the OTC market.
While certain security-based swaps
may be suitable for central clearing, the
Commission recognizes the possibility
that some security-based swaps may not
be suitable for clearing if their risks
cannot be adequately managed by the
security-based swap clearing agency.
Clearing products whose risks cannot be
adequately managed may increase the
potential of a default of a participant or
even the failure of the security-based
swap clearing agency.42 This in turn
could adversely affect systemic risk, as
participants and their customers would
likely have significant funds and
securities tied to the clearing agency
and would be dependent on the
continued operations of a security-based
swap clearing agency in order to enter
into new transactions in security-based
swaps. This again highlights the
potential tensions between sound risk
management and the increased use of
central clearing services. Expanding the
number and scope of products cleared
would in some cases be in the best
interests of the security-based swap
clearing agency and the security-based
swaps market generally, because it
provides processing efficiencies and
replaces bilateral counterparty risk.
However, allowing a greater number and
scope of products to be centrally cleared
would in some cases be harmful to the
security-based swap clearing agency and
the security-based swaps market, if
sound risk management standards are
compromised in order to clear those
products.
The Commission is mindful of the
need to balance goals associated with
promoting the central clearing of
security-based swaps and assuring that
proposed rules are designed to increase
the number of products eligible for
central clearing with the goals
associated with effective risk
management. The Commission is also
aware that any rules that it may
ultimately adopt relating to conflicts of
interest may affect this balance. The
Infrastructure,’’ Federal Reserve Bank of New York
Staff Report No. 424, dated January 2010, as revised
March 2010 (‘‘Even after an OTC derivatives
product has achieved relatively active trading
* * * dealers have an incentive to maintain the
wide bid-ask spreads that they can obtain in the
OTC market * * *. Thus, from the viewpoint of
profits, dealers may prefer to reduce the migration
of derivatives trading from the OTC market to
central exchanges.’’).
42 Section 763(a) adds new Section 3C(d)(3)(A) to
the Exchange Act, which prohibits the Commission
from requiring any clearing agency to accept a
security-based swap for central clearing. See Public
Law 111–203, Section 763(a).
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Commission believes, however, that
decisions regarding the products that
are eligible for clearing by a securitybased swap clearing agency should not
be subject to undue influence by parties
that have a financial interest in keeping
such products from being centrally
cleared, while also noting that nonparticipants may have an interest in
increasing access, which potentially
could serve to compromise effective risk
management.
c. Reduced Risk Management Controls
Security-based swap clearing agencies
will perform a critical function in
mitigating financial risk for market
participants. The Commission believes
that through uniform margining and
other risk controls, including controls
over market-wide concentrations that
cannot be implemented effectively
when counterparty risk management is
decentralized, security-based swap
clearing agencies would help to prevent
a single market participant’s failure
from destabilizing other market
participants and, ultimately, the broader
financial system.
Although participants may seek to
raise risk management controls in order
to restrict access to the clearing agency
or protect their financial stake in the
clearing agency, they might also seek to
lower certain risk management controls
such as margin requirements in order to
release collateral that they may wish to
use for other purposes. Furthermore, as
security-based swap clearing agencies
become more established and the
mandatory clearing requirement under
Section 763 is implemented, more
security-based swaps will likely be
centrally cleared and clearing
participants will be required to provide
a substantially larger amount of liquid
collateral to security-based swap
clearing agencies in the form of margin.
As a result, participants may be willing
to accept greater risk than is prudent for
the security-based swap clearing agency
in order to reduce the amount of their
margin contributions. A reduction in
risk management controls ultimately
could function to increase systemic risk
by increasing the potential for a
financial loss that must be borne by the
participants of the security-based swap
clearing agency.43
The Commission recognizes that
participants generally have a financial
incentive to ensure that the securitybased swap clearing agency collects
sufficient margin from each participant.
43 Such a scenario would arise, for example,
where a defaulting participant has contributed
insufficient margin to meet its obligations to the
security-based swap clearing agency.
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A clearing agency’s rules and
procedures typically provide that in the
event of a participant default, losses
exceeding a participant’s individual
margin contribution may be satisfied
from a guaranty fund composed of
contributions from all participants. As a
result, participants have a unique
financial incentive to ensure that the
security-based swap clearing agency has
sufficient collateral from each
participant to withstand a participant
default in almost all market conditions.
However, participant defaults occur
infrequently and the incentive for
participants to protect their guaranty
fund contributions may have less weight
than the incentive to reduce margin
requirements in order to release margin
collateral for immediate use.
A non-participant does not contribute
to a guaranty fund and may not have the
same incentives as a participant with
respect to establishing and maintaining
sufficiently robust participant margin
requirements. Non-participants’
incentives may be to focus less on risk
management and focus more on
allowing more participants to be
admitted to the clearing agency and
more products to be made eligible for
central clearing.
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d. Implications for Ownership and
Governance
As described above, conflicts of
interest may arise if participants
exercise undue control or influence over
a security-based swap clearing agency.
This influence, typically acquired
through an ownership stake in the
clearing agency, generally may be
exercised by participants through either
(i) voting interests in the security-based
swap clearing agency or (ii)
participation in the governance of the
security-based swap clearing agency,
such as by selecting (or influencing the
selection of) the directors of the
security-based swap clearing agency.44
In either case, undue control or
influence may be particularly acute if (i)
the participants are part of the process
for nominating the directors, even if
such participants are not themselves
directors, or (ii) the election of directors
is subject to concentrated voting power
in a small number of participants,
especially if such participants also
44 Section 765 of the Dodd-Frank Act authorizes
the Commission to adopt rules regarding conflicts
of interest of Specified Entities at security-based
swap clearing agencies in general. However, the
Commission preliminarily believes that those
entities that are participants in a security-based
swap clearing agency will have a conflict of interest
that could be acted upon to adversely affect the
development of the market for security-based swaps
consistent with the policy objectives of Section 765
of the Dodd-Frank Act.
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dominate much of the trading in
security-based swaps and could use
their controlling position to maintain or
extend their dominant market position.
In addition, it is important to consider
the likely incentives of individual
directors, once they are on the Board,
when they are governing the securitybased swap clearing agency.45 Directors
of a security-based swap clearing agency
owe a fiduciary duty to the securitybased swap clearing agency and all of its
shareholders. In addition, among other
obligations, the Board as a whole is
ultimately responsible for overseeing
the clearing agency’s compliance with
the regulatory obligations of securitybased swap clearing agencies under the
Dodd-Frank Act and the Exchange Act,
including the open and fair access
requirements. At the same time,
however, directors may be subject to
different perspectives when fulfilling
these duties and roles. Although the
Commission recognizes that incentives
and motivations may vary among
directors and over time for a range of
reasons—and therefore it is not possible
to predict precisely how any individual
director will address a particular
matter—directors who are appointed by
or related to participants (‘‘participantrelated directors’’) may on balance be
more likely to reflect the views of
participants than would directors who
are not appointed by or related to
participants (‘‘non-participant-related
directors’’).46
In light of these dynamics, as between
the two categories of directors,
participant-related directors, like
participants themselves, may on balance
be more likely to favor reducing or
minimizing the risk exposure of the
clearing agency, potentially at the
expense of more open access. In
addition, participant-related directors
may also be more likely to favor
45 The Commission’s discussion in this Release of
the motivations or incentives of directors of a
clearing agency, SB SEF, or SBS exchange comes in
the context of requiring modes of governance that
permit consideration of a variety of perspectives. As
noted throughout this Release, a company’s
directors have a duty to all the company’s
shareholders, and the Commission does not regard
any directors as simply surrogates for a particular
group of shareholders. The Commission’s
discussion is intended to forestall possible conflicts
and does not reflect findings that particular
conflicts are present.
46 This distinction between participant-related
and non-participant-related directors may be most
significant where the clearing agency is (i) a
publicly owned corporation, or part of a publicly
owned corporation, or (ii) otherwise owned by
persons other than participants. The Commission
recognizes that ownership structures for clearing
agencies may take other forms, including ownership
solely by participants, in which case the incentives
and perspectives of the directors may be somewhat
different.
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restricting access to the clearing agency,
which as discussed above would serve
to preserve profits that participants earn
through trading security-based swaps in
the OTC markets.
In contrast, non-participant-related
directors may, on balance, be more
likely to seek to maximize the value of
the enterprise, which, in addition to
sound risk management, may involve
increasing the revenues of the securitybased swap clearing agency, such as by
expanding the number and scope of
products being cleared. Moreover, at a
minimum it would seem less likely that
non-participant-related directors would
favor unduly restricting access to the
clearing agency and its services. Thus,
non-participant-related directors may be
inclined to favor expanded access to
products and services, which may
increase the amount of risk that the
clearing agency must successfully
manage. The interest in expanded
access to products and services may be
especially relevant in the early stages of
a clearing agency’s development, when
establishing a new entity as a viable
clearing agency is especially important.
The Commission recognizes that other
factors may also affect director
incentives and behavior. For example, it
may be argued that participant-related
directors may in general have greater
risk management expertise and
experience than non-participant-related
directors, and that non-participantrelated directors may tend to defer to
the views or judgment of participants or
participant-related directors on risk
matters, with the effect that open access
may be unduly compromised in favor of
risk management. On the other hand, it
may be argued that qualified nonparticipant-related directors with
sufficient risk management expertise
can be readily found, and in any event
these directors’ independence of
participants would justify their
heightened involvement on the Board.
In addition, directors may face other
conflicts of interest. For example, there
may be conflicts between the competing
interests of different shareholders—
whether or not participants—which
could have implications for director
behavior, as discussed more fully below.
There also may be a tension between the
directors’ incentives to maximize profits
and their duties to oversee the securitybased swap clearing agency’s
compliance with applicable legal
restrictions which, although not
necessarily unique to clearing agencies,
may nevertheless affect how they decide
any particular matter.
As described more fully below, the
proposed rules are intended to strike a
balance among these various
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considerations by allowing participants
to maintain a significant voice within a
security-based swap clearing agency
while also imposing ownership
limitations and independent director
requirements to mitigate the potential
influences of participant owners and
participant-related directors.
e. Request for Comments Regarding
Identified Conflicts of Interest
The Commission requests comment
on the conflicts of interest it has
identified with respect to security-based
swap clearing agencies, including the
conflicts related to participant
standards, product eligibility, and risk
management. Do commenters agree with
the potential conflict concerns that the
Commission has identified? Some
parties have questioned the benefits of
central clearing generally in terms of
reducing systemic risk,47 potentially
suggesting a different analysis with
respect to the identified conflicts of
interest. What are commenters views on
the potential benefits and costs of
central clearing and the resulting effect
on the conflicts of interest analysis?
What effect would the identified
conflicts of interest likely have? Should
the Commission focus on any of these
conflicts more than others? Are there
other existing conflicts concerns that
commenters believe warrant scrutiny? If
so, what are they and how are they
likely to affect security-based swap
clearing agencies?
The conflicts of interest discussed in
part stem from the current concentrated
market structure for security-based
swaps. How is the current market
structure likely to evolve over time?
What effect will that evolution have on
the consideration of conflicts of
interest? Are there any other conflicts of
interest that may result due to expected
changes in the security-based swaps
market or the clearing of security-based
swaps that the Commission should
consider? If so, what are they and how
are they likely to affect security-based
swap clearing agencies?
The central clearing of security-based
swaps is still developing and may
change significantly as the market for
security-based swaps develops. In
particular, the new provisions in the
Dodd-Frank Act relating to the central
clearing of security-based swaps are not
yet effective. Once they become
effective, security-based swap clearing
agencies will be subject to substantially
more regulation, which may have an
effect on conflicts of interest. How are
47 See, e.g., Craig Pirrong, ‘‘The Inefficiency of
Clearing Mandates,’’ Cato Institute Policy Analysis
No. 665, July 21, 2010.
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conflicts of interest likely to change as
the central clearing of security-based
swaps, and security-based swap clearing
agencies, become more established?
What potential new conflicts of interest
could arise that the Commission should
consider? How will potential changes in
the trading of security-based swaps
affect conflicts of interest at securitybased swap clearing agencies? In
addition, competitive forces within the
security-based swaps market may help
to mitigate conflicts of interest, for
example, by increasing the number of
institutions that trade in security-based
swaps and creating a broader market in
security-based swaps. How might
competition issues affect or change
current conflicts of interest? Will
competition potentially create different
or additional conflicts of interest that
the Commission should consider? Will
competition potentially mitigate
conflicts of interest?
What other parties may have conflicts
of interest that would affect whether
they should control or participate in the
governance of a security-based swap
clearing agency? In what circumstances
do these conflicts of interest arise?
Under certain circumstances, there is
the potential that incentives of
shareholders to maximize profits could
compromise prudent risk management
by a security-based swap clearing
agency. For example, shareholders
could seek to increase revenue from
clearing fees by increasing the number
of products cleared by the clearing
agency beyond those that can be
appropriately risk managed or by having
the clearing agency expand its services
or engage in new lines of business that
would expose the security-based swap
clearing agency to increased risk.
Shareholders that are not users of a
security-based swap clearing agency
may also not have the same incentives
to keep the costs of clearing low. The
Commission requests comment on the
conflicts of interest that non-participant
shareholders may have and the effect
such conflicts could have on a securitybased swap clearing agency. What are
the differences in conflicts of interest
between participants and nonparticipants? What are the different
effects these conflicts could have on a
security-based swap clearing agency?
Which conflicts of interest could
potentially cause the greatest harm to
the security-based swap clearing
agency?
Do persons who are selected to be
directors of a security-based swap
clearing agency by participants have a
conflict of interest based on their status
as directors that would affect their
ability to act in the best interest of the
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65889
clearing agency, to act in conformity
with the Exchange Act, or to act to meet
the policy objectives in Section 765 of
the Dodd-Frank Act? Would directors be
less likely to act to meet the policy
objectives in Section 765 of the DoddFrank Act if they are selected by
shareholders seeking to maximize the
profits of the security-based swap
clearing agency? What effect would they
likely have on security-based swap
clearing agencies? How do participants’
conflicts of interest that affect risk
management and open access issues
compare with non-participants’ interests
regarding these issues? How do
participants’ incentives with respect to
risk management compare with the
incentives of non-participant
shareholders or directors? How do the
incentives of independent directors
differ from the non-independent
directors in terms of considering the
potential for conflicts of interest?
The Commission also requests
comment on the interplay of the
identified conflicts of interest, and any
additional conflicts of interest identified
by commenters, and how that may affect
a security-based swap clearing agency.
For example, there may at times be a
trade-off between risk management
standards and open access to the
clearing agency. What is the best way to
balance these and other potential
conflicts of interest in order to assure
that the clearing agency has both robust
risk management and fair and open
access to clearing services? Are there
any other conflicts of interest that pose
similar trade-offs? What conflicts are
these and how should the Commission
balance the related concerns?
The Commission recognizes that other
conflicts of interest may arise in the
governance of security-based swap
clearing agencies—for example, there
may be a conflict between the interests
of certain shareholders. The rules the
Commission is proposing today focus on
the conflicts of interest presented by the
potential influence of participants in the
security-based swaps market because, as
described above, the Commission
believes those conflicts may be most
relevant to the development of securitybased swap clearing agencies. The
Commission recognizes that conflicts of
interest may also arise with respect to
independent directors and has
attempted to achieve a balance between
the different incentives of participantrelated and non-participant-related
directors and the potential benefits each
might bring to the Board of a securitybased swap clearing agency.
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B. Security-Based Swap Execution
Facilities and National Securities
Exchanges
The Commission has also reviewed
the potential for conflicts of interest at
SB SEFs and SBS exchanges in
accordance with Section 765 of the
Dodd-Frank Act and has identified
those conflicts that it believes may be
mitigated by rules designed to improve
the governance of a SB SEF or SBS
exchange, promote competition, or
mitigate conflicts of interest in
connection with the operation of a SB
SEF or SBS exchange by a securitybased swap execution facility
participant (‘‘SB SEF participant’’) 48 or a
member of an SBS exchange (‘‘SBS
exchange member’’) 49 that has an
ownership interest in the SB SEF or SBS
exchange. As with security-based swap
clearing agencies, the Commission
preliminarily believes that conflicts of
interest that may have an adverse affect
on the statutory goals of Section 765 are
those that arise when a small number of
market participants, including
participants that are Specified Entities
and including related persons of
participants,50 exercise control or undue
influence over a SB SEF or SBS
exchange. This influence may be
exercised either through ownership of
voting interests 51 or participation in the
governance of the SB SEF or SBS
exchange.
The Commission believes that
through ownership of voting interests or
ability to influence governance, market
participants could exercise influence
with respect to the services provided by
SB SEFs or SBS exchanges, the rules
and policies applicable to participants
or members of such entities, and, more
generally, the security-based swaps
48 The term ‘‘security-based swap execution
facility participant’’ means a person permitted to
directly effect transactions on the security-based
swap execution facility. See proposed Rule 700(z)
under Regulation MC.
49 A ‘‘member’’ when used with respect to a
national securities exchange means (i) any natural
person permitted to effect transactions on the floor
of the exchange without the services of another
person acting as broker, (ii) any registered broker or
dealer with which such a natural person is
associated, (iii) any registered broker or dealer
permitted to designate as a representative such a
natural person, and (iv) any other registered broker
or dealer which agrees to be regulated by such
exchange and with respect to which the exchange
undertakes to enforce compliance with the
provisions of the Exchange Act, the rules and
regulations thereunder, and its own rules. See
Section 3(a)(3)(A) of the Exchange Act, 15 U.S.C.
78c(a)(3)(A).
50 See infra Section V.A. for a discussion of
‘‘related person’’ in the context of a SB SEF and SBS
exchange or facility thereof.
51 See infra Section V.A. for a discussion of the
ownership and voting limits of proposed Rule 702
under Regulation MC.
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market. When a small group of those
same market participants also dominate
much of the trading in security-based
swaps, control of a SB SEF or SBS
exchange by these participants raises a
heightened concern. If a SB SEF or a
SBS exchange is controlled by a small
group of dealers who also dominate
trading in the market for security-based
swaps, the dealers may have
competitive incentives to exert undue
influence to control the level of access
to the SB SEF or SBS exchange and thus
impede competition by other market
participants. In other words,
participants or members in a SB SEF or
SBS exchange, as applicable, might seek
to limit the number of direct
participants in the trading venue in
order to limit competition and increase
their ability to maintain higher profit
margins. Given such incentives, a SB
SEF or SBS exchange that is controlled
by a limited number of participants or
members might adopt policies and
procedures that are designed to restrict
access.
Participants or members also might be
motivated to restrict the scope of
security-based swaps that are eligible for
trading at SB SEFs or SBS exchanges if
there is a strong economic incentive to
keep such swaps in the OTC market. On
the other hand, this concern may be
mitigated by competitive forces if a
greater number and variety of facilities
where security-based swaps can be
traded are available. A small number of
firms currently dominate trading in the
OTC derivatives market.52 Centralized
trading of security-based swaps likely
would result in lower spreads and lower
transaction costs for end-users,
particularly as a result of increased pretrade and post-trade transparency of
prices, assuming sufficient trading
volume and liquidity.53 As noted above,
increased price transparency might help
to eliminate much of the basis for
asymmetrical information, reduce
spreads, and reduce the profit per trade
for firms that dominated the OTC
security-based swaps market. As a
result, this might create an incentive for
participants or members in a SB SEF or
SBS exchange, as applicable, to seek to
limit the number of security-based
swaps that are made available for
trading by such venues. The
Commission recognizes, however, that
there could in certain circumstances be
legitimate concerns regarding liquidity
or other trading characteristics of a
security-based swap that reasonably
52 See
supra note 40.
Commission will address the issue of
transparency of security-based swap pricing and
transaction data in a separate rulemaking.
53 The
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might justify the decision of participants
in a SB SEF or members of a SBS
exchange not to make a particular
product available for trading on a SB
SEF or a SBS exchange. However,
decisions regarding the eligibility of
security-based swaps for trading on a SB
SEF or SBS exchange should not be
subject to undue influence by parties
that have a financial interest in keeping
such products from being centrally
traded on a facility or exchange.
Finally, the Commission also believes
that a SB SEF or SBS exchange could
have potential conflicts of interest
between the commercial interests of the
SB SEF or SBS exchange or the SB SEF’s
or SBS exchange’s owners and the SB
SEF’s or SBS exchange’s market
oversight responsibilities.54 With
respect to these kinds of conflicts of
interest, the Commission’s proposal is
informed, in part, by its experience
overseeing national securities
exchanges. The Commission notes,
however, that a SB SEF’s regulatory
obligations under Section 763(c) of the
Dodd-Frank Act are not identical to
those of a national securities exchange’s
obligations under Section 6 of the
Exchange Act.
National securities exchanges are selfregulatory organizations (‘‘SROs’’) and
are statutorily required to comply, and
enforce compliance by their members
and their associated persons, with the
Federal securities laws, the rules and
regulations thereunder, and their own
rules.55 Exchanges also generally
operate for-profit markets and, as a
result, are concerned with preserving
and enhancing their competitive
`
positions vis-a-vis other exchanges.56
Consequently, exchanges have potential
conflicts of interest between carrying
out their regulatory obligations to
vigorously oversee their members and
marketplace and promoting their and
their shareholders’ economic interests.
For example, an exchange could put its
interest and that of its members or
54 An entity that registers as a SB SEF will have
oversight responsibility over its market pursuant to
the Exchange Act (as amended by the Dodd-Frank
Act) and rules adopted thereunder. See Section
763(c) of the Dodd-Frank Act, Public Law 111–203,
Section 763(c). Similarly, all national securities
exchanges, including those that may post or make
available for trading security-based swaps, have
oversight responsibilities over their markets and
their members pursuant to the Exchange Act. See
Section 6 of the Exchange Act, 15 U.S.C. 78(f).
55 See Sections 6(b)(1) of the Exchange Act, 15
U.S.C. 78f(b)(1).
56 Historically, national securities exchanges were
structured as not-for-profit or similar organizations
owned by their members. Exchanges, however, have
more recently evolved to become shareholderowned. See supra note 49 for the definition of
‘‘member’’ as applicable to national securities
exchanges.
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shareholders ahead of its regulatory
responsibilities by failing to take
regulatory or enforcement actions or to
adequately fund self-regulation. Further,
the commercial interests of the
shareholders of an exchange may
conflict with the regulatory obligations
of an exchange. A shareholder may be
incentivized to maximize profits
through the economic stake it has in the
exchange or, if the shareholder is also a
member of the exchange, to more
directly further its own commercial
interests.57 For example, a shareholder
could promote the distribution of the
exchange’s revenues in a manner that
could result in inadequate funding of
the exchange’s regulatory operations or,
if also an exchange member, could use
the exchange’s disciplinary process
potentially to harass or penalize a
competitor.
The Commission has considered the
conflicts between an exchange’s
regulatory responsibilities and its
commercial interests in operating a
marketplace for the trading of securities.
To address these types of concerns, the
Commission has developed, consistent
with the requirements of Section 6 of
the Exchange Act,58 an approach to
mitigate conflicts of interest for national
securities exchanges.59 Specifically,
through its review of proposals filed by
exchanges with respect to changes to
their ownership and governance
structures (generally from memberowned to shareholder-owned
organizations) pursuant to Section 19 of
the Exchange Act 60 or of applications
filed by entities to register as national
securities exchanges pursuant to Section
6 of the Exchange Act,61 the
Commission examines the way in which
an exchange applies ownership and
57 See SRO Governance Proposing Release, 69 FR
71126, infra note 59.
58 See Section 6(b) of the Exchange Act, 15 U.S.C.
78f(b).
59 See, e.g., Securities Exchange Act Release Nos.
61698 (March 12, 2010), 75 FR 13151 (March 18,
2010) (In the Matter of the Applications of EDGX
Exchange, Inc., and EGDA Exchange, Inc. for
Registration as National Securities Exchanges;
Findings, Opinion, and Order of the Commission)
(‘‘Exchange Act Release No. 61698’’); 58375 (August
18, 2008), 73 FR 49498 (August 21, 2008) (In the
Matter of the Application of BATS Exchange, Inc.
for Registration as a National Securities Exchange;
Findings, Opinion, and Order of the Commission)
(‘‘Exchange Act Release No. 58375’’). In 2004, the
Commission proposed rules relating to: the fair
administration and governance of SROs; disclosure
and regulatory reporting by SROs; recordkeeping
requirements by SROs; ownership and voting
limitations for SROs; and listing and trading of
affiliated securities by SROs. The Commission has
not taken action on these proposed rule changes.
See Securities Exchange Act Release No. 50699
(November 18, 2004), 69 FR 71126 (December 8,
2004) (‘‘SRO Governance Proposing Release’’).
60 15 U.S.C. 78s.
61 15 U.S.C. 78f.
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voting limits and addresses certain
governance principles.62 Namely, the
Commission looks to ensure that there
are limits on the ability of persons to
own and control exchanges by, for
example, requiring at a minimum that
no person, alone or together with its
related persons,63 be permitted to own
more than 40%, and no member, alone
or together with its related persons, be
permitted to own more than 20%, of the
ownership interests of the exchange or
be entitled to vote shares in excess of
20%.64 Further, the Commission also
looks to ensure that an exchange
provide fair representation of members
in the selection of directors and the
administration of its affairs, consistent
with the requirement in Section 6(b)(3)
of the Exchange Act,65 that an exchange
is organized in a manner that allows it
to carry out the purposes of the
Exchange Act pursuant to Section
6(b)(1) of the Exchange Act,66 and that
62 See, e.g., Securities Exchange Act Release Nos.
62158 (May 24, 2010), 75 FR 30082 (May 28, 2010)
(order approving the demutualization of the
Chicago Board Options Exchange, Incorporated
(‘‘CBOE’’)) and 53382 (February 27, 2006), 71 FR
11251 (March 6, 2006) (order approving the merger
of New York Stock Exchange, Inc. (‘‘NYSE’’) and
Archipelago and NYSE’s demutualization).
63 Generally, a ‘‘related person’’ means, with
respect to any person, any other person, directly or
indirectly, controlling, controlled by, or under
common control with such person or any person
acting in concert with such person.
64 See, e.g., Exchange Act Release No. 61698, 75
FR at 13156, supra note 59. The exchange’s Board
may waive the voting and ownership limits if it
makes certain findings, including a finding that
such a waiver would be consistent with the
exchange’s self-regulatory obligations. The board,
however, may not waive these limits for any
exchange members. Moreover, the exchange must
file such waiver with the Commission as a proposed
rule change for approval before it could be
implemented.
The ownership limits currently in place for
exchanges generally apply to any ownership
interest. See, e.g., Exchange Act Release No. 61698,
75 FR 13151, supra note 59; Amended and Restated
Certificate of Incorporation of BATS Global
Markets, Inc., Article FIFTH. In contrast, proposed
Rule 702 would apply ownership limits only with
respect to those shares or other interests entitled to
vote. See infra Section V.A. for a discussion of the
differences between the ownership and voting
limits in proposed Rule 702 and those limits
currently in place for exchanges.
65 15 U.S.C. 78f(b)(3). Pursuant to Section 6(b)(3),
the Commission generally requires, at a minimum,
that at least 20% of the directors on the board be
selected by exchange members. The Commission
also requires that exchange members be permitted
to participate in the nomination process of such
representative directors and that they have the right
to petition for alternative candidates. See, e.g.,
Securities Exchange Act Release No. 58375, 73 FR
at 49500, supra note 59.
66 15 U.S.C. 78f(b)(1). Pursuant to Section 6(b)(1),
the Commission generally requires, at a minimum,
that the number of non-industry directors on the
exchange’s board equal or exceed the number of
industry directors. Generally, a ‘‘non-industry
director’’ is someone who is not subject to
regulation by the exchange, is not a broker or dealer
or an officer, director, or employee of a broker or
PO 00000
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65891
it provides fair procedures for
disciplining members, consistent with
the requirements in Sections 6(b)(6) and
6(b)(7) of the Exchange Act.67
The Commission’s recognition of
potential conflicts of interest at
exchanges and its approach to date in
reviewing and approving measures
designed to mitigate those conflicts of
interest are a useful point of reference
as the Commission identifies, and
develops proposals to mitigate, the
conflicts of interest potentially faced by
SB SEFs and SBS exchanges as the
trading of security-based swaps moves
to regulated markets. However, as noted
above, the Commission recognizes that
a SB SEF’s regulatory obligations are not
the same as a national securities
exchange’s regulatory obligations.
The Commission in 2004 proposed
rules to promote the fair administration
and governance of, and to impose
ownership and voting limitations on,
national securities exchanges and
registered national securities
associations.68 Among other things, the
proposal would have required an
exchange to: Have a Board composed of
a majority of independent directors;
maintain fully independent nominating,
compensation, and audit committees;
separate its regulatory obligations and
business functions by establishing a
fully independent regulatory oversight
committee (‘‘ROC’’) or equivalent
structure; and limit ownership and
voting control by members.69 This
proposal was intended to improve the
governance of certain SROs by
establishing independence standards for
the board of directors (‘‘Board’’) and key
committees and by minimizing conflicts
of interest by instituting ownership and
voting limitations and the separation of
the exchange’s regulatory obligations
and commercial interests. Although the
dealer, is not associated with an entity that is
affiliated with a broker or dealer, and has neither
a material ownership interest nor investment in a
broker or dealer. See, e.g., CBOE By-Laws, Article
III, Section 3.1. Some exchanges also have
‘‘independent directors.’’ Typically, an independent
director has no material relationship with the
exchange or an exchange member. See, e.g.,
Amended and Restated By-Laws of BATS Exchange,
Inc., Article I(m). For example, an officer or director
of a listed issuer generally is considered a nonindustry director rather than an independent
director. The definitions of ‘‘non-industry’’ and
‘‘independent’’ do, however, differ across
exchanges.
67 15 U.S.C. 78f(b)(6) and (7). To find an
exchange’s disciplinary rules to be consistent with
the Exchange Act, the Commission generally
requires that disciplinary processes be balanced and
include industry member participation. See, e.g.,
Exchange Act Release No. 61698, 75 FR at 13160,
n. 124, supra note 59.
68 See SRO Governance Proposing Release, 69 FR
71126, supra note 59.
69 Id.
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Commission has not acted further on
this proposal, a number of exchanges
have adopted some of the governance
concepts on their own initiative 70 and
all of the exchanges registered under
Section 6 of the Exchange Act have
adopted ownership and/or voting
limitations, with the Commission’s
approval.71
Each potential conflict of interest
identified in this Section III.B. could
limit the benefits of centralized trading
in the security-based swaps market and
potentially undermine the mandatory
trading requirement in new Section
3C(h) of the Exchange Act, thereby
negatively affecting efficiency and
competition in the security-based swaps
market.72 Further, while the
Commission believes that its past
application of statutory requirements
has been appropriate to improve the
governance of, and mitigate the conflicts
of interest for, exchanges, given the
difference in the structure of the OTC
derivatives market and the markets for
exchange-listed securities, it also
believes that potential conflicts of
interest in SBS exchanges can and
should be further examined.73 Namely,
70 See, e.g., CBOE By-Laws, Article III, Board of
Directors (‘‘Board of Directors’’ must have a majority
of ‘‘Non-Industry Directors’’) and Article IV,
Committees (‘‘Regulatory Oversight Committee’’
must consist of at least three directors, all of whom
shall be ‘‘Non-Industry Directors’’); By-Laws of the
NASDAQ Stock Market LLC (‘‘Nasdaq’’), Article III,
Board of Directors, Section 2, Qualifications (‘‘Board
of Directors’’ must have a majority of ‘‘Non-Industry
Directors’’) and Section 5, Committees Composed
Solely of Directors (Regulatory Oversight
Committee must consist of at least three members,
each of whom shall be a ‘‘Public Director’’ and an
‘‘independent director’’ as defined in Nasdaq Rule
4200).
71 See, e.g., Amended and Restated Certificate of
Incorporation of BATS Global Markets, Inc., Article
FIFTH.
72 See Public Law 111–203, Section 763(a).
Section 3C(h) of the Exchange Act imposes a
mandatory trading requirement, which provides
that counterparties shall execute a transaction in a
security-based swap subject to the clearing
requirement of Section 3C(a)(1) on an exchange or
a registered SB SEF or a SB SEF that is exempt from
registration pursuant to Section 3D(e) of the
Exchange Act.
73 Within the past several years, the Commission
has reviewed and assessed comprehensively the
governance structure of each national securities
exchange, either in connection with a significant
transaction by the exchange or as part of its
application for registration as a national securities
exchange. See, e.g., Securities Exchange Act Release
Nos. 58324 (August 7, 2008), 73 FR 46936 (August
12, 2008) (order approving The NASDAQ OMX
Group, Inc.’s (‘‘Nasdaq OMX’’) acquisition of the
Boston Stock Exchange, Inc. (‘‘BSE’’)); 58179 (July
17, 2008), 73 FR 42874 (July 23, 2008) (order
approving Nasdaq OMX’s acquisition of the
Philadelphia Stock Exchange, Inc. (‘‘Phlx’’)); 55293
(February 14, 2007), 72 FR 8033 (February 22, 2007)
(order approving the business combination between
NYSE and Euronext N.V.); 56955 (December 13,
2007), 72 FR 71979 (December 19, 2007) (order
approving acquisition of International Securities
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unlike exchange-listed securities,
trading in the OTC derivatives market is
currently dominated by a small group of
dealers.74 Although mechanisms in
place to address conflicts of interest
among members, shareholders, and
exchanges would help mitigate some
concerns about conflicts of interest that
could result from dealer control of the
current security-based swaps market,
the Commission believes that additional
measures may be necessary to
effectively mitigate conflict of interest
concerns. For example, applying
standards approved for exchanges to SB
SEFs and SBS exchanges, as described
above, may not alone adequately
address the potential concern that a
small group of dealers could gain
control over such entities and limit
security-based swaps from trading on,
and participant or member access to, a
centralized market. Accordingly, the
Commission is proposing rules for SB
SEFs and SBS exchanges that are
designed to mitigate the potential
conflicts of interest that it has identified
in the context of the security-based
swaps market, including ownership
limitations and governance
requirements, as more fully described
below.75
The Commission has considered the
mechanisms in place to mitigate
conflicts of interest at national securities
exchanges in developing its proposals to
mitigate conflicts of interest for SB SEFs
and SBS exchanges. The Commission
notes that there are similarities and
differences between the exchange-listed
markets and the market for securitybased swaps that merit consideration in
crafting appropriate proposals to
mitigate conflicts of interest for SB SEFs
and SBS exchanges. National securities
exchanges list and trade cash equity
securities and options pursuant to a
well-developed body of their own rules,
as well as Commission rules, and
compete actively with each other and
with other non-exchange trading venues
for market share and revenues
associated with trading volume. The
markets for cash equity securities and
Exchange, Inc. (‘‘ISE’’) by Eurex Frankfurt AG);
Exchange Act Release No. 58375, 73 FR at 49500,
supra note 59; 61152 (December 10, 2009), 74 FR
66699 (December 16, 2009) (order approving
application of C2 Options Exchange, Incorporated
to register as a national securities exchange);
Exchange Act Release No. 61698, 75 FR at 13156,
supra note 59; 53128 (January 13, 2006), 71 FR 3550
(January 23, 2006) (order approving Nasdaq’s
application to register as a national securities
exchange).
74 See supra note 40.
75 As of the date of this release, the Commission
has not proposed rules regarding the scope,
registration requirements, and operation of a SB
SEF, including the types of entities that would
qualify for registration as a SB SEF.
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listed options are generally liquid,
trading is widely dispersed, and there
are numerous trading venues and
market participants. Unlike the wellestablished cash equity and options
markets, the security-based swaps
market is at an earlier stage of
development and, as noted above, is
currently dominated by a small number
of dealers. Further, the regulatory
structure governing the security-based
swaps market will not be completely
realized until all provisions of the
Dodd-Frank Act and any rules
promulgated thereunder are fully
implemented. However, like exchanges,
SB SEFs may have shareholder-owners
who also may be SB SEF participants
and may compete with any other SB
SEF to the extent that they trade the
same security-based swaps. In addition,
although SB SEFs would not be SROs
and therefore would not be subject to
the same obligations under the
Exchange Act as SROs, they nonetheless
will be subject to regulatory
responsibilities under Section 763(c) of
the Dodd-Frank Act and, as a result, will
have to establish rules and enforce
compliance with those rules by their
participants.76 Thus, the conflicts of
interest that the Commission has
experienced with exchanges may be
similar, although not necessarily
identical, to the conflicts of interest that
SB SEFs and SBS exchanges may face.
The Commission nevertheless is
mindful of the need to mitigate conflicts
of interest for SB SEFs and SBS
exchanges without unduly restricting
the ability of trading facilities to be
formed or the emergence of a
competitive market for the trading of
security-based swaps.
The Commission requests comment
on the types of conflicts of interest it has
identified with respect to SB SEFs and
SBS exchanges, including the listing
and trading of security-based swaps on
SB SEFs and SBS exchanges. Has the
Commission identified all of the
significant potential conflicts concerns?
Do commenters disagree with any
potential conflicts concerns that the
Commission has identified? What other
conflicts concerns may exist, if any?
As discussed above, the Commission
seeks to minimize the conflicts of
interest for national securities
exchanges through ownership
limitations and governance
requirements. Are the conflicts of
interest relating to exchanges, which
could elect to trade swaps and thus
become SBS exchanges, different than
the conflicts of interest relating to SB
76 See Section 763(c) of the Dodd-Frank Act,
Public Law 111–203, Section 763(c).
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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules
SEFs, and, if so, how? To what extent,
if any, should the Commission draw on
its experience with conflicts of interest
that may arise in the exchange context
and with efforts to mitigate those
conflicts and apply that experience in
assessing conflicts of interest that may
arise in the context of SB SEFs and SBS
exchanges? What are the differences and
similarities between the conflicts of
interest that the Commission has
encountered with respect to national
securities exchanges and the conflicts of
interest that it has identified with
respect to SB SEFs and SBS exchanges?
Further, are the conflicts of interest
relating to SBS exchanges different than
the conflicts of interest relating to
exchanges that do not post or make
available for trading security-based
swaps? If there are no differences,
should the Commission propose to
adopt rules to mitigate conflicts of
interest with respect to national
securities exchanges that are not SBS
exchanges or are the existing
approaches to mitigating conflicts of
interest for such exchanges sufficient?
The Commission also requests
comment on potential changes in these
conflicts of interest. The Commission
recognizes that the conflicts of interest
that may exist today with respect to the
trading of security-based swaps by SB
SEFs and SBS exchanges may evolve
over time and that, as this market
evolves, the conflicts of interest that the
Commission has identified for SB SEFs
and SBS exchanges may change. The
centralized trading of security-based
swaps is still developing and may
change significantly as the market for
security-based swaps develops. In
particular, the provisions in the DoddFrank Act relating to the centralized
trading of security-based swaps are not
yet effective. Once they become
effective, market participants that trade
security-based swaps will be subject to
substantially more regulation, which
may have an effect on the conflicts of
interest at SB SEFs and SBS exchanges.
What are commenters’ views on
whether and how conflicts of interest
for SB SEFs and SBS exchanges may
evolve over time and how the
Commission should respond to such
changes? How are conflicts of interest
likely to change as the centralized
trading of security-based swaps and SB
SEFs and SBS exchanges become more
established? Are the conflicts of interest
identified by the Commission likely to
change as the trading of security-based
swaps moves to regulated markets that
must provide for impartial access and,
if so, how? What potential new conflicts
of interest could arise that the
Commission should consider? How will
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potential changes in the clearing of
security-based swaps affect conflicts of
interest at SB SEFs and SBS exchanges?
In addition, competitive forces within
the security-based swaps market may
help to mitigate conflicts of interest, for
example, by increasing the number of
institutions that trade security-based
swaps and creating a broader market for
security-based swaps. How will
competition issues affect or change
current or identified conflicts of
interest? Will competition potentially
create different or additional conflicts of
interest that the Commission should
consider? Would the Commission’s
proposal to apply to SB SEFs and SBS
exchanges standards to mitigate
conflicts of interest that are similar to
those approved for national securities
exchanges influence whether those
conflicts of interest will increase,
diminish, or remain unchanged over
time?
Are there any other conflicts of
interest that warrant examination? What
other parties may have conflicts of
interest that would affect whether they
should control or participate in the
governance of a SB SEF or SBS
exchange? In what circumstances would
these conflicts of interest arise? For
example, might non-participant or nonmember shareholders have a conflict of
interest? What would be the differences
in conflicts of interest between
participants and non-participants or
members and non-members that would
affect the SB SEF or SBS exchange?
Would persons who are selected to be
directors of a SB SEF or SBS exchange
by participants or members have
conflicts of interest based on their status
as directors that would affect their
ability to act in the best interest of the
entity or in conformity with the
Exchange Act, or to act to meet the
policy objectives in Section 765 of the
Dodd-Frank Act? Would directors be
less likely to act to meet the policy
objectives in Section 765 of the DoddFrank Act if they are selected by
shareholders seeking to maximize the
profits of the SB SEF or SBS exchange?
How would participants’ or members’
potential conflicts of interest concerning
open access and products traded
compare to non-participants’ or nonmembers’ conflicts on such issues? How
do the incentives of independent
directors differ from those of nonindependent directors with respect to
increasing access or promoting
competition?
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IV. Discussion of Proposed Regulation
MC: Mitigation of Conflicts of Interest
of Security-Based Swap Clearing
Agencies
Section 765 directs the Commission to
adopt rules to mitigate conflicts of
interest, which rules may include
numerical limits on control of, or voting
rights with respect to, any securitybased swap clearing agency. The
Commission preliminarily believes that
requirements applicable to both
governance and voting interests can
play an essential role in mitigating
conflicts of interests. However, the
Commission recognizes that the nature
of the governance, ownership and
voting requirements to mitigate conflicts
may differ depending on the conflicts of
interest of the persons making decisions
on behalf of the security-based swap
clearing agency. In particular, the nature
of the ownership and voting power of
stockholders of the security-based swap
clearing agency plays a role in
determining the nature of the conflicts
of interest that directors of the securitybased swap clearing agency will face.
As previously noted, the Commission
preliminarily believes that conflicts of
interest may arise when a small number
of participants exercise control or undue
influence over a security-based swap
clearing agency. Conflicts of interest
may also arise, however, simply because
directors and other decision-makers at a
security-based swap clearing agency
have multiple interests and goals,
including maximizing profit for the
benefit of shareholders and imposing
risk restraints that may limit short-term
profits, among others.
In seeking to address conflicts of
interests, the imposition of governance
restrictions may lessen the need to
impose certain voting limitations, while
the imposition of certain voting
limitations may alleviate the need to
impose certain governance restrictions.
Accordingly, the Commission is
proposing two alternative approaches
with respect to voting limitations and
governance that would place differing
levels of emphasis on each of these
factors.77
The proposed rule would allow the
security-based swap clearing agency to
elect between the two alternatives. The
first alternative places an emphasis on
voting limitations while also imposing
certain governance restrictions (‘‘Voting
Interest Focus Alternative’’).78 The
second alternative places an emphasis
on governance restrictions while also
77 See
proposed Rule 701(a) and (b) of Regulation
MC.
78 See
proposed Rule 701(a) under Regulation
MC.
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imposing certain voting limitations
(‘‘Governance Focus Alternative’’).79
Although the Commission is proposing
two separate alternatives, the
Commission may also consider adopting
only one alternative as the final rule or
may combine aspects of each proposed
alternative and adopt it as a single
rule.80
In addition, the existing standards in
Section 17A of the Exchange Act also
help to mitigate conflicts of interest at
registered clearing agencies and will be
applied in addition to any standards
adopted by the Commission under the
Dodd-Frank Act.81
A. Alternative I: Voting Interest Focus
Alternative
As more fully described below, under
the Voting Interest Focus Alternative,
the Commission is proposing limitations
on the voting interests held by
individual participants of a securitybased swap clearing agency and by
participants acting collectively as a
group. In addition, the Commission is
proposing certain requirements related
to governance that would give
independent directors a strong role in
overseeing the security based-swap
clearing agency.
1. Voting Interest Focus Alternative:
Individual Voting Limitation
The Voting Interest Focus Alternative
would provide that a security-based
swap clearing agency may not permit a
participant, either alone or together with
its related persons, to (1) beneficially
own, directly or indirectly, any interest
in the security-based swap clearing
agency that exceeds 20% of any class of
securities, or other ownership interest,
entitled to vote of such security-based
swap clearing agency or (2) directly or
indirectly vote, cause the voting of, or
give any consent or proxy with respect
to the voting of, any interest in the
security-based swap clearing agency
that exceeds 20% of the voting power of
any class of securities or other
ownership interest of such securitybased swap clearing agency.82 This
proposed limitation on individual
79 See
proposed Rule 701(b) under Regulation
MC.
srobinson on DSK8KYBLC1PROD with PROPOSALS2
80 See
infra Section VIII requesting comment on
whether alternatives with or without modifications
should be allowed and whether certain
requirements in each alternative should be
combined to form a single approach.
81 See discussion infra Section IV.C. Securitybased swap clearing agencies will be required to be
registered with the Commission under Section 17A
of the Exchange Act upon the effective date of Title
VII and, as a result, must comply with the standards
in Section 17A that are applicable to all registered
clearing agencies.
82 See proposed Rule 701(a)(1)(i) and (ii) under
Regulation MC.
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participant voting interest is designed to
prevent any individual participant from
owning, on a direct or indirect basis, a
voting interest that would allow it to act
on conflicts of interest in the securitybased swap clearing agency to the
detriment of such security-based swap
clearing agency and the security-based
swaps market.
The terms ‘‘beneficial ownership,’’
‘‘beneficially owns’’ or any derivatives
thereof would be defined in reference to
Rule 13d–3 under the Exchange Act,
Determination of Beneficial
Ownership.83 The concept of beneficial
ownership in Rule 13d–3 is designed to
encompass any person or group of
persons that may be able to act to
influence or control an issuer. The
Commission proposes to use the same
definition of beneficial ownership in
this rule because it also would describe
those persons or groups of persons that
may be able to act to influence or
control a security-based swap clearing
agency. However, to the extent any
participant beneficially owns any
security or other ownership interest
solely because such participant is a
member of a group within the meaning
of Section 13(d)(3) of the Exchange Act,
such participant would not be deemed
to beneficially own such security or
other ownership interest for purposes of
this section, unless such person had the
power to direct the vote of such security
or other ownership interest. The
Commission proposes to exclude
beneficial ownership that results solely
from being a member of a group to
provide more certainty to those that
would be required to comply with the
limitations, in light of the effect of
exceeding the ownership limit—i.e.,
that the participant will be divested of
the excess interest.
While the Commission has not
previously adopted voting interest
limitations for registered clearing
agencies in the other securities markets,
the security-based swaps market
presents a different potential concern
with respect to conflicts of interests. In
83 See proposed Rule 700(b) under Regulation
MC, which provides that the terms ‘‘beneficial
ownership,’’ ‘‘beneficially owns,’’ or any derivative
thereof would be defined as having the same
meaning, with respect to any security or other
ownership interest, as set forth in § 240.13d–3, as
if (and whether or not) such security or other
ownership interest were a voting equity security
registered under Section 12 of the Exchange Act (15
U.S.C. 78l); provided that to the extent any person
beneficially owns any security or other ownership
interest solely because such person is a member of
a group within the meaning of Section 13(d)(3) of
the Exchange Act (15 U.S.C. 78m(d)(3)), such
person shall not be deemed to beneficially own
such security or other ownership interest, unless
such person has the power to direct the vote of such
security or other ownership interest.
PO 00000
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the securities markets for which clearing
agencies currently registered with the
Commission provide clearance and
settlement services,84 there are
significantly more dealers and
participants. The incentives of
participant-owners of these registered
clearing agencies are generally aligned
with those of the clearing agency: To
accept for clearing as many participants
that can meet reasonable participation
standards and as many transactions that
fit into the clearing agencies’ risk
management structure. Furthermore, the
OTC derivatives market has a relatively
high concentration of market activity
among a limited number of dealers 85
that earn significant revenues from the
currently opaque OTC market.86 The
existing cash equities and listed options
markets, on the other hand, are
transparent and widely disbursed over a
range of market participants. As
previously discussed, participants in a
security-based swap clearing agency
may have incentives to limit
participation in the clearing agency and
to limit the scope of products cleared.
Moreover, the Commission’s experience
regulating security-based swap clearing
agencies along with the views expressed
by market participants suggest that
security-based swap clearing agencies
may be particularly susceptible to
conflicts of interest.87 The Commission
preliminarily believes that prohibiting a
participant and its affiliates and related
persons from having more than a 20%
voting interest in a security-based swap
clearing agency, taking into account the
other requirements under the Voting
Interest Focus Alternative as described
below, would establish a sufficiently
high threshold to preclude any one
participant from exerting undue
influence over the security-based swap
clearing agency. The 20% threshold
proposed for participant voting interests
in a security-based swap clearing agency
is similar to the threshold that the
Commission previously proposed for
national securities exchanges and
national securities associations, is the
same as the threshold now being
proposed for SBS exchanges and SB
SEFs, and is consistent with the limits
84 The four clearing agencies registered with the
Commission that have active business operations
include: The Depository Trust Company, The
National Securities Clearing Corporation, The Fixed
Income Clearing Corporation, and The Options
Clearing Corporation.
85 See supra note 40.
86 Id. (stating that U.S. commercial banks reported
trading revenues of $8.3 billion in the first quarter
of 2010).
87 See supra notes 26 and 34.
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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules
currently in place with respect to
national securities exchanges.88
voting interests could be circumvented
by holding the interest through an
affiliated party or by holding an interest
2. Voting Interest Focus Alternative:
in a controlling entity. For purposes of
Aggregate Voting Limitation
determining a security-based swap
The Voting Interest Focus Alternative clearing agency participant’s voting
would provide that a security-based
interest, the proposed rule would, as
swap clearing agency may not permit a
indicated in the description of the rules
participant, either alone or together with above, combine such person’s interest
its related persons, to in the aggregate
with those of its ‘‘related persons.’’ 92
with any other security-based swap
The Commission proposes to define
clearing agency participants and their
the term ‘‘related person’’ to include
related persons (1) beneficially own,
directly or indirectly, any interest in the persons whose relationship with respect
to a participant would likely cause them
security-based swap clearing agency
to have the same conflicts of interest
that exceeds 40% of any class of
with respect to the security-based swap
securities, or other ownership interest,
clearing agency (e.g., ‘‘affiliate,’’
entitled to vote of such security-based
‘‘immediate family member,’’ and
swap clearing agency or (2) directly or
‘‘person associated with a participant in
indirectly vote, cause the voting of, or
a security-based swap clearing agency’’).
give any consent or proxy with respect
Specifically, proposed Rule 700(u)
to the voting of, any interest in the
would define ‘‘related person’’ as that
security-based swap clearing agency
that exceeds 40% of the voting power of term relates to security-based swap
clearing agencies as: (i) Any affiliate 93
any class of securities or other
of a participant in a security-based swap
ownership interest of such securitybased swap clearing agency.89 Under the clearing agency; (ii) any person
associated with a participant in a
individual participant voting limitation
94
and without this aggregate limitation on security-based swap clearing agency;
voting interest, five entities that have
92 See proposed Rule 700(u) of Regulation MC.
voting interests of 20% could control
93 The term ‘‘affiliate’’ would be defined as any
the security-based swap clearing agency.
person that, directly or indirectly, controls, is
Since a small number of dealers
controlled by, or is under common control with, the
currently control the OTC derivatives
person. See proposed Rule 700(a) under Regulation
90 the Commission preliminarily
market,
MC. ‘‘Control’’ would be defined as the possession,
believes that this aggregate limitation on direct or indirect, of the power to direct or cause
the direction of the management and policies of a
voting interest is a necessary corollary
person, whether through the ownership of voting
to the individual participant voting
securities, by contract, or otherwise. Any person
limitation. The 40% aggregate limitation that (i) is a director, general partner, or officer
exercising executive responsibility (or having
on voting interest, which is consistent
similar status or function); (ii) directly or indirectly
with limits used in similar contexts,91
has the right to vote 25% or more of a class of
would restrict participants’ ability to
voting securities or has the power to sell or direct
collectively acquire a majority voting
the sale of 25% or more of a class of voting
interest, while maintaining the integrity securities; or (iii) in the case of a partnership, has
the right to receive, upon dissolution, or has
of the 20% individual participant
contributed, 25% or more of the capital, is
limitation.
presumed to control that person. See proposed Rule
srobinson on DSK8KYBLC1PROD with PROPOSALS2
3. Voting Interest Focus Alternative:
Indirect or Affiliate Ownership and
Ownership Through Related Persons
The Voting Interest Focus Alternative
would also address conflicts of interest
created by indirect voting interests of
the security-based swap clearing agency
because a rule that limits only direct
88 As previously noted, national securities
exchanges generally prohibit exchange members,
alone or together with their related persons, from
owning more than 20% of the exchange or being
entitled to vote shares in excess of 20%. See, e.g.,
Securities Exchange Act Release No. 61698, 75 FR
at 13156, supra note 59.
89 See proposed Rule 701(a)(1)(iii) and (iv) under
Regulation MC.
90 See supra note 40.
91 As previously noted, the Commission has
generally prohibited any person, alone or together
with its related persons, from owning more than
40% of a national securities exchange. See, e.g.,
Securities Exchange Act Release No. 61698, 75 FR
at 13156, supra note 59.
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700(e) under Regulation MC.
94 There is currently not a definition for a ‘‘person
associated with a participant in a clearing agency’’
in the Exchange Act or in Commission rules.
However, the Commission believes that the
definition for the term ‘‘person associated with a
member’’ in Section 3(a)(21) of the Exchange Act
should be used as the basis for the definition of the
term ‘‘person associated with a participant in a
security-based swap clearing agency,’’ as the
purposes of the two defined terms are similar.
Accordingly, the Commission proposes to define
the term ‘‘person associated with a participant in a
security-based swap clearing agency’’ as (1) any
partner, officer, director, or branch manager of such
security-based swap dealer or major security-based
swap participant (or any person occupying a similar
status or performing similar functions); (2) any
person directly or indirectly controlling, controlled
by, or under common control with such securitybased swap dealer or major security-based swap
participant; or (3) any employee of such securitybased swap dealer or major security-based swap
participant. This term does not include any person
associated with a participant in a security-based
swap clearing agency whose functions are solely
clerical or ministerial. See proposed Rule 700(r) of
Regulation MC.
PO 00000
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65895
(iii) any immediate family member 95 of
a participant in the security-based swap
clearing agency that is a natural person,
or any immediate family member of the
spouse of such person, who, in each
case, has the same home as the
participant in the security-based swap
clearing agency, or who is a director or
officer of the security-based swap
clearing agency or any of its parents or
subsidiaries; and (iv) any immediate
family member of a person associated
with a participant in the security-based
swap clearing agency that is a natural
person, or any immediate family
member of the spouse of such person,
who, in each case, has the same home
as the person associated with the
participant in the security-based swap
clearing agency, or who is a director or
officer of the security-based swap
clearing agency, or any of its parents or
subsidiaries.
A voting interest limitation of 20% for
an individual participant of a securitybased swap clearing agency and an
aggregate voting interest limitation of
40% for all participants of a securitybased swap clearing agency is intended
to restrict the ability of security-based
swap clearing agency participants to
exercise undue influence over the
governance of a security-based swap
clearing agency for their own selfinterest. At the same time, these voting
limitations would still permit
participants to hold significant
economic interests in a security-based
swap clearing agency.
4. Voting Interest Focus Alternative:
Divestiture and Voting Restriction
Requirement
In order to assure that a securitybased swap clearing agency maintains
the proposed voting interest limitations,
the Commission is proposing to require
security-based swap clearing agencies to
have rules in place for the divestiture of
voting interests that exceed the
prescribed limitations.96 The
Commission preliminarily believes that
in order for the voting limitations to be
effective, the rule must require securitybased swap clearing agencies to take
action to reduce participants’ and
participants’ related persons’ voting
interests.
The Commission is proposing to
provide security-based swap clearing
agencies flexibility in determining how
95 The term ‘‘immediate family member’’ would be
defined in the proposed rules as a person’s spouse,
parents, children, and siblings, whether by blood,
marriage, or adoption, or anyone residing in such
person’s house. See proposed Rule 700(i) under
Regulation MC.
96 See proposed Rule 701(a)(2) under Regulation
MC.
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to implement this divesture
requirement. Any rules adopted by a
security-based swap clearing agency
must assure that the security-based
swap clearing agency has a viable,
enforceable mechanism to divest a
participant and its related persons of
any voting interest owned in excess of
the 20% limitation, and not to give
effect to the portion of any voting
interest in excess of the 20% individual
limitation or the 40% aggregate
limitation. The Commission is also
proposing to require a security-based
swap clearing agency’s procedures to
provide a mechanism for the securitybased swap clearing agency to obtain
information relating to the voting
interests in the security-based swap
clearing agency held by its participants
and their related persons.97 The
Commission believes that this
requirement is essential to a securitybased swap clearing agency’s ability to
monitor the voting interest held by its
participants and their related persons in
relation to the proposed voting
limitations.
srobinson on DSK8KYBLC1PROD with PROPOSALS2
5. Voting Interest Focus Alternative:
Independent Directors on Board
The Commission’s Voting Interest
Focus Alternative would impose
substantive requirements on the
governance of security-based swap
clearing agencies that are designed to
address the concern that participants’
conflicts of interest may lead them to
take actions that would potentially limit
fair and open access and product
eligibility for central clearing, as well as
potentially weaken the risk management
of security-based swap clearing
agencies. The proposed governance
provisions, as discussed below, are
intended to help mitigate potential
conflicts of interest and assure the fair
administration and governance of a
security-based swap clearing agency by
limiting the control that any one
participant or group of participants may
exercise over the security-based swap
clearing agency.
The Commission proposes under the
Voting Interest Focus Alternative to
require the Board 98 of a security-based
swap clearing agency to be composed of
at least 35% independent directors.99
The presence of a significant number of
97 Id.
98 The term ‘‘Board’’ would be defined as the
Board of Directors or Board of Governors of the SB
SEF, SBS exchange or facility thereof that posts or
makes available for trading security-based swaps, or
security-based swap clearing agency, as applicable,
or any equivalent body. See proposed Rule 700(c)
under Regulation MC.
99 The term ‘‘director’’ would be defined as any
member of the Board. See Proposed Rule 700(f)
under Regulation MC.
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independent directors on the Board of a
security-based swap clearing agency
should provide the addition of strong
and independent oversight within the
security-based swap clearing agency to
serve as a potential check against
conflicts of interest that could pose a
detriment to the security-based swap
clearing agency, other firms, or the
security-based swaps market generally.
The Commission preliminarily believes
that a level below 35% independent
directors may not be sufficient to assure
that independent directors have a
significant voice.100 A requirement
lower than 35% would potentially place
independent directors in a small enough
minority that, relative to the remaining
director slots that could potentially be
filled by participant or management
directors, the views of the independent
directors would not be given enough
consideration. While independent
directors would have less than a
majority representation on the Board
under the Voting Interest Focus
Alternative, they would have a
meaningful opportunity to contribute to
determinations made by the Board and
the various Board committees. The
Commission is proposing to require at
least 35% independent directors
combined with the proposal to limit
participant voting interests in a securitybased swap clearing agency, both on an
individual and aggregate basis, as a
means of effectively mitigating conflict
of interest concerns while also
permitting a greater proportion of
participants to serve on the Board of a
security-based swap clearing agency.101
This aspect of the proposal may address
potential concerns that requiring a
majority independent Board would
affect the Board’s ability to effectively
perform risk management functions.
The Commission also proposes that
no director may qualify as an
independent director unless the Board
affirmatively determines that the
director does not have a material
relationship with the security-based
swap clearing agency or any affiliate of
the security-based swap clearing agency,
or a participant in the security-based
100 Other regulators have previously chosen 35%
as an appropriate level for independent
representation on the Board of self-regulatory
organizations. See 72 FR 6936 (February 14, 2007),
which adopts final rules to address conflicts of
interest at self-regulatory organizations regulated by
the CFTC. Specifically, the final rules establish
acceptable practices under Core Principle 15
applicable to DCMs and that provide that the Board
is composed of at least 35% public directors.
101 Proposed Rule 700(c) under Regulation MC
does not prescribe the number of participant
directors that are required to be on the Board. A
security-based swap clearing agency may choose to
have the majority of the Board be composed of
independent directors.
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swap clearing agency, or any affiliate of
a participant in the security-based swap
clearing agency. The purpose of this
proposal is to provide assurance that an
independent director candidate does not
have any relationships or affiliations
that would prevent the candidate from
being independent of the security-based
swap clearing agency. Accordingly, the
Commission proposes to define the term
‘‘independent director,’’ as it is used
with respect to a security-based swap
clearing agency, as a director who has
no material relationship with:
(1) The security-based swap clearing
agency;
(2) Any affiliate of the security-based
swap clearing agency;
(3) A participant in the security-based
swap clearing agency; or
(4) Any affiliate of a participant in the
security-based swap clearing agency.102
Some relationships or affiliations
would clearly exclude a director from
qualifying as independent of a securitybased swap clearing agency. For
example, a director would not be
considered independent if any of the
following circumstances exists:
• The director, or an immediate
family member, is employed by or
otherwise has a material relationship
with the security-based swap clearing
agency or any affiliate thereof; or within
the past three years was employed by or
otherwise had a material relationship
with the security-based swap clearing
agency or any affiliate thereof;
• The director is a participant in the
security-based swap clearing agency or
within the past three years was
employed by or affiliated with a
participant or any affiliate thereof, or
the director has an immediate family
member that is, or within the past three
years was, an executive officer of a
participant in the security-based swap
clearing agency or any affiliate thereof;
• The director, or an immediate
family member, has received during any
twelve-month period within the past
three years payments that reasonably
could affect the independent judgment
or decision-making of the director from
the security-based swap clearing agency
or any affiliate thereof or from a
participant in the security-based swap
clearing agency or any affiliate thereof,
other than the following:
Æ Compensation for Board or Board
committee services;
Æ Compensation to an immediate
family member who is not an executive
officer of the security-based swap
clearing agency or any affiliate thereof
or of a participant in the security-based
102 See
proposed Rule 700(j) under Regulation
MC.
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swap clearing agency or any affiliate
thereof; or
Æ Pension and other forms of deferred
compensation for prior services, not
contingent on continued service.
• The director, or an immediate
family member, is a partner in, or
controlling shareholder or executive
officer of, any organization to or from
which the security-based swap clearing
agency or any affiliate thereof made or
received payments for property or
services in the current or any of the past
three full fiscal years that exceed 2% of
the recipient’s consolidated gross
revenues for that year, other than the
following:
Æ Payments arising solely from
investments in the securities of the
security-based swap clearing agency or
affiliate thereof; or
Æ Payments under non-discretionary
charitable contribution matching
programs.
• The director, or an immediate
family member, is, or within the past
three years was, employed as an
executive officer of another entity where
any executive officers of the securitybased swap clearing agency serve on
that entity’s compensation committee;
• The director, or an immediate
family member, is a current partner of
the outside auditor of the security-based
swap clearing agency or any affiliate
thereof, or was a partner or employee of
the outside auditor of the security-based
swap clearing agency or any affiliate
thereof who worked on the audit of the
security-based swap clearing agency or
any affiliate thereof, at any time within
the past three years; or
• In the case of a director that is a
member of the audit committee, such
director (other than in his or her
capacity as a member of the audit
committee, the Board, or any other
Board committee), accepts, directly or
indirectly, any consulting, advisory, or
other compensatory fee from the
security-based swap clearing agency or
any affiliate thereof or a participant in
the security-based swap clearing agency
or any affiliate thereof, other than fixed
amounts of pension and other forms of
deferred compensation for prior service,
provided such compensation is not
contingent in any way on continued
service.103
Under the proposed rule, the term
‘‘material relationship’’ would be
defined as a relationship, whether
compensatory or otherwise, that
reasonably could affect the independent
judgment or decision-making of the
103 See
proposed Rule 700(j)(2) under Regulation
MC.
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director.104 This definition is intended
to encompass all significant instances in
which a director’s independence is
compromised.105 In determining
whether a ‘‘material relationship’’ exists,
security-based swap clearing agencies
should consider the known
relationships between a director and the
security-based swap clearing agency to
determine whether the relationship is
likely to impair the independence of the
director in making decisions that affect
the security-based swap clearing agency.
The proposed definitions of
‘‘independent director’’ and ‘‘material
relationship’’ should help to reduce the
potential that the independent directors
on the Board of the security-based swap
clearing agency are subject to conflicts
of interest.
Under the Voting Interest Focus
Alternative, the security-based swap
clearing agency would be required to
establish policies and procedures to
require each director, on his or her own
initiative or upon request of the
security-based swap clearing agency, to
inform the security-based swap clearing
agency of the existence of any
relationship or interest that may
reasonably be considered to bear on
whether such director is an independent
director.106 The security-based swap
clearing agency would be expected to
take reasonable measures to confirm the
accuracy of the information provided.
This requirement should help the
security-based swap clearing agency to
assure that it is informed of the
existence of any relationship or interest
that may reasonably be considered to
bear on whether a director is
independent as soon as possible and
without requiring the security-based
swap clearing agency to investigate for
such information.
6. Voting Interest Focus Alternative:
Board Committees
a. Nominating Committee
The Voting Interest Focus Alternative
would require security-based swap
clearing agencies to create and maintain
a nominating committee for the
selection of Board members, and would
require that such nominating committee
be composed of a majority of
104 See
proposed Rule 700(l) under Regulation
MC.
105 See Securities Exchange Act Release No.
48745 (November 4, 2003), 68 FR 64154 (November
12, 2003) (order approving SRO rules that would
find a director independent only where that
director does not have a relationship with the
company that would impair her independence).
106 See proposed Rule 701(a)(3)(iii) under
Regulation MC.
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independent directors.107 Directors
serving on the nominating committee
that are not independent may be more
likely to select Board candidates whose
views align with such directors’
interests instead of the interests of the
security-based swap clearing agency or
the markets generally. Having a
nominating committee that is composed
of majority independent directors
should help to address and facilitate the
selection of independent directors.
The Voting Interest Focus Proposal
would also require that the nominating
committee identify candidates for Board
membership through a consultative
process with the participants of the
security-based swap clearing agency
consistent with criteria approved by the
Board.108 This should help assure that
the selection of directors of the Board is
conducted in a prudent manner while at
the same time allowing for the
participants of the security-based swap
clearing agency to have fair
representation in the selection of the
directors of the Board.109
b. Other Board Committees
The Voting Interest Focus Alternative
would require that other Board
committees of a security-based swap
clearing agency that are delegated
authority to act on the Board’s behalf,
including but not limited to the risk
committee, consist of at least 35%
independent directors similar to the
requirement that would be imposed on
the Board itself.110 This requirement
should give independent directors a
meaningful voice, similar to the one
they would have in the Board itself,
within Board committees that
essentially perform the functions of a
Board. The proposed requirement
would also apply to an ‘‘advisory
committee’’ to the extent that the
committee is authorized to act on behalf
of the Board, including instances where
the Board is required to seek approval
from the committee before making a
determination. However, the
Commission preliminarily believes that
the independence requirement should
not extend to a committee that functions
in a purely advisory role, because
members of those committees are not in
a position to exercise powers of the
107 See proposed Rule 701(a)(4)(i) under
Regulation MC.
108 See proposed Rule 701(a)(4)(ii) under
Regulation MC.
109 Section 17A(a)(3)(C) of the Exchange Act
requires fair representation among participants of a
clearing agency by providing them with a
meaningful opportunity to participate in the
selection of directors. 15 U.S.C. 78q–1(a)(3)(C).
110 See proposed Rule 701(a)(5) under Regulation
MC.
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Board or exert influence over the Board
by dictating how the Board will act.
c. Disciplinary Panels
The Commission’s Voting Interest
Focus Alternative would impose special
requirements on the composition of
disciplinary panels (or their
equivalents) of security-based swap
clearing agencies that have not been
delegated authority to act on the Board’s
behalf.111 The Commission believes that
participants of a security-based swap
clearing agency should be appropriately
disciplined for failure to comply with
the rules of a security-based swap
clearing agency, particularly as they
relate to the ongoing risk management
related requirements applicable to
participants. Accordingly, the
Commission is proposing that the
disciplinary processes of a securitybased swap clearing agency preclude
any group or class of persons that are
participants in the security-based swap
clearing agency from exercising
disproportionate influence on any
disciplinary panels. In other words, to
the extent that there is more than one
type of group or class of persons that are
participants in a security-based swap
clearing agency, the composition of the
disciplinary panel shall include
representation of each group or class
and shall not allow one group or class
to have representation on the
disciplinary panel that is out of
proportion as compared to other groups
or classes of persons that are
participants in the security-based swap
clearing agency. Furthermore, the
disciplinary panel of the security-based
swap clearing agency would include at
least one person who would qualify as
an independent director.
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7. Voting Interest Focus Alternative:
Request for Comment
The Commission requests comment
on all aspects of the voting limitations
under the Voting Interest Focus
Alternative, including whether the 20%
limitations on individual participant
voting interest and the 40% aggregate
limitation on participant voting interest
are sufficient to limit the ability of a
participant or a group of participants to
exercise undue influence or control over
the governance of a security-based swap
clearing agency. Should the 20% and
111 See proposed Rule 701(a)(6) under Regulation
MC. If the security-based swap clearing agency does
not have a disciplinary panel, these requirements
should be interpreted as applying to the equivalent
of a disciplinary panel in the security-based swap
clearing agency’s internal processes, unless the
disciplinary panel (or its equivalent) has been
delegated authority to act on the Board’s behalf, in
which case it would be subject to the 35%
independent director requirement.
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40% limitations be lower given the
existing concentration of the industry in
a small number of large dealers? If so,
what limitations would be appropriate
and why? Are there other conflicts of
interest not discussed in this release
that the Commission should consider
generally and specifically with respect
to voting limitations? Would the
proposed restrictions have an effect on
the ability to form new security-based
swap clearing agencies or to effectively
operate existing security-based swap
clearing agencies?
The Commission also requests
comment on whether there may be other
ways to structure the interests in a
security-based swap clearing agency to
mitigate potential conflicts of interest.
Are there other thresholds for voting
limitations or approaches that the
Commission should consider? Are there
other methods for mitigating conflicts of
interest the Commission should
consider, such as limitations on holding
non-voting interests in a security-based
swap clearing agency? How would nonvoting interests affect the potential for
conflicts of interests?
Section 765 enumerates Specified
Entities for the Commission to consider
in its rulemaking. The proposed rule
would apply only to Specified Entities
that are participants of the securitybased swap clearing agency and not to
other Specified Entities, because the
Commission preliminarily believes that
those entities that are participants of a
clearing agency are most likely to have
a conflict of interest that would affect
the access, product eligibility, and risk
management issues discussed in this
release. However, the Commission
requests comment on whether all
Specified Entities, regardless of
participant status, should be subject to
the proposed restrictions on voting
interests. What are the potential
conflicts of interest associated with
Specified Entities that are not
participants? Might Specified Entities
that are not participants in a securitybased swap clearing agency have an
interest in limiting the number or type
of security-based swaps that are
accepted for clearing to the extent that
they may profit from trading securitybased swaps that are not centrally
cleared? Are there any other classes of
persons, such as participants or
members of SB SEFs or SBS exchanges,
that should also be subject to the
proposed restrictions even though they
are not participants of a security-based
swap clearing agency? What effect
would such restrictions have on
mitigating conflicts of interest at
security-based swap clearing agencies?
What effect would such restrictions
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have on the ability to form new securitybased swap clearing agencies?
The Voting Interest Focus Alternative
would require that voting limitations be
determined by including interests held
directly by a participant in the securitybased swap clearing agency, by
including indirect interests of a
participant in the security-based swap
clearing agency, and by including
interests held by related persons of a
participant in the security-based swap
clearing agency. The Commission
requests comment on whether its
formulation for calculating the aggregate
and individual limits is appropriate.
Specifically, the Commission requests
comment on whether the scope of the
definitions of ‘‘affiliate,’’ ‘‘immediate
family member,’’ and ‘‘related person’’
are over-inclusive or under-inclusive
and, if either, why? Is there a different
methodology to reach the interest of any
person with whom a security-based
swap clearing agency participant may be
able to act in concert with to unduly
influence or control a security-based
swap clearing agency that the
Commission should consider?
The Commission seeks comment on
whether requiring the Board of a
security-based swap clearing agency to
be composed of at least 35%
independent directors would improve
governance of the security-based swap
clearing agency and mitigate potential
conflicts of interest. Is 35% sufficient to
give independent directors a meaningful
voice within the Board, or would a
higher or lower level be appropriate?
Should the Commission require that a
majority of the Board be composed of
independent directors? How are these
independent directors likely to affect
the activities of the security-based swap
clearing agency? What are their
incentives to assure open and fair
access, increased product eligibility,
and sound risk management at a
security-based swap clearing agency? Do
independent directors have any
conflicts of interest that would affect
their ability to facilitate these
objectives?
The Commission also requests
comment on whether other measures
concerning governance should be used
to mitigate conflicts of interest at
security-based swap clearing agencies,
either in addition to or instead of the
proposals outlined in this release. In
particular, what other approaches
would improve governance and mitigate
conflicts of interest for security-based
swap clearing agencies? For example,
would State laws governing the
fiduciary duty owed by the Board to a
corporation help to mitigate conflicts of
interest? Should the Commission
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consider any additional requirements
related to fiduciary duties? The policies
and charter documents of individual
corporations also often impose
additional responsibilities and
obligations on directors. Should
security-based swap clearing agencies
be required to put in place specific
policies or charters to address conflicts
of interest by the Board? What policies
or charters would be necessary to
provide assurance that participant
directors will act in the best interests of
the security-based swap clearing
agency? What other requirements, if
any, should be in place with respect to
the duties owed by the Board in order
to mitigate conflicts of interest at
security-based swap clearing agencies?
In addition, the Commission requests
comment on its proposed definitions,
including the definitions of
‘‘independent director’’ and ‘‘material
relationship.’’ Are there other ways to
define ‘‘independent director’’ or
‘‘material relationship?’’ If so, what are
they? Should the Commission adopt
other provisions that contain particular
circumstances that would preclude a
finding that a director is independent or
that would deem a relationship
material? Should the Commission take
into account a director’s salary or
benefits he or she receives for being a
director in order to consider whether an
interest in keeping the directorship
could make a director more likely to act
favorably toward those that control the
Board? Should the Commission adopt a
specific look-back period within which
to determine whether a ‘‘material
relationship’’ exists? Should additional
terms used in the proposed rule be
defined?
The Commission requests comment
on the proposed compositional
requirements of committees of the Board
under the Voting Interest Focus
Alternative. Is the requirement that
Board committees that are delegated
authority to act on behalf of the Board
be composed of at least 35%
independent directors appropriate? The
Commission also requests comment on
whether there may be other ways to
structure governance restrictions for
security-based swap clearing agencies to
mitigate potential conflicts of interest.
In particular, the Commission requests
comment on the proposed
compositional requirements of the
nominating committee. What is the
potential effect of requiring a securitybased swap clearing agency to have a
majority independent nominating
committee? Are there other processes
for the selection of independent
directors and the fair representation of
the participants and shareholders of a
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security-based swap clearing agency
that the Commission should consider
with respect to the nominating
committee? Should end-users or any
other group be given guaranteed rights
of participation in the governance of the
security-based swap clearing agency?
Should the Commission participate in
the Board selection process, such as by
requiring consultation on
appointments? Should the Commission
consider an alternative to a
compositional requirement for a
nominating committee, such as allowing
a security-based swap clearing agency to
have a board of trustees responsible for
nominating candidates for the Board? If
this were a viable alternative, should
there be compositional requirements or
other limits imposed on the board of
trustees? How should such a board of
trustees be appointed? Would the
alternative of a board of trustees to
nominate directors provide greater
assurance that independent directors are
truly independent not only at the time
of their nomination but during their
service on the Board as well?
With respect to governance as it
relates to the risk committee, should
there be special requirements relating to
the risk committee, or its equivalent, of
the Board? For instance, one possible
alternative approach could be to provide
separate requirements applicable only to
the risk committee that reflect the
highly specialized risk management
expertise required of directors serving
on that committee. For example, instead
of requiring that the risk committee be
composed of at least 35% independent
directors (where such committee is
delegated authority to act on the Board’s
behalf), the requirement could apply to
a smaller number of independent
directors, and also explicitly require
that other interested persons, such as
customers of participants, be
represented on the risk committee. The
Commission requests comment on
whether a more prescriptive approach
such as the one described above would
be appropriate for the risk committee
and what levels of participation by
participants, customers of participants,
or others would be appropriate. Are
there factors that warrant treating the
risk committee differently from other
Board committees? Should the
Commission require the Board to report
to the Commission if the Board
disagrees with a recommendation of the
risk committee? Is the risk committee
more or less prone to conflict of interest
issues? Are there factors other than
conflicts of interest that should be taken
into consideration? Is it desirable to
have an explicit requirement with
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65899
respect to customers of participants? If
so, how many customers should serve
on the risk subcommittee relative to
independent directors and participant
directors? What definition of customer
should be used for these purposes? Are
there distinctions that should be made
between the different types of customer
firms for this purpose?
Another possible alternative approach
could be to limit the applicable
restrictions on the risk committee to
circumstances where a specific range of
topics is being addressed. For example,
restrictions on participation in a risk
committee could be limited to only
those circumstances in which a
determination about issues such as
participant standards and product
eligibility were being made. What are
the potential advantages or
disadvantages of such an approach?
Would it be possible to separate
activities of a committee based on
topics? Are there certain issues that
pose more or less of a concern with
respect to conflicts of interests?
The Commission also requests
comment regarding whether any
requirements should be imposed on
advisory committees. Would an
independence requirement on a purely
advisory committee mitigate potential
conflicts of interest? Are there
circumstances in which a purely
advisory committee exercises
substantial power over the Board?
The Commission requests comment
on the composition of the disciplinary
panel of the security-based swap
clearing agency. Would the proposed
rule be sufficient to address potential
conflicts of interest that may interfere
with the fair and effective disciplinary
processes of a security-based swap
clearing agency? Should different
restrictions be imposed?
Although independent directors may
address some of the conflicts of interest
concerns that underlie Section 765 of
the Dodd-Frank Act, they may not
effectively eliminate all conflicts. The
Commission, however, believes that
effective governance via a partially
independent Board is compatible with
the characteristics of security-based
swap clearing agencies, and the types of
conflicts that may be inherent with
respect to such entities.
B. Alternative II: Governance Focus
Alternative
As more fully described below, under
the Governance Focus Alternative, the
Commission is proposing governance
restrictions including requiring a
majority of independent directors on the
Board and voting restrictions that would
be applicable only to individual
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participants of a security-based swap
clearing agency. The Governance Focus
Alternative differs from the Voting
Interest Focus Alternative in that it
provides greater emphasis on
requirements regarding the governance
arrangements of a security-based swap
clearing agency as the primary means to
mitigate conflicts of interest. As with
the Voting Interest Focus Alternative,
the Commission is proposing rules
related to the governance of a securitybased swap clearing agency and the
voting interests held by participants
because the Commission believes each
contributes to conflict of interest
concerns. However, the Voting Interest
Focus Alternative places greater
emphasis on the ability of participants
to hold voting interests in the securitybased swap clearing agency than it does
on participants’ ability to participate in
the governance of the security-based
swap clearing agency, while the
Governance Focus Alternative, as
described in more detail below, places
greater emphasis on the ability of
participants to participate in the
governance of the security-based swap
clearing agency than it does on the
ability of participants on a collective
basis to hold a voting interest in the
security-based swap clearing agency.
1. Governance Focus Alternative: Voting
Limitation
The Governance Focus Alternative
would require that a security-based
swap clearing agency may not permit a
participant, either alone or together with
its related persons, to (1) beneficially
own, directly or indirectly, any interest
in the security-based swap clearing
agency that exceeds 5% of any class of
securities, or other ownership interest,
entitled to vote of such security-based
swap clearing agency or (2) directly or
indirectly vote, cause the voting of, or
give any consent or proxy with respect
to the voting of, any interest in the
security-based swap clearing agency
that exceeds 5% of the voting power of
any class of securities or other
ownership interest of such securitybased swap clearing agency.112 The 5%
limitation on participant voting interest
is intended to help mitigate conflicts of
interest because each individual
participant’s voting interest would be
substantially limited and, therefore, its
ability to control the security-based
swap clearing agency would also be
limited.113 As discussed previously, the
112 See
proposed Rule 701(b)(1) under Regulation
MC.
113 The 5% threshold level for ownership has
previously been found by the Commission in other
contexts to trigger reporting requirements to the
Commission related to the ability to control an
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Voting Interest Focus Alternative would
permit a higher individual participant
voting interest of 20%, but would limit
the aggregate voting interests held by all
participants to 40%. However, the
Voting Interest Focus Alternative would
allow a security-based swap clearing
agency to have a Board with a majority
of directors selected by participants.
The Commission believes that the 5%
limit per participant, in combination
with the requirements related to
governance arrangements described
below, is sufficiently low that there is
no need for the 40% aggregate cap on
the voting interests held by all
participants.
Furthermore, the Commission notes
that the 40% aggregate cap on
participant voting interests proposed in
the Voting Interest Focus Alternative
may restrict the potential formation of
participant-owned security-based swap
clearing agencies. Some clearing
agencies currently registered with the
Commission are user-owned or usercontrolled institutions that function as
quasi-utilities. This structure may
provide certain benefits to the
participants and the securities markets
generally because such clearing agencies
generally seek to match the fees charged
to participants to the clearing agency’s
costs and not to maximize profits.114
In addition, potential users may have
a strong incentive to form a new
clearing agency if they believe an
existing clearing agency is not
effectively serving the security-based
swaps market. Not imposing an
aggregate cap on participant voting
interests in a security-based swap
clearing agency could help encourage
organization. See Rule 13d–1(a) under the Exchange
Act, 17 CFR 240.13d–1(a) (‘‘Any person who, after
acquiring directly or indirectly the beneficial
ownership of any equity security of a class which
is specified in paragraph (i) of this section, is
directly or indirectly the beneficial owner of more
than 5% of the class shall, within 10 days after the
acquisition, file with the Commission, a statement
containing the information required by Schedule
13D’’). In addition, investors acquiring more than a
5% interest in a company must file a form certifying
that they acquired that interest without ‘‘the effect
of changing or influencing the control of the issuer
* * *’’ Rule 13d–1(c)(1) under the Exchange Act, 17
CFR 240.13d–1(c)(1). See, also, Gaf Corp. v.
Milstein, 453 F.2d 709 (2d Cir. N.Y. 1971), stating
that ‘‘[T]he purpose of section 13(d) is to alert the
marketplace to every large, rapid aggregation or
accumulation of securities, regardless of technique
employed, which might represent a potential shift
in corporate control. * * *’’ Id. at 717.
114 See, e.g., ‘‘The US Model for Clearing and
Settlement: An Overview of DTCC,’’ available at:
https://www.dtcc.com/downloads/about/
US%20Model%20for%20Clearing%
20and%20Settlement.pdf. (‘‘[O]wnership and
governance of [The National Securities Clearing
Corporation] and [The Depository Trust Company]
were from the outset those typical of market
utilities.’’).
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the formation of new security-based
swap clearing agencies and thereby
increase the potential for competition
among security-based swap clearing
agencies. In addition, the 5% voting
interest limitation may encourage open
access by creating incentives for a larger
number of participants to acquire a
voting interest in the security-based
swap clearing agency. While the
Commission has not previously adopted
voting limitations or governance rules
for registered clearing agencies in the
other securities markets, as previously
discussed under the Voting Interest
Focus Alternative, the security-based
swaps market presents different
concerns with respect to potential
conflicts of interests that warrant
additional scrutiny and efforts to
mitigate such conflicts.
2. Governance Focus Alternative:
Indirect or Affiliate Ownership and
Ownership Through Related Persons
The Commission believes that a rule
that limits only direct voting interests
could be circumvented by holding the
interest through an affiliated party or by
holding an interest in a controlling
entity. Accordingly, similar to the
Voting Interest Focus Alternative,115 the
Governance Focus Alternative would
address conflicts of interest created by
indirect voting interests of the securitybased swap clearing agency and would
require aggregation of a security-based
swap clearing agency participant’s
voting interest with its related
persons’ 116 voting interests.117
3. Governance Focus Alternative:
Divestiture and Voting Restriction
Requirement
Similar to the Voting Interest Focus
Alternative,118 the Governance Focus
Alternative would require securitybased swap clearing agencies to have
rules in place for the divestiture of
voting interests that exceed the 5%
limitation and a mechanism to not give
effect to the portion of any voting
interest held by a participant in excess
of the 5% voting limitation.119 The
Commission believes that this
requirement is essential to a securitybased swap clearing agency’s ability to
monitor voting interests by its
participants in relation to the proposed
voting limitations.
115 See
supra Section I.A.3.
supra note 92 and accompanying text.
117 See proposed Rule 701(b)(1) under Regulation
MC.
118 See supra Section I.A.4.
119 See proposed Rule 701(b)(2) under Regulation
MC.
116 See
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4. Governance Focus Alternative:
Majority Independent Board
As discussed previously, the
Governance Focus Alternative differs
from the Voting Interest Focus
Alternative by placing greater emphasis
on the governance arrangements of the
security-based swap clearing agency.
Each alternative approach seeks to strike
a balance between the appropriate
restrictions imposed on a security-based
swap clearing agency relating to
governance and voting rights held by
participants. Under the Governance
Focus Alternative, participants on a
collective basis could potentially own
all voting interests in a security-based
swap clearing agency. While this option
allows for potential benefits in terms of
participants’ ability to form new
clearing agencies, it also allows
participants’ to control 100% of the
voting interest in a security-based swap
clearing agency, in contrast to the
Voting Interest Focus Alternative, which
would limit participants to holding no
more than 40% of the voting interest.
Accordingly, in order to balance the
increased voting interest that may be
held by participants collectively, the
Commission proposes that a greater
proportion of the Board be composed of
independent directors under the
Governance Focus Alternative.
The Governance Focus Alternative is
intended to mitigate conflicts of interest
by limiting the influence participants
may have in the determinations of the
Board or in the administration of a
security-based swap clearing agency.
Specifically, the Governance Focus
Alternative would require the Board 120
of a security-based swap clearing agency
to be composed of a majority of
independent directors.121 The presence
of a majority of independent directors
on the Board of a security-based swap
clearing agency is intended to reduce
the ability of non-independent directors
to influence the operation of the
security-based swap clearing agency in
favor of their own self-interests and to
promote open and fair access, product
eligibility, and sufficient risk
management standards. This should in
turn benefit non-participant firms that
enter into correspondent clearing
arrangements with participants, and
SBS exchanges and SB SEFs who will
rely on the availability of a securitybased swap clearing agency. A majority
independent Board requirement is
consistent with accepted corporate
120 See
supra note 98.
proposed Rule 701(b)(3)(i) under
Regulation MC. See supra note 99 for the definition
of ‘‘director.’’
121 See
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governance ‘‘best practices.’’ 122
Furthermore, requiring a majority of the
Board of a security-based swap clearing
agency to be independent would still
permit the security-based swap clearing
agency to provide participants with fair
representation in the selection of
directors and the administration of the
affairs of the security-based swap
clearing agency as required under the
Exchange Act.123
The Commission also proposes that
no director may qualify as an
independent director unless the Board
affirmatively determines that the
director does not have a material
relationship with the security-based
swap clearing agency or any affiliate of
the security-based swap clearing
agency,124 or a participant in the
security-based swap clearing agency, or
any affiliate of a participant in the
security-based swap clearing agency.125
The proposed definitions of
‘‘independent director’’ and ‘‘material
relationship’’ are designed to reduce the
potential that the Board of the securitybased swap clearing agency is
controlled by persons who are subject to
conflicts of interest.
While the proposal that a majority of
the Board be composed of independent
directors should help to mitigate certain
conflicts of interest, and particularly
those conflicts that are most likely to
result in an adverse effect on the
security-based swap clearing agency, the
Commission recognizes that it would
not completely eliminate conflicts of
interest. Participant directors would still
be permitted to serve on the Board. The
Commission believes that participants
may have operational, risk management,
and market expertise that may be useful
for effective oversight of a securitybased swap clearing agency.
In addition, independent directors
themselves may not be free of conflicts
of interest. Although the independent
directors would not have a material
relationship with the clearing agency or
any of its participants, they could still
be influenced by other sources such as
non-participant shareholders of the
security-based swap clearing agency.
The presence of independent directors
122 See, e.g., James H. Cheek III, et al., Report of
the American Bar Association Task Force on
Corporate Responsibility (2003); and The Business
Roundtable, Principles of Corporate Governance
(May 2010).
123 Section 17A(b)(3)(C) of the Exchange Act
requires that the rules of a registered clearing
agency assure a fair representation of its
shareholders (or members) and participants in the
selection of its directors and administration of its
affairs. 15 U.S.C. 78q–1(b)(3)(C).
124 See supra note 102 and accompanying text.
125 See proposed Rule 701(b)(3)(ii) under
Regulation MC.
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may be an effective mechanism to
address certain types of conflicts in
certain types of institutions but not
necessarily in all instances nor for all
institutions. The Commission, however,
believes that effective governance via a
majority independent Board is
compatible with the characteristics of
security-based swap clearing agencies,
and the types of conflicts that may be
inherent with respect to such entities.
To help address these concerns, the
proposed rules would require each
security-based swap clearing agency to
establish policies and procedures to
require each director, on his or her own
initiative or upon request of the
security-based swap clearing agency, to
inform the security-based swap clearing
agency of the existence of any
relationship or interest that may
reasonably be considered to bear on
whether such director is an independent
director.126 This requirement should
keep the security-based swap clearing
agency informed of the existence of any
relationship or interest that may
reasonably be considered to bear on
whether a director is independent as
soon as possible without requiring the
security-based swap clearing agency to
investigate for such relationships or
interest.
5. Governance Focus Alternative: Board
Committees
a. Nominating Committee
The Governance Focus Alternative
would require security-based swap
clearing agencies to create and maintain
a nominating committee composed
entirely of independent directors.127
This is consistent with the purpose of
the Governance Focus Alternative to
place enhanced requirements on the
governance arrangements of a securitybased swap clearing agency, including
the composition of the Board and Board
committees, with less emphasis on the
requirements with respect to the voting
interests held by participants. Nonindependent directors on the
nominating committee could
circumvent the majority independence
requirement by nominating a candidate
that is subject to their influence.
Specifically, directors serving on the
nominating committee that are not
independent may be more likely to
select Board candidates whose views
align with such directors’ interests
instead of the interests of the securitybased swap clearing agency or the
markets generally. A requirement that
126 See proposed Rule 701(b)(3)(iii) under
Regulation MC.
127 See proposed Rule 701(b)(4)(i) under
Regulation MC.
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all directors serving on the nominating
committee be independent of
participants would address these
concerns by limiting participants’
control over the nomination process. A
fully independent nominating
committee may be warranted under the
Governance Focus Alternative because
the lack of an aggregate cap in this
proposal means that participants may
collectively hold greater voting interests
in selecting the independent directors.
The Governance Focus Alternative
would also require that the nominating
committee identify candidates for Board
membership through a consultative
process with the participants of the
security-based swap clearing agency
consistent with criteria approved by the
Board.128 This should assure that the
selection of the independent directors of
the Board is conducted in a prudent
manner while at the same time allowing
participants of the security-based swap
clearing agency to have a fair voice in
the selection of the directors of the
Board.129
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b. Other Board Committees
The Governance Focus Alternative
would require that other Board
committees of a security-based swap
clearing agency that are delegated
authority to act on the Board’s behalf,
including but not limited to the risk
committee, consist of a majority of
independent directors similar to the
requirement that would be imposed on
the Board itself.130 This requirement
should prevent the dilution of the
majority Board independence
requirement that may result if Board
committees that essentially perform the
functions of a Board are not themselves
subject to a similar requirement. The
proposed requirement would also apply
to an ‘‘advisory committee’’ to the extent
that such a committee is authorized to
act on behalf of the Board, including
instances where the Board is required to
seek approval from the committee
before making a determination.
However, the Commission preliminarily
believes that this majority independence
requirement should not extend to a
committee that functions in a purely
advisory role, because members of those
committees are not in a position to
exercise powers of the Board or exert
influence over the Board by dictating
the actions of the Board.
128 See proposed Rule 701(b)(4)(ii) under
Regulation MC.
129 See supra note 123.
130 See proposed Rule 701(b)(5) under Regulation
MC.
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c. Disciplinary Panels
Similar to the Voting Interest Focus
Alternative,131 the Governance Focus
Alternative would impose special
requirements on the composition of
disciplinary panels (or their
equivalents) of security-based swap
clearing agencies that have not been
delegated authority to act on the Board’s
behalf.132
6. Governance Focus Alternative:
Request for Comment
The Commission requests comment
on all aspects of the 5% participant
voting interest limitation. Is the 5%
voting limitation appropriate, or should
the Commission consider a higher or
lower limitation? How does the relative
concentration of the security-based
swaps market among a small number of
large dealers affect whether a 5%
limitation is appropriate? Would 5%
still allow a relatively small number of
participants to effectively dominate the
Board of a clearing agency? Should the
Commission consider any form of an
aggregate cap under this alternative?
How likely is it that a security-based
swap clearing agency would adopt a
utility model, given the status of the
security-based swaps market? Would
the 5% limit impede the ability of a
clearing agency to adopt a utility model?
What advantages or disadvantages
would such a model have? Are there
other conflicts of interest, not discussed
in this release, that the Commission
should consider generally and
specifically with respect to voting
interest limitations? Would the
proposed restrictions have an effect on
the ability to form new security-based
swap clearing agencies?
Are there other ways to more
narrowly target voting limitations?
Should the Commission impose voting
restrictions on only the largest
participants because those participants
control the majority of the securitybased swaps market (based on either the
volume of transactions cleared at the
security-based swap clearing agency or
the notional value of the participant’s
outstanding security-based swap
positions)? If such an approach is
preferable, what should the threshold be
for determining whether a participant is
‘‘large’’? Should the Commission require
the security-based swap clearing agency
to consider the participant’s volume of
cleared transactions at the securitybased swap clearing agency, the
notional value of the participant’s
131 See
supra Section I.A.8.d. and accompanying
text.
132 See
proposed Rule 701(b)(6) under Regulation
MC.
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outstanding security-based swap
positions at the security-based swap
clearing agency, or both? Should the
Commission require the security-based
swap clearing agency to consider either
volume or outstanding notional value of
a participant’s positions held outside of
a security-based swap clearing agency?
How often should the Commission
require the security-based swap clearing
agency to reevaluate its standard? How
effectively would such an approach
address conflict of interest concerns?
What would be the advantages and
disadvantages of this approach
compared to the approach proposed
above? Are there administrative
complexities associated with
determining and monitoring the point at
which a firm reaches large participant
status? Are the conflicts of interest
concerns regarding all large participants
similar or should there be differences in
the voting limitations among large
participants?
Should the restrictions on voting
interests apply to other large entities,
such as the Specified Entities listed in
Section 765, even if they are not
participants in a security-based swap
clearing agency? What potential
conflicts of interest could result if
Specified Entities that are not large
participants controlled the voting
interest in a security-based swap
clearing agency? How should such
potential conflicts of interest be
addressed?
Should the Commission consider a
limitation on the non-voting interests
owned by participants? Should the
Commission consider a limitation on
the voting and non-voting interests held
by Specified Entities?
The Commission seeks comment on
whether requiring the Board of a
security-based swap clearing agency to
be composed of a majority of
independent directors would improve
governance of the security-based swap
clearing agency and mitigate potential
conflicts of interest. Would a majority
independent Board be helpful in
mitigating conflicts of interest if the
voting interest of a security-based swap
clearing agency is owned by
participants? If a majority independent
Board is not appropriate to mitigate
conflicts, what percentage of the Board
should be independent? What are the
costs and benefits of requiring the
Boards of security-based swap clearing
agencies to be composed of a majority
of independent directors? How do these
costs and benefits differ from the
proposal that 35% of the Board be
composed of independent directors?
Would independent directors be likely
to have the necessary experience and
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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules
expertise to serve on the Board? Could
less experience or expertise negatively
affect risk management practices or the
efficiency of the clearing agency and, if
so, how? If any such experience or
efficiency issues exist, how could they
be overcome? What are the independent
directors’ incentives regarding fair and
open access, product eligibility, and
sound risk management? How are these
incentives different from those of
participants? Do they result in conflicts
of interest? If so, how are the conflicts
of interest different from those of
participants? How should they be
addressed by the Commission?
Should the Commission consider
alternative limits, or alternative
combinations of limits, on voting
interests or independent directors? For
example, should the voting interest
restrictions of 20% on individual
interests and 40% in the aggregate be
combined with the requirements for a
majority independent Board and a 100%
independent nominating committee?
Would an alternative combination of
requirements related to voting interests
and independent directors be more
effective? For example, would a higher
requirement in each case (e.g., a 10%
limit on individual voting interests and
a requirement for 60% independent
directors) be more effective? Or would
other combinations be more effective?
Should the Commission reduce the
restrictions over time if conflict of
interest concerns are lessened as the
security-based swaps market develops?
For example, if participation in the
security-based swaps market becomes
more open and includes a broader range
of participants, the interests of the
participants may become more aligned
with those of the clearing agency and
the markets generally. Would
restrictions on voting interests and
governance still be needed in this
circumstance? Are there other
circumstances where the voting interest
and governance restrictions may be
reduced or eliminated altogether? If,
over time, the security-based swaps
market does not become more
competitive, should the Commission
consider additional governance and
voting measures to promote open access
and competition? What measures would
be appropriate? What standards should
the Commission use to determine
whether additional restrictions should
or should not be imposed?
Could restrictions regarding the
governance structure of a security-based
swap clearing agency alone be sufficient
to address conflict of interest concerns
or are both restrictions on governance
and voting interests needed? Would
participants of a security-based swap
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clearing agency be able to exercise
undue influence over a security-based
swap clearing agency through a voting
interest even if a majority of the Board
is independent? Are requirements
related to the governance structure of a
security-based swap clearing agency
more or less effective than voting
limitations at addressing conflicts of
interest?
The Commission requests comment
on the proposed compositional
requirements of the nominating
committee. What is the potential effect
of requiring a security-based swap
clearing agency to have an entirely
independent nominating committee?
Would requiring an entirely
independent nominating committee,
which is required to consult with
participants of the security-based swap
clearing agency, be consistent with the
fair representation requirement under
the Exchange Act? Should end-users or
any other group be given guaranteed
rights of participation in the governance
of the security-based swap clearing
agency? Should the Commission have
some oversight of the Board selection
process? Should the Commission
consider an alternative to a
compositional requirement for a
nominating committee, such as allowing
a security-based swap clearing agency to
have a board of trustees responsible for
nominating candidates for the Board? If
this were a viable alternative, should
there be compositional requirements or
other limits imposed on the board of
trustees? How should such a board of
trustees be appointed? Would the
alternative of a board of trustees to
nominate directors provide greater
assurance that independent directors are
truly independent not only at the time
of their nomination but during their
service on the Board as well?
The Commission requests comment
on the proposed compositional
requirements of committees of the Board
under the Governance Focus
Alternative. Is the requirement that
Board committees that are delegated
authority by the Board be composed of
a majority of independent directors
appropriate? Should there be special
requirements relating to the risk
committee, or its equivalent, of the
Board? The Commission requests
comment on the possible alternatives for
risk committee governance as discussed
in Section IV.A.7. Would the possible
alternatives for the risk committee be
more or less desirable with respect to
the Governance Focus Alternative?
Under the Governance Focus
Alternative, should the percentage of
directors on the risk committee be
higher or lower than what is proposed?
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The Commission also requests comment
on whether there are other ways to
structure governance arrangements for
security-based swap clearing agencies to
mitigate potential conflicts of interest.
The Commission requests comment
on the composition of the disciplinary
panel of the security-based swap
clearing agency. Would the proposed
rule be sufficient to address potential
conflicts of interest that may interfere
with the fair and effective disciplinary
processes of a security-based swap
clearing agency? Should different
restrictions be imposed?
C. Existing Standards for Registered
Clearing Agencies
In addition to any new rules adopted
by the Commission with respect to
conflicts of interest at security-based
swap clearing agencies, the standards in
the Exchange Act that apply to all
securities clearing agencies registered
with the Commission will apply to
security-based swap clearing agencies.
The Dodd-Frank Act requires securitybased swap clearing agencies to be
registered as clearing agencies with the
Commission under Section 17A of the
Exchange Act.133 Thus, security-based
swap clearing agencies will be required
to comply with the standards in Section
17A of the Exchange Act. Some of these
standards may be used to address
concerns related to conflicts of interest,
regardless of whether a security-based
swap clearing agency elects the Voting
Interest Focus Alternative or the
Governance Focus Alternative. As a
result, the standards in Section 17A
would be used in addition to specific
conflict of interest rules adopted under
Section 765 of the Dodd-Frank Act.134
The Section 17A standards may be
used to mitigate conflicts of interest or
the effects of conflicts of interest in a
133 Depository institutions or derivatives clearing
organizations that have previously cleared swaps
pursuant to an exemption from registration as a
clearing agency will be deemed to be registered
with the Commission under Section 17A of the
Exchange Act. See Public Law 111–203, Section
763(l).
134 See Section 17A(b)(3) of the Exchange Act,
which sets forth the standards for registered
clearing agencies. 15 U.S.C. 78q–1(b)(3). See also
Securities Exchange Act Release No. 16900
(‘‘Standards Release’’) (June 17, 1980), 20 FR 416
(July 1, 1980). The Standards Release provides
guidance on the standards to be used by the
Commission’s Division of Trading and Markets in
connection with the registration of clearing
agencies. The standards also serve as staff
guidelines to assist clearing agencies in modifying
their organizations, capacities, and rules to comply
with the clearing agency registration provisions of
the Exchange Act.
The Commission is also considering matters
related to conflicts of interests as part of broader
standards that would be applicable to clearing
agencies in association with requirements under
Sections 763(b) and 805(a) of the Dodd-Frank Act.
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number of ways. As part of the initial
registration process, the Commission
approves the organizational structure of
a clearing agency.135 The Commission
also reviews and approves significant
changes to a clearing agency’s
governance structure after it is
registered.136 In addition, a clearing
agency must admit persons such as
banks and broker-dealers, and other
entities that the Commission may
designate by rule, as participants,137
subject to the participation standards of
the clearing agency.138
Clearing agencies also may not permit
unfair discrimination in the admission
of participants or among participants in
the use of the clearing agency.139 These
standards in Section 17A help to
mitigate concerns related to conflicts of
interest by promoting access to and use
of a clearing agency by all qualified
persons on an equivalent basis.140 The
Section 17A standards also help to
prevent a participant from using its
135 Section 17A(b)(3)(A) provides in full a
clearing agency shall not be registered unless the
Commission determines that the ‘‘clearing agency is
so organized and has the capacity to facilitate the
prompt and accurate clearance and settlement of
securities transactions and derivative agreements,
contracts, and transactions for which it is
responsible, to safeguard securities and funds in its
custody or control or for which it is responsible, to
comply with the provisions of [the Exchange Act]
and the rules and regulations thereunder, to enforce
(subject to any rule or order of the Commission
pursuant to section 17(d) or 19(g)(2) of [the
Exchange Act]) compliance by its participants with
the rules of the clearing agency, and to carry out
the purposes of [Section 17A of the Exchange Act].’’
15 U.S.C. 78q–1(a)(3)(C).
136 See Securities Exchange Act Release Nos.
612194 (December 22, 2009), 74 FR 68883
(December 22, 2009) (File No. SR–FICC–2009–10);
61215 (December 22, 2009), 74 FR 68888 (December
29, 2009) (File No. SR–NSCC–2009–10); and 61216
(December 22, 2009), 74 FR 68877 (December 29,
2009) (File No. SR–DTC–2009–16), notice and order
granting accelerated approval of proposed rule
changes filed by the clearing agency subsidiaries of
the Depository Trust and Clearing Corporation
(DTC, NSCC, and FICC) to permit DTCC to
nominate non-participant candidates for election to
its Board.
137 15 U.S.C. 78q–1(b)(3)(B).
138 Id. See also Section 17A(b)(4)(B), which
provides that a registered clearing agency may deny
participation to, or condition the participation of,
any person if such person does not meet such
standards of financial responsibility, operational
capability, experience, and competence as are
prescribed by the rules of the clearing agency. A
registered clearing agency may examine and verify
the qualifications of an applicant to be a participant
in accordance with procedures established by the
rules of the clearing agency. 15 U.S.C. 78q–
1(b)(4)(B).
139 15 U.S.C. 78q–1(b)(3)(F).
140 See Standards Release, supra note 134, at 419.
All participants utilizing similar clearing agency
services, with the exception of participants that are
registered clearing agencies for which specialized
requirements apply, should be required to comply
fully with the clearing agency’s internal financial
and operational rules such as clearing fund
deposits, mark-to-market payments, and margin
deposits related to the services used.
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influence to amend the rules of the
clearing agency in a manner that favors
its own institution to the disadvantage
of other participants because the rules of
a clearing agency may not be applied on
a discriminatory basis.141
Finally, the Section 17A standards
help to mitigate conflict of interest
concerns by providing that the rules of
a registered clearing agency may not
impose a burden on competition that is
not necessary or appropriate in
furtherance of the purposes of the
Exchange Act. This helps assure that the
clearing agency operates in a manner
that is consistent with the public
interest and is not used by participants
or other interested parties to gain an
unfair competitive advantage.142 The
Commission staff has previously
interpreted these standards as requiring
that a clearing agency must justify any
anticompetitive effect of membership
criteria and that it will evaluate an
anticompetitive effect in light of the
following factors: (1) The essential
nature of the service; (2) the number and
type of potential participants denied
access to clearance and settlement
services; (3) the number of entities
providing comparable clearance and
settlement services; and (4) the
availability of correspondent clearing
arrangements to provide indirect access
to a clearing agency’s services.143 The
Commission believes these factors
should also be used to evaluate the
anticompetitive effect of the
membership standards of security-based
swap clearing agencies once they are
registered clearing agencies under
Section 17A of the Exchange Act.
The Commission requests comment
on the application of the standards
under Section 17A to security-based
swap clearing agencies in conjunction
with the proposed rules to address
conflicts of interest. Will the proposed
rules effectively build on the Section
17A standards? Should the Commission
take a more targeted approach by
141 Id at 418. The provisions in Section 17A
recognize that a clearing agency may discriminate
among persons in the admission to, or the use of,
the clearing agency, by requiring that participants
meet certain financial, operational, and other fitness
standards. However, Section 17A also requires that
sanctioned discriminations must not be unfair. In
addition, the Commission must find that clearing
agency rules embodying any discriminations are in
the public interest and are consistent with the
requirements of the Exchange Act.
142 The standard does not prohibit all burdens on
competition. However, if a proposed rule of a
clearing agency would impose a burden on
competition, the burden must be weighed against
the benefits of the rule in achieving the purposes
of the Exchange Act. For example, a clearing agency
may impose participation standards that have an
anticompetitive effect as long as any such
anticompetitive effect is justified.
143 See Standards Release, supra note 134, at 419.
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focusing new requirements under
Section 765 of the Dodd-Frank Act on
Section 17A standards alone, such as by
having requirements addressing only
membership standards and
determinations whether to clear
products? Would such an approach
sufficiently address conflicts of
interests? If not, are the proposed rules
sufficient to address potential gaps in
the way Section 17A alone would
address conflicts of interest with respect
to security-based swap clearing
agencies? Should additional rules be
proposed under Section 17A to further
address conflict of interest concerns?
Should the Commission extend the
application of the proposed rules for
security-based swap clearing agencies to
all registered clearing agencies? To what
extent would competitive pressures in
the security-based swaps market,
particularly as it continues to develop,
help to mitigate conflicts of interest?
Would the standards under Section 17A
help to promote competition in a way
that would help to mitigate conflicts of
interest? To what extent does the
Commission’s oversight of clearing
agencies pursuant to the standards
under Section 17A alleviate the need for
ownership limitations and governance
requirements?
V. Discussion of Proposed Rule 702
Under Regulation MC for SecurityBased Swap Execution Facilities and
National Securities Exchanges That
Post or Make Available for Trading
Security-Based Swaps
A. Ownership and Voting Limitations
Section 765 requires the Commission
to adopt rules to mitigate conflicts of
interest, which may include numerical
limits on control of, or the voting rights
with respect to, any clearing agency that
clears security-based swaps, or on the
control of any SB SEFs or SBS
exchanges. Pursuant to this directive,
the Commission is proposing ownership
and voting limits for a SB SEF that
would apply to any SB SEF participant
and for a SBS exchange or facility of a
national securities exchange that posts
or makes available for trading securitybased swaps (‘‘SBS exchange facility’’)
that would apply to any SBS exchange
member. Specifically, the Commission
proposes that a SB SEF, SBS exchange,
or SBS exchange facility shall not
permit any SB SEF participant or SBS
exchange member, as applicable, either
alone or together with its related
persons, to: (1) Beneficially own,
directly or indirectly, any interest in the
SB SEF, SBS exchange, or SBS exchange
facility, as applicable, that exceeds 20%
of any class of securities, or other
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ownership interest, entitled to vote of
such SB SEF, SBS exchange, or SBS
exchange facility; or (2) directly or
indirectly vote, cause the voting of, or
give any consent or proxy with respect
to the voting of, any interest in the SB
SEF, SBS exchange, or SBS exchange
facility, as applicable, that exceeds 20%
of the voting power of any class of
securities or other ownership interest of
such SB SEF, SBS exchange, or SBS
exchange facility.144
The Commission is concerned that if
a SB SEF participant or SBS exchange
member, either alone or together with
its related persons, were to own a
significant stake in the SB SEF, SBS
exchange, or SBS exchange facility,
respectively, the SB SEF participant or
SBS exchange member could use its
significant ownership interest to
influence the operations of the SB SEF,
SBS exchange, or SBS exchange facility
to unduly derive benefits at the expense
of other owners and market participants.
The Commission is particularly
concerned that a SB SEF participant or
SBS exchange member may have
financial incentives to limit the level of
access to, and the scope of products
traded on, these trading venues as a
means to impede competition from
other market participants. For example,
the Commission understands that many
of the electronic multi-dealer trading
platforms that exist today for OTC
derivatives or fixed income products
limit the number of dealers from which
a customer can request a quote. The
Commission believes that a fewer
number of dealers participating on a
platform or exchange could result in
less competition on pricing. The
Commission believes that imposing
ownership and voting limits, as
described above, could mitigate
potential conflicts of interest with
respect to the level of access to the
market and determinations as to which
products are traded by limiting the
ability of a small group of persons (such
as dealers) to control the Board 145 and
thus the governance of the SB SEF, SBS
exchange, or SBS exchange facility.146
Unlike the Voting Interest Focus
Alternative or the Governance Focus
Alternative for security-based swap
144 See
proposed Rule 702(b) under Regulation
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MC.
145 See supra note 98 for the proposed definition
of ‘‘Board.’’
146 The Commission also believes that such limits
would further the ability of the SB SEF and SBS
exchange to effectively carry out its obligations.
Section 763(c) of the Dodd-Frank Act and Section
6 of the Exchange Act, respectively, and, in
particular, provide market participants with
impartial access to SB SEFs. See Section 763(c) of
the Dodd-Frank Act, Public Law 111–203, Section
763(c), and 15 U.S.C. 78f.
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clearing agencies, the Commission is not
proposing an aggregate 40% voting
interest limit collectively on all SB SEF
participants (with respect to SB SEFs)
and SBS exchange members (with
respect to SBS exchanges) or a 5%
individual voting interest limit,
respectively. The Commission
recognizes that, as with security-based
swap clearing agencies, the proposed
rule would limit, but not eliminate, the
ability of a small group of SB SEF
participants or SBS exchange members,
as applicable, to own a SB SEF, SBS
exchange, or SBS exchange facility.
Specifically, as few as five entities could
own SB SEFs, SBS exchanges, and SBS
exchange facilities under this proposal.
However, the Commission’s concerns
with respect to concentration of
ownership in security-based swap
clearing agencies and SB SEFs, SBS
exchanges, and SBS exchange facilities
are informed by the differences in the
structure for clearing and trading of
security-based swaps. The
Commission’s experience has been that
the central clearing model in the
securities markets historically has
tended toward convergence to a single
clearing agency for each type of cleared
product, while the market structure for
securities trading historically has not
necessarily tended toward a similar
model.147 The Commission also notes
that security-based swap clearing
agencies perform a critical function in
mitigating financial risk for securitybased swaps market participants.
Although SB SEFs, SBS exchanges, and
SBS exchange facilities are critical to
promoting price transparency and
therefore market efficiency, the
Commission does not believe that the
operation of SB SEFs, SBS exchanges,
and SBS exchange facilities would pose
the same level of systemic risk as
security-based swap clearing agencies.
There generally will be a lower barrier
to entry with respect to trading
platforms because participants of a SB
SEF or members of an SBS exchange
would not incur the margin, guaranty
fund, or other obligations that members
of a clearing agency would incur, and
thus multiple venues for the trading of
security-based swaps are more likely to
emerge. Thus, the Commission is not
proposing identical ownership
requirements for security-based swap
clearing agencies and SB SEFs, SBS
exchanges, and SBS exchange facilities.
147 The Commission has not made any
determinations about whether security-based swap
clearing agencies will also tend to converge to a
single clearing agency or even a small number of
clearing agencies, as the central clearing of securitybased swaps is still a developing area.
PO 00000
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For purposes of calculating a SB SEF
participant’s or SBS exchange member’s
ownership and voting interests, the
proposed rule would aggregate such
person’s ownership and voting interests
with those of its related persons. When
used with respect to a SB SEF, proposed
Rule 700(u) under Regulation MC would
define the term ‘‘related person’’ to
mean: (1) Any affiliate of a securitybased swap execution facility
participant; (2) any person associated
with a security-based swap execution
facility participant; (3) any immediate
family member of a security-based swap
execution facility participant or any
immediate family member of the spouse
of such person, who, in each case, has
the same home as the security-based
swap execution facility participant or
who is a director or officer of the
security-based swap execution facility
or any of its parents or subsidiaries; or
(4) any immediate family member of a
person associated with a security-based
swap execution facility participant or
any immediate family member of the
spouse of such person, who, in each
case, has the same home as the person
associated with the security-based swap
execution facility participant or who is
a director or officer of the security-based
swap execution facility or any of its
parents or subsidiaries.
Further, when used with respect to a
SBS exchange or SBS exchange facility,
proposed Rule 700(u) under Regulation
MC would define the term ‘‘related
person’’ to mean: (1) Any affiliate of a
member of the national securities
exchange that posts or makes available
for trading security-based swaps; (2) any
person associated with a member of the
national securities exchange that posts
or makes available for trading securitybased swaps; (3) any immediate family
member of a member of the national
securities exchange that posts or makes
available for trading security-based
swaps or any immediate family member
of the spouse of such person, who, in
each case, has the same home as the
member of the national securities
exchange that posts or makes available
for trading security-based swaps or who
is a director or officer of the national
securities exchange or facility thereof
that posts or makes available for trading
security-based swaps, or any of its
parents or subsidiaries; or (4) any
immediate family member of a person
associated with a member of the
national securities exchange that posts
or makes available for trading securitybased swaps or any immediate family
member of the spouse of such person,
who, in each case, has the same home
as the person associated with the
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national securities exchange that posts
or makes available for trading securitybased swaps or who is a director or
officer of the national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps or any of its parents or
subsidiaries. To further the purpose of
the proposed limits, the Commission
preliminarily believes that it would be
important to aggregate the SB SEF
participant’s or SBS exchange member’s
ownership and voting interests with the
interest of any person with whom such
person may be able to act together to
influence or control the SB SEF, SBS
exchange, or SBS exchange facility.
The proposed rule would restrict
indirect as well as direct ownership and
voting of a SB SEF, SBS exchange, or
SBS exchange facility. Because the
proposed rule could be easily
circumvented if the Commission were to
limit solely direct ownership and
voting, the Commission preliminarily
believes it would be important to further
the purpose of imposing ownership and
voting limits to also restrict the indirect
ownership and voting interests of SB
SEF participants and SBS exchange
members. For example, if the
Commission simply proposed to
prohibit a SB SEF participant from
directly owning or voting shares, the
participant could hold its ownership
interests in the SB SEF through a
holding company, thus easily
circumventing the intent of the
proposed rule. Accordingly, the
ownership and voting limits would
apply to ownership and voting of
interests in a parent company of the SB
SEF, SBS exchange, or SBS exchange
facility. For example, if the SB SEF were
wholly-owned by a holding company, a
SB SEF participant would be prohibited
from owning or voting more than 20%
of the voting interest in the parent
company. Finally, the proposed limits
also would apply to a SB SEF
participant or SBS exchange member
that beneficially owns more than 25% of
an entity that itself owns more than
20% of a SB SEF, SBS exchange, or SBS
exchange facility.148
To assure that SB SEFs, SBS
exchanges, and SBS exchange facilities
maintain an ownership structure
consistent with the proposed ownership
and voting limits, the Commission
proposes that these entities have rules
that (1) provide an effective mechanism
to divest a SB SEF participant’s or SBS
exchange member’s ownership that,
alone or together with its related
persons, exceeds 20% and (2) are
148 See supra note 93 for the proposed definition
of ‘‘control.’’
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reasonably designed not to give effect to
a SB SEF participant’s or SBS exchange
member’s voting interest that, alone or
together with its related persons,
exceeds 20%.149 The Commission
believes that in order for the ownership
and voting limits to be effective, each
SB SEF, SBS exchange, and SBS
exchange facility must take measures to
reduce a SB SEF participant’s or
member’s ownership interest or not give
effect to any voting interest that exceeds
the proposed limits. The Commission
intends to provide SB SEFs, SBS
exchanges, and SBS exchange facilities
flexibility in determining how to
implement these requirements. Any
rules adopted by these trading venues,
however, must assure that they have a
viable, enforceable mechanism to divest
a SB SEF participant or SBS exchange
member of any interest held in excess of
the 20% limit and to not give effect to
the portion of voting interest held in
excess of the 20% limit. The
Commission also proposes to require
each SB SEF, SBS exchange, or SBS
exchange facility to have rules to
provide a mechanism to obtain
information relating to its ownership
and voting interests.150 The Commission
believes that a requirement to collect
information regarding ownership and
voting interests of SB SEF participants
and SBS exchange members is essential
for registered trading venues to monitor
and comply with the proposed
ownership and voting limits.151
The Commission believes that an
ownership and voting limit of 20% is an
appropriate threshold. On the one hand,
the restriction would limit the ability of
a SB SEF participant or SBS exchange
member to exert undue influence over
the governance of a SB SEF, SBS
exchange, or SBS exchange facility,
respectively. On the other hand, such an
ownership and voting limit should not
overly interfere in such an entity’s
organizational structure or the ability of
a SB SEF participant or SBS exchange
member to acquire a substantial equity
interest in a SB SEF, SBS exchange, or
SBS exchange facility, as applicable.152
149 See proposed Rules 702(c)(1) and (2) under
Regulation MC.
150 See proposed Rule 702(c)(3) under Regulation
MC.
151 See supra Section IV.A.4.
152 National securities exchanges that may trade
security-based swaps currently prohibit a member
from owning or voting more than 20% of the
exchange, although an exchange’s method of
calculating the 20% interest, aggregated with any
person with whom such person may be able to act
together to influence or control an exchange, may
vary from the Commission’s proposal. See, e.g.,
Amended and Restated Certificate of Incorporation
of BATS Global Markets, Inc., Article FIFTH;
Amended and Restated Certificate of Incorporation
of NYSE Euronext, Article V.
PO 00000
Frm 00026
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Sfmt 4702
Thus, the proposed ownership and
voting limits should strike an
appropriate balance between the
objectives of mitigating conflicts of
interest and refraining from
unnecessarily hindering the ability of
entities to form new trading venues. In
addition, there may be incentives to
create a new SBS exchange or SB SEF
because a SBS exchange or SB SEF may
draw significant new business by
making available to trade a securitybased swap that is required to be cleared
under Section 763(a).153 Furthermore,
the risk management and economies of
scale issues that may create a barrier to
entry with respect to new security-based
swap clearing agencies generally would
not affect the creation of SBS exchanges
or SB SEFs.
While the Commission believes that
the proposed 20% ownership and
voting limits are appropriate, it also
understands that the movement of
trading of security-based swaps onto SB
SEFs, SBS exchanges, or SBS exchange
facilities will foster enhanced
transparency and market efficiency. The
Commission does not intend to
unnecessarily impede the emergence of
what could be vital sources of, among
other things, liquidity and pricing
transparency for security-based swaps.
However, imposing on SB SEFs and SBS
exchanges ownership and voting limits
similar to those that shareholder-owned
cash equities and options exchanges
have in place could have the
unintended consequence of deterring
new, competitive trading venues at a
time when organized markets for
security-based swaps are just beginning
to develop. A trading platform that
currently trades security-based swaps in
the OTC market but would not meet the
proposed ownership and voting limits
would need to revise its ownership
structure if it chooses to become a SB
SEF. There could be costs and delays as
the potential SB SEF seeks to find one
or more additional owners to satisfy the
proposed limits, with a possible
diminution in the value of the original
owner(s)’ investment. Moreover, it is
possible that imposing these limits may
affect the security-based swaps market
differently than the cash equities and
listed options markets. Ownership and
153 The counterparties to a transaction in a
security-based swap that is required to be cleared
under Section 763(a)(2) of the Dodd-Frank Act will
be required to execute the transaction on a SBS
exchange or on a SB SEF. There is an exception
from the execution requirement if no SBS exchange
or SB SEF makes the security-based swap available
to trade. See Public Law 111–203, Section 763(h).
The exception from trade execution is also available
if the exception from mandatory clearing under
Section 763(g) applies. See Public Law 111–203,
Section 763(g).
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voting limits were implemented at
national securities exchanges at a time
when the trading of exchange-listed
securities was fairly well established
and competitive. Consequently, a 20%
ownership and voting limit may not
negatively affect the ability of cash
equity and options exchanges to
promote competing trading venues but,
if applied to the security based-swaps
market that is in its infancy, could
retard market development.
The Commission is sensitive to
arguments against imposing ownership
and voting limits for SB SEFs, SBS
exchanges, and SBS exchange facilities,
some of which were articulated at the
Conflicts Roundtable. However, it also
understands that the OTC derivatives
market is highly concentrated and
dealer dominated. Although ownership
and voting limits arguably may have a
less negative effect on new entrants to
the cash equities and options markets
and their ability to compete, there may
also be less need for such limitations in
those markets. In contrast, although
ownership and voting limits may more
directly affect the ability of SB SEFs and
SBS exchanges to start up, the lack of
market characteristics to promote
competing trading venues for securitybased swaps may emphasize the greater
need for ownership and voting limits. If
the market characteristics for securitybased swaps naturally promote dealer
domination without robust competing
trading venues, there is more need to
mitigate the types of concerns that
underlie Section 765, such as by
imposing ownership and voting
limits.154
The Commission must weigh the
potential implications of imposing
ownership and voting limits against
imposing other requirements that would
allow a dealer-dominated security-based
swaps market to continue. As part of the
balance between mitigating conflicts of
interest without unduly restricting the
ability of a competitive market for
trading of security-based swaps to
emerge, the Commission proposes to
limit ownership in SB SEFs, SBS
154 In the equities market a small group of brokerdealers or single-dealer proprietary firms can and
do own alternative trading systems (‘‘ATSs’’) and
thus it can be argued that SB SEFs and SBS
exchanges should be permitted to operate similarly.
See Securities Exchange Act Release No. 60997
(November 13, 2009), 74 FR 61208 (November 23,
2009) (as of November 2009, there were
approximately 73 ATSs that are subject to
Regulation ATS). However, ATSs exist in the
context of a marketplace with robust competition
among numerous trading venues. Therefore, ATSs
that are owned by one broker-dealer or a small
group of broker-dealers, by virtue of their
ownership structure alone, generally do not present
a concern that they could lessen price competition
or market efficiency.
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exchanges, and SBS exchange facilities
specifically to those interests entitled to
vote.155 Consequently, a SB SEF
participant or SBS exchange member
would not be prohibited from owning
any percentage of a nonvoting interest
in a SB SEF, SBS exchange, or SBS
exchange facility. In contrast, national
securities exchanges generally limit
their members from owning more than
20% of any interest, voting or otherwise.
However, as discussed above, trading
venues for exchange-listed securities are
well established and highly competitive.
In this regard, the Commission does not
believe that it is necessary to propose
the same ownership limits as those
currently in place at national securities
exchanges. Further, the proposed 20%
limit on ownership and voting would
still allow as few as five entities to own
a SB SEF, SBS exchange, or SBS
exchange facility. Thus, the proposed
limit by itself would not completely
prohibit a small number of entities from
potentially exerting undue influence
over SB SEFs, SBS exchanges, or SBS
exchange facilities in a way that could
benefit the few to the detriment of
others.
The Commission requests comment
on all aspects of the proposed
ownership and voting limits, including
whether it is necessary and appropriate
to have ownership and voting limits at
all. If commenters believe that it is
necessary and appropriate to impose
ownership and voting limits to mitigate
conflicts of interest, the Commission
requests comment on whether the
proposed limits are appropriate, or
whether they would unduly hinder the
development of SB SEFs without
serving to mitigate any conflicts.156
155 See
supra note 64.
the SRO Governance Proposing Release, the
Commission proposed a similar 20% ownership
and voting limit for members of a national
securities exchange. A number of commenters
favored this proposal, including several
commenters that were national securities exchanges
or a facility of a registered securities association.
See, e.g., letter from Michael J. Simon, Secretary,
ISE, to Jonathan G. Katz, Secretary, Commission,
dated March 8, 2005 (‘‘ISE Comment Letter’’) (‘‘[The
ownership limitation] provides SROs with
flexibility, yet recognizes the unique conflicts that
could arise if a member were to own a controlling
interest in an SRO with regulatory responsibility for
the member.’’); letter from Meyer S. Frucher,
Chairman and Chief Executive Officer, Phlx, to
Jonathan G. Katz, Secretary, Commission, dated
March 8, 2005 (‘‘Phlx Comment Letter’’) (‘‘The
Exchange unequivocally agrees with the
Commission that a significant shareholder could
use its voting power to influence the operations of
an exchange in a way that adversely affects the
mission, integrity or regulatory capacity of the
exchange, or otherwise is detrimental to the public
interest.’’); letter from Philip D. DeFeo, Chairman
and Chief Executive Officer, Pacific Exchange, Inc.
(‘‘PSX’’), to Jonathan G. Katz, Secretary,
Commission, dated March 8, 2005 (‘‘PSX Comment
156 In
PO 00000
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65907
Should the Commission require a voting
limit, but not an ownership limit or a
different limit for ownership versus
voting? Even with the prohibition
against owning more than 20% of any
interest entitled to vote, a SB SEF
participant or SBS exchange member
could have sufficient ownership of
nonvoting interest, either alone or in
addition to voting interest, to exert
influence on these trading venues.
Should the Commission require the
ownership limit to apply to any class of
equity securities or other ownership
interest rather than any class of
securities, or ownership interest,
entitled to vote? 157 Would the proposed
limits impede the number or types of SB
SEFs from being established? Should
the proposed ownership and voting
limits be phased in for SB SEFs to
provide a grace period for those entities
that would not meet the requirements
under Regulation MC?
The Commission also seeks comment
on whether the proposed ownership and
voting limits would continue to be
important as the market for securitybased swaps evolves. If multiple SB
SEFs emerge as this market develops,
would competitive pressures alleviate
any of the conflicts of interest that are
the basis for the Commission’s
proposals? In that case, would it be
appropriate for the Commission to
impose different limits? Should the
Commission reduce the restrictions over
time, if conflict of interest concerns are
lessened as the security-based swaps
market develops? For example, if
participation in the trading of securitybased swaps becomes more open and
includes a broader range of participants,
and multiple SB SEFs or SBS exchanges
evolve to trade the same security-based
swaps, would there still be a need to
retain ownership and voting limits or
are there factors that would allow such
limits to be revised? What factors
should the Commission consider in
assessing whether any ownership and
voting limits it may impose on SB SEFs
should be revisited?
As mentioned above, each national
securities exchange currently prohibits
Letter’’); letter from Edward S. Knight, Executive
Vice President and General Counsel, Nasdaq Stock
Market, Inc., to Jonathan G. Katz, Secretary,
Commission, dated March 8, 2005 (‘‘Nasdaq
Comment Letter’’). The Commission notes, however,
that the SRO Governance Proposing Release related
to national securities exchanges that trade equity
securities and listed options and registered
securities associations, and the comments received
did not address potential conflicts in other contexts.
157 The CFTC has proposed similar ownership
and voting limits for DCMs and registered SEFs,
and applies the ownership limit only to any class
of equity securities entitled to vote. See https://
www.cftc.gov/ucm/groups/public/@newsroom/
documents/file/federalregister_governance.pdf.
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its members from owning an interest,
voting or otherwise, or voting more than
20% (or less) of the exchange or a
facility of the exchange.158 Therefore,
the Commission preliminarily does not
believe that the proposed rules would
have a material effect on an exchange’s
ability to post or make available for
trading security-based swaps.
Nevertheless, the Commission requests
comment on whether the proposed
limits in this rulemaking could affect a
national securities exchange’s ability or
decision to post or make available for
trading security-based swaps. Also,
given that national securities exchanges
currently have limits on ownership and
voting by members, would codifying the
proposed limits help to further mitigate
the types of conflicts of interest that
underlie the Dodd-Frank Act for SBS
exchanges? Would there be any effect on
the willingness of entities to register to
become a national securities exchange
and trade security-based swaps? What
would be the implication, if any, on an
exchange that chose to trade securitybased swaps through a facility that is a
separate legal entity? More generally, for
SB SEFs and SBS exchanges or SBS
exchange facilities, should ownership
and voting be limited to the same
threshold or should they be different? If
the Commission should take a different
approach for ownership and voting,
what should that approach be?
As described above, Section 765
enumerates Specified Entities that the
Commission should consider in its
rulemaking. The Commission
understands that, depending on who
may be permitted to directly effect
transactions on a SB SEF (or is a SBS
exchange member), limits on ownership
and voting that apply only to SB SEF
participants or SBS exchange members
could be either over-inclusive or underinclusive or both, with respect to the
Specified Entities. For example,
restricting control of a SB SEF based on
an entity’s direct participation on the SB
SEF could capture a person who is not
one of the Specified Entities or,
conversely, fail to take into
consideration a Specified Entity.
Accordingly, the Commission requests
comment on whether the scope of the
158 A member has in the past been permitted on
a pilot basis to own more than 20% of a facility of
an exchange subject to certain terms and
conditions. See Securities Exchange Act Release
Nos. 59281 (January 22, 2009), 74 FR 5014 (January
28, 2009) (order approving on a pilot basis 50%
ownership of the New York Block Exchange, a
trading facility of NYSE, by BIDS ATS, a member
of NYSE). This pilot has since been extended for an
additional year and will expire on January 22, 2011
unless further extended or permanently approved.
See Securities Exchange Act Release No. 61409
(January 22, 2010), 75 FR 4889 (January 29, 2010).
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proposed ownership and voting limits is
appropriate. Should the limits on
ownership and voting extend to all or
some of the Specified Entities,
regardless of their direct participation
on the SB SEF or SBS exchange? If so,
why? What are the potential conflicts
concerns that such Specified Entities
may pose? How are conflicts concerns
posed by such Specified Entities
different from those posed by SB SEF
participants or SBS exchange members
who are not also Specified Entities? In
this regard, the Commission notes that
the definition of ‘‘related person’’ would
encompass any such entity that is
affiliated with such a SB SEF
participant or SBS exchange member,
although it may not itself be a SB SEF
participant or SBS exchange member.
In addition, national securities
exchanges generally limit ownership
and voting by non-members, as well as
members.159 Specifically, exchanges
generally limit each non-member to no
more than 40% ownership of the
exchange. The limit on ownership by
non-members of an exchange is
designed in part to provide the
Commission and the exchange with the
proper tools (such as access to books
and records) necessary to carry out the
Commission’s and the exchange’s
respective regulatory oversight
responsibilities, as well as to mitigate
more general conflict concerns between
owners’ commercial interests and the
exchange’s regulatory obligations. The
Commission requests comment on
whether it should impose, as part of this
rulemaking, similar limits on ownership
and voting. Such an ownership limit
would apply to the Specified Entities, to
the extent they are not subject to the
proposed ownership limit described
above. In addition to the requirements
of Section 765, the Dodd-Frank Act
more generally requires a SB SEF to
establish and enforce rules to minimize
conflicts of interest in its decisionmaking process and establish a process
for resolving the conflicts of interest.
What are the types of conflicts that a
person who is not a SB SEF participant
or SBS exchange member may pose?
The Commission also requests
comment on whether its formulation for
calculating the 20% threshold is
appropriate. Specifically, the
Commission requests comment on all
prongs of the definition of ‘‘related
person,’’ including whether the
definition is over-inclusive or underinclusive. What other method could the
Commission use to reach the interest of
any person with whom a SB SEF
participant or SBS exchange member
159 See
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may be able to act together to influence
or control a SB SEF or SBS exchange?
Finally, the Commission expects a SB
SEF, SBS exchange, and SBS exchange
facility to have in place an effective
mechanism for enforcing the ownership
and voting limits. The Commission
requests comment on whether the
proposed rules related to divesture of
ownership and voting limits are
appropriate. Should the Commission
explicitly require in the proposed rules
specific ways to divest ownership and
voting interest of SB SEF participants
and SBS exchange members who violate
the ownership and voting limits? Is the
proposed rule pertaining to obtaining
information on ownership and voting
interest of SB SEFs, SBS exchanges, and
SBS exchange facilities appropriate?
Should the Commission require that
trading venues collect information
pertaining to certain ownership or
voting thresholds?
B. Governance Requirements
The Commission is proposing
substantive requirements with respect to
the governance of SB SEFs, SBS
exchanges, and SBS exchange facilities
that are designed to address the conflict
of interest concerns identified above,
including the concern that dealerowners could unduly influence the
governance and operation of a SB SEF
or SBS exchange. These governance
provisions, as discussed below, should
help mitigate conflicts of interest as
directed by Section 765 of the DoddFrank Act.
1. Board
The Commission proposes that the
Board of a SB SEF, SBS exchange, or
SBS exchange facility be composed of a
majority of independent directors.160
The presence of a majority of
independent directors on the Board
should reduce the ability of ownerdirectors of a SB SEF, SBS exchange, or
SBS exchange facility to improperly
influence the operation of such entity to
their own advantage and to the
detriment of other users or potential
users of the facility or exchange. A
majority independent director
requirement should help foster a greater
degree of independent decision-making
consistent with the objectives of the
Dodd-Frank Act and the Exchange Act
and should reduce the ability of owners
that are participants or members to
control key decisions regarding the
operation of the SB SEF or SBS
exchange and thereby potentially limit
160 See proposed Rule 702(d)(1) under Regulation
MC. See also supra note 102 and accompanying text
for the proposed definition ‘‘independent director.’’
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access to, or limit the products made
available for trading on, the SB SEF or
SBS exchange, which could adversely
affect the trading of security-based
swaps in regulated markets. Further, the
definition of independent director is
designed to assure that the independent
director would not have a direct
economic stake in the SB SEF or SBS
exchange, or other relationship that
would call into question the impartiality
of the director, and thus would not be
subject to the conflicts of interest
identified above.
SB SEFs and SBS exchanges are
intended to serve important roles in
providing centralized, transparent
trading of security-based swaps and,
under Section 763(c) of the Dodd-Frank
Act or existing Section 6 of the
Exchange Act, as applicable, will have
a number of responsibilities.161
Requiring a majority independent Board
should help assure that SB SEFs and
SBS exchanges would operate in an
impartial manner with respect to these
(and other) mandated duties. Moreover,
requiring a majority independent Board
for SB SEFs and SBS exchanges would
be commensurate with the manner in
which national securities exchanges
generally are governed today 162 and
comports with the listing rules of
exchanges, which are approved by the
Commission.163
One of the alternatives the
Commission proposes for security-based
swap clearing agencies is to require the
Board of any security-based swap
161 For SB SEFs, these responsibilities include
establishing and enforcing rules with respect to the
terms and conditions of the security-based swaps
traded or processed on or through the facility and
any limitation on access to the facility; trading
procedures to be used in entering and executing
orders traded on SB SEFs; and monitoring trading
in SB SEFs to prevent manipulation, price
distortion, and disruptions of the settlement process
through surveillance, compliance and disciplinary
practices and procedures. See Section 763(c) of the
Dodd-Frank Act, Public Law 111–203, Section
763(c).
162 See supra Section III.B. Currently, the
governance structure of a facility of an exchange
that is a separate legal entity from the exchange and
that is not a wholly-owned subsidiary of the
exchange is not subject to any specific board or
committee compositional requirements. Given the
nature of the conflict concerns for the trading of
security-based swaps and the structure of the
security-based swaps market—namely, the
dominance by a small group of dealers and the
concern with respect to undue influence in the
operation of the SB SEF or SBS exchange—the
Commission believes that it is necessary and
appropriate to impose the same board and
committee compositional requirements on a facility
of an exchange if that facility posts or makes
available for trading security-based swaps.
163 See Securities Exchange Act Release No.
48745 (November 4, 2003), 68 FR 64154 (November
12, 2003) (order approving File Nos. SR–NYSE–
2002–33, SR–NASD–2002–77, SR–NASD–2002–80,
SR–NASD–2002–138, SR–NASD–2002–139, and
SR–NASD–2002–141).
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clearing agency be composed of 35%
independent directors. The Commission
proposes this 35% independence
alternative to address potential concerns
that requiring a majority independent
Board for security-based swap clearing
agencies would affect the Board’s ability
to effectively perform risk management
functions. Security-based swap clearing
agencies perform a critical function in
mitigating financial risk for securitybased swaps market participants.
Although critical to promoting price
transparency and therefore market
efficiency, as noted above, the
Commission does not believe that the
operation of SB SEFs, SBS exchanges,
and SBS exchange facilities would pose
the same level of systemic risk as
security-based swap clearing agencies
because they do not assume the risk of
managing open positions or of
guaranteeing the settlement of
transactions. Thus, the Commission is
not making the same proposal with
respect to SB SEFs, SBS exchanges, and
SBS exchange facilities.
Although a majority independent
Board may address conflicts of interest
concerns that underlie Section 765 of
the Dodd-Frank Act, it may not
effectively eliminate all conflicts. The
presence of independent directors may
be an effective mechanism to address
certain types of conflicts in certain types
of institutions but not necessarily in all
instances nor for all institutions. The
Commission, however, does not believe
that the characteristics of SB SEFs and
SBS exchanges, and the types of
conflicts that may be inherent with
respect to such entities, pose a set of
circumstances that are incompatible
with an effective governance via a
majority independent Board.
Taking into account these and other
concerns, the Commission has
considered a less prescriptive
governance rule to address conflicts of
interest for venues that trade securitybased swaps. However, especially
because SB SEFs are not SROs and thus
their rules are not subject to
Commission approval pursuant to
Section 19 of the Exchange Act,164 a
principles-based approach to
governance may not give the
Commission sufficient ability to address
potential conflicts in the operation of SB
SEFs. Although the Commission,
through its authority to approve
applications to register as a SB SEF, may
be able to ascertain that a SB SEF at the
time of its registration has a governance
structure that sufficiently would
mitigate conflicts of interest, a less
prescriptive approach could make it
164 15
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more difficult for the Commission to
assure that the SB SEF’s governance
structure continues to meet the
proposed requirements over time.
The Commission welcomes
commenters’ insights to inform its
understanding of the governance of
trading venues for security-based swaps.
As discussed above, a majority
independent Board may not effectively
address all conflicts. The Commission
therefore seeks comment on all aspects
of its proposal for a majority
independent Board. Should the
Commission adopt a less prescriptive
approach to mitigating conflicts of
interest in the governance of SB SEFs
and SBS exchanges? Are there other
approaches that would improve
governance and mitigate conflicts of
interest? For example, would State laws
governing the fiduciary duty owed by
corporate board members help to
mitigate conflicts of interest or, as noted
above, would such laws potentially
aggravate the types of conflicts of
interest that the Commission is trying to
address? Should the Commission
consider any additional requirements
related to fiduciary duties to either
enhance mitigation of conflicts or
address deficiencies?
Further, the Commission requests
comment on whether requiring the
Board of a SB SEF, SBS exchange, or
SBS exchange facility to be composed of
a majority of independent directors
would improve the governance of the
SB SEF, SBS exchange, or SBS exchange
facility, as applicable, and mitigate
conflicts of interest that could arise. The
Commission specifically requests
comment on whether there are other
Board structures that could help
mitigate conflicts of interest. If having a
majority independent Board is not
necessary to mitigate conflicts, but some
lesser percentage of independent
directors would help address such
concerns, what percentage of Board
members should be required to be
independent? What are the benefits and
costs of requiring Boards of SB SEFs,
SBS exchanges, and SBS exchange
facilities to be composed of a majority
of independent directors? Would a
majority independent Board help to
mitigate conflicts of interest if the
ownership of a SB SEF, SBS exchange,
or SBS exchange facility is concentrated
in a small group of owners (e.g., five
owners) rather than a larger group (e.g.,
greater than ten owners)? Would a
majority independent Board help to
mitigate conflicts of interest that could
arise between the commercial interests
of a SB SEF, SBS exchange, or SBS
exchange facility or the owners of the
SB SEF, SBS exchange or SBS exchange
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facility and the regulatory
responsibilities of the SB SEF or SBS
exchange? Are there experience or
efficiency issues if a majority of the
Board must be composed of
independent directors? Are there
remedies for overcoming any such
experience or efficiency issues? 165
The Commission also notes that
currently, for national securities
exchanges, at a minimum, the number
of non-industry directors should equal
or exceed the number of industry
directors.166 The Commission requests
comment on whether requiring a
majority independent Board could
further mitigate conflicts for SBS
exchanges or whether the current
standards exchanges have in place
would sufficiently address the conflict
concerns with respect to exchanges that
would post or make available for trading
security-based swaps. Further, the
Commission requests comment as to
whether the requirement for Board
composition should be different for SB
SEFs and SBS exchanges and, if so, why
and how?
The Commission also requests
comment on the proposed definitions of
‘‘independent director’’ and ‘‘material
relationship.’’ 167 Are the definitions of
‘‘independent director’’ and ‘‘material
relationship’’ appropriate? If not, how
should they be defined? The proposed
rule provides circumstances that would
preclude a finding that a director is
independent.168 The Commission
165 The SRO Governance Proposing Release
proposed that the board of a national securities
exchange or national securities association be
composed of a majority of independent directors.
See SRO Governance Proposing Release, supra note
59. A number of commenters, particularly national
securities exchanges, favored this proposal. See,
e.g., PSX Comment Letter, supra note 156; Letter
from Anthony K. Stankiewicz, Esq., Vice President,
Legal and Governance, BSE, to Jonathan G. Katz,
Secretary, Commission, dated March 8, 2005
(supporting the majority independent board
requirement but objecting to the definition of
independence) (‘‘BSE Comment Letter’’); Letter from
Mary Yeager, Assistant Secretary, NYSE, to
Jonathan G. Katz, Secretary, Commission, dated
March 8, 2005 (‘‘NYSE Comment Letter’’). A few
commenters objected to it as being an unnecessary
requirement to mandate for all exchanges. See, e.g.,
ISE Comment Letter, supra note 156; Letter from
William J. Brodsky, Chairman and Chief Executive
Officer, Chicago Board Options Exchange,
Incorporated, to Jonathan G. Katz, Secretary,
Commission, dated March 8, 2005 (‘‘CBOE
Comment Letter’’). The Commission notes, however,
that the SRO Governance Proposing Release related
to national securities exchanges that trade equity
securities and listed options and registered
securities associations, and the comments received
did not address potential conflicts in other contexts.
166 See supra Section III.B.
167 See proposed Rules 700(j) and (l) under
Regulation MC.
168 See Section 303A.02 of the NYSE Listed
Company Manual and Nasdaq Rule 5605(a)(2), both
of which contain specific circumstances that, if
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requests comment on whether this
approach is appropriate or whether the
Commission should take a less
prescriptive approach. The Commission
also notes that the proposed rule
precludes a director from being deemed
independent if he or she has received
from the SB SEF, SBS exchange, or SBS
exchange facility within the past three
years payments that reasonably could
affect his or her independent judgment
or decision-making, excluding
remunerations for Board or Board
committee services. The Commission
requests comment on whether it is
appropriate to exclude compensation for
Board or Board committee service from
disqualifying a director as an
independent director. Are there
circumstances or levels of compensation
that should disqualify a candidate from
being deemed independent? The
Commission also requests comment on
whether, instead of independence
requirements, it should require that the
number of ‘‘non-industry’’ directors
equal or exceed the number of
‘‘industry’’ directors, as such terms are
generally defined by the exchanges.169
Are there other types of affiliations that
the Commission should be concerned
about that are not addressed by the
proposed definitions of ‘‘independent
director’’ or ‘‘material relationship’’?
The Commission is not proposing that
the Board composition requirement
apply to parent companies of a SB SEF,
SBS exchange, or SBS exchange
facility.170 In other words, the
Commission is not proposing to require
a holding company that wholly owns, or
entities that control, a SB SEF, SBS
exchange, or SBS exchange facility to
have a majority independent Board.171
The Commission preliminarily believes
that the composition of the Board of a
parent that wholly owns or controls a
SB SEF, SBS exchange, or SBS exchange
facility does not raise conflicts concerns
that require Commission rulemaking.
The Commission, however, requests
comment on whether the majority
independent Board requirement should
apply to an entity that owns and
satisfied, would preclude a determination that the
director is independent.
169 See supra note 66.
170 If the parent company of a SB SEF, SBS
exchange or SBS exchange facility was itself a
regulated entity that is subject to the Exchange Act
and rules and regulations thereunder, then it would
comply with any requirements that it is subject to
in that capacity.
171 The CFTC has proposed to apply a ‘‘public
director’’ requirement to parent companies that
operate DCMs and SEFs. See https://www.cftc.gov/
ucm/groups/public/@newsroom/documents/file/
federalregister_governance.pdf.
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controls a SB SEF, SBS exchange, or
SBS exchange facility.
2. Regulatory Oversight Committee
In addition to a majority independent
Board, the Commission proposes that a
SB SEF or SBS exchange establish a
ROC that is composed solely of
independent directors to oversee the SB
SEF’s obligations under Section 763(c)
of the Dodd-Frank Act or the SBS
exchange’s regulatory oversight
responsibilities under Section 6 of the
Exchange Act, respectively.172 This
requirement also would apply to a
national securities exchange that posts
or makes available for trading securitybased swaps through a facility of the
exchange.173 The ROC would oversee
the regulatory program on behalf of the
Board. Specifically, the Commission
expects that a ROC, among other things,
would monitor a SB SEF’s or SBS
exchange’s regulatory program for
sufficiency, effectiveness, and
independence; oversee all facets of the
regulatory program; review the size and
allocation of the regulatory budget and
resources; and review regulatory
proposals and advise the Board as to
whether and how such changes may
affect regulation. The proposed rule also
would require that any recommendation
of the ROC that is not adopted or
implemented by the Board be reported
promptly to the Commission.174
The proposed provisions relating to
the ROC should help limit the ability of
owners of the SB SEF and SBS exchange
to unduly influence the operation of
these entities, and thus would further
the objectives of good governance and
mitigation of conflicts of interest that
underlie Section 765 of the Dodd-Frank
Act. A ROC is intended to have an
important role in assuring that a SB SEF
or SBS exchange carries out its
obligations in an even-handed and
effective manner and that its oversight
functions are adequately funded.
Although the Commission encourages
national securities exchanges to have a
wholly independent ROC, it has not in
172 See Section 763(c) of the Dodd-Frank Act,
Public Law 111–203, Section 763(c), and 15 U.S.C.
78(f). See also proposed Rule 702(e)(1) under
Regulation MC.
173 Proposed Rule 702(e) under Regulation MC
does not explicitly include a SBS exchange facility.
A facility that posts or makes available for trading
a security-based swap would do so under the
registration of an exchange of which it is a facility.
Therefore, the exchange is deemed the statutory
entity posting or making available for trading the
security based swap and is responsible for the
regulatory oversight of the facility. Accordingly, the
exchange whose facility posts or makes available for
trading a security-based swap must itself establish
the requisite ROC.
174 See proposed Rule 702(e)(2) under Regulation
MC.
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the past required them to do so.175 As
mentioned above, however, the conflict
concerns that Section 765 is intended to
address are not entirely analogous to
those posed by national securities
exchanges. Rather, there is a heightened
concern regarding conflicts of interest
for trading venues of security-based
swaps because a small group of dealers
may exert undue influence to control
the level of access to, and the scope of
products traded on such venues.
Further, while SB SEFs do not possess
the full range of self-regulatory
obligations that exchanges have, they
nonetheless have a number of regulatory
duties that are set forth in the core
principles for SB SEFs contained in
Section 763(c) of the Dodd-Frank Act.176
Thus, it appears that a need for a wholly
independent ROC may be greater for SB
SEFs and SBS exchanges than for other
registered national securities
exchanges.177
The Commission also recognizes that,
as mentioned above, an independent
director, who by definition would be
outside the management of a SB SEF or
175 In the SRO Governance Proposing Release, the
Commission proposed to require SROs to have a
ROC and to require that all members of such
committee be independent. See SRO Governance
Proposing Release, supra note 59. Some
commenters generally favored the requirement of a
ROC. See, e.g., PSX Comment Letter, supra note
156; CBOE Comment Letter, supra note 165.
However, a number of commenters objected to the
requirement that certain board committees,
including the ROC, be composed solely of
independent directors. See, e.g., Phlx Comment
Letter, supra note 156 (‘‘To impose this requirement
on all Standing Committees would potentially
exclude persons with the most experience and
knowledge from serving on these committees.’’);
CBOE Comment Letter, supra note 165; letter from
Neal Wolkoff, Acting Chief Executive Officer, the
American Stock Exchange LLC, to Jonathan G. Katz,
Secretary, Commission, dated March 8, 2005 (‘‘[A]
number of the exchanges may find it difficult to
find enough qualified independent directors with
sufficient expertise to satisfy all of these
committees.’’); letter from the Archipelago
Exchange, BSE, the Chicago Stock Exchange, ISE,
the Nasdaq Stock Market, and Phlx, to Jonathan G.
Katz, Secretary, Commission, dated March 8, 2005
(‘‘[As] a result of the potential loss of flexibility, we
disagree with the mandated requirement for specific
committees composed exclusively of directors that
meet the [Commission’s] proposed definition of
independence.’’). The Commission notes, however,
that the SRO Governance Proposing Release related
to national securities exchanges that trade equity
securities and listed options and registered
securities associations, and the comments received
did not address potential conflicts in other contexts.
176 See supra note 54.
177 Some exchanges have voluntarily created
ROCs. See, e.g., Securities Exchange Act Release
Nos. 51149 (February 8, 2005), 70 FR 7531
(February 14, 2005) (order approving
demutualization of the Chicago Stock Exchange
(‘‘CHX’’)) (at the time of the demutualization, CHX
proposed to have, and currently has, majority
public directors on its ROC) and 62158 (May 24,
2010), 75 FR 30082 (May 28, 2010) (order approving
the demutualization of CBOE) (CBOE’s ROC is
composed solely of non-industry directors).
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SBS exchange and not a SB SEF
participant or SBS exchange member
may not have access to the same amount
or types of information as nonindependent directors. Therefore, a ROC
composed solely of independent
directors may need to rely on
management or non-independent
directors for information, with attendant
biases of information from such sources.
If directors on a ROC, moreover, lack
necessary information or are otherwise
not sufficiently knowledgeable, the
committee’s effectiveness as a whole
may be compromised. Such ROC may
defer to management’s expertise or the
expertise of non-independent directors
on the Board. Further, as mentioned
above, independent directors may have
their own biases that could compromise
the structural protections intended by a
wholly independent ROC. Therefore,
the Commission seeks comment on the
proposal relating to the composition and
duties of the ROC. Would the
establishment of a fully independent
ROC help mitigate the identified
conflicts of interest? Are there particular
circumstances under which a ROC
should be permitted to have nonindependent directors? If so, please
identify them.
Separately, the Commission requests
comment on whether it should specify
in the proposed rule the duties of the
ROC. If so, what should be the scope of
the ROC’s duties? For example, should
a ROC be required to oversee decisions
as to which entities have access to the
trading facility and under what
circumstances, or which products are
made available for trading? Is it
appropriate to require that the Board
submit to the Commission any
recommendation of the ROC that it does
not adopt or implement? Would this
requirement help assure good
governance that may mitigate conflicts?
Should such reports be required to be
submitted promptly to the Commission?
Would a different time period be more
appropriate? For instance, should such
reports instead be required to be
submitted semi-annually or, for SB
SEFs, should they be incorporated as
part of the annual report of the Chief
Compliance Officer, which is required
pursuant to core principle 14 under
Section 763(c) of the Dodd-Frank Act?
Are there reasons, consistent with
mitigation of conflicts, why SB SEFs
and SBS exchanges should be treated
differently with respect to the proposal
to require a fully independent ROC? Are
there other ways in which material
information pertaining to the ROC’s
ability to carry out its duties effectively
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can be brought to the Commission’s
attention?
3. Other Board Committees
The Commission is proposing
compositional and other requirements
with respect to various other Board
committees. In this regard, proposed
Rule 702(f)(1) under Regulation MC
would require that the nominating
committee of a SB SEF, SBS exchange,
or SBS exchange facility be composed
solely of independent directors. The
proposed requirement for the Board of
the SB SEF, SBS exchange, or SBS
exchange facility to be composed of a
majority of independent directors could
be undercut if the nominating
committee were dominated by persons
that had an ownership interest in these
entities, were affiliated with such
owners, or were selected by the ownerdirectors or their affiliates. Further, the
proposed rule would require that any
committee of the Board that is delegated
the authority to act on the Board’s
behalf, such as any executive
committee, also must be composed of a
majority of independent directors.178
This proposed provision extends to
Board committees that are authorized to
act on behalf of the Board the
compositional requirement proposed for
the full Board and is designed to assure
that the SB SEF, SBS exchange or SBS
exchange facility would not subvert the
proposed majority Board independence
standard by delegating the Board’s
duties to a committee that does not have
the same majority independence
standard.
With respect to a wholly independent
nominating committee, the Commission
recognizes that the proposal may not
sufficiently mitigate concerns that
certain shareholders may be able to
influence or control the director
nominating process and thus undermine
the intent of a majority independent
Board. As discussed above, an
independent director may not truly be
independent from the influence of, or
bias toward, a large shareholder or
group of shareholders, other nonindependent directors, or even from
management. Consequently, if the
nominating committee is composed of
enough directors who are subject to
such influence or bias, the palliative
purpose of requiring a wholly
independent nominating committee
could be compromised. Accordingly,
the Commission requests comment on
178 See proposed Rule 702(f) under Regulation
MC. This proposed provision would not apply to
the ROC or the nominating committee since the
proposals would require the ROC and the
nominating committee to be composed solely of
independent directors.
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whether it should prescribe or limit the
manner in which a SB SEF, SBS
exchange, or SBS exchange facility
could appoint the nominating
committee. Should the Commission
consider an alternative to a
compositional requirement for a
nominating committee, such as allowing
a SB SEF, SBS exchange, or SBS
exchange facility to have a board of
trustees responsible for nominating
candidates for the Board? If this were a
viable alternative, should there be
compositional requirements or other
limits imposed on the board of trustees?
How should such a board of trustees be
appointed? Would the alternative of a
board of trustees to nominate directors
provide greater assurance that
independent directors are truly
independent not only at the time of
their nomination but during their
service on the Board as well?
Conversely, the Commission also
notes that dealer-owners that are Board
members would not be able to serve on
a wholly independent nominating
committee and thus would not have a
voice in the process of nominating
candidates for Board seats. This would
mean that the nominating committee
would not have access to the dealerowners’ potentially valuable insights
with respect to qualified candidates for
either independent or non-independent
director positions. Accordingly, the
Commission invites commenters to
suggest the appropriate compositional
requirements for the nominating
committee and explain their views.
Should the Commission instead require
a majority independent nominating
committee? Would a majority
independent nominating committee be
consistent with the proposal’s goal to
mitigate conflicts for SB SEFs and SBS
exchanges? 179
SB SEFs are not subject to ‘‘fair
representation’’ requirements, like
national securities exchanges, which
must assure their members ‘‘fair
representation’’ in the selection of
directors and the administration of the
exchange’s affairs.180 Should the
Commission adopt additional
compositional requirements to provide
SB SEF participants a guaranteed voice
179 The SRO Governance Proposing Release
proposed that certain committees, including the
nominating committee, be composed solely of
independent directors. See SRO Governance
Proposing Release, supra note 59. Some
commenters favored this requirement. See, e.g., PSX
Comment Letter, supra note 156. A number of
commenters, particularly national securities
exchanges, objected to the requirement that certain
board committees be composed solely of
independent directors. See supra note 175.
180 See Section 6(b)(3) of the Exchange Act, 15
U.S.C. 78f(b)(3).
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in the selection of the SB SEF’s directors
and the administration of its affairs? 181
For example, should the Commission
require that the nominating committee
consult with participants in the SB SEFs
or SBS exchanges, as applicable? Or,
should the Commission require that the
participants in the SB SEFs or SBS
exchanges select a certain percentage of
directors? If so, should the Commission
also limit the ability of owner
participants (such as dealers) to
participate in this process? If that is the
case, should any such limitation depend
on whether ownership is concentrated
in a small number of dealers? Should
end users also be given guaranteed
rights of participation in the governance
of the SB SEF?
The Commission also seeks comment
on whether the proposed compositional
requirements relating to any committee
that is delegated the authority to act on
behalf of the Board are appropriate and
whether there are any other areas in
which the Commission should propose
compositional requirements for SB SEF
and SBS exchange committees. For
example, the Commission requests
comment on whether it should require
any SB SEF, SBS exchange, or SBS
exchange facility committee that
determines which security-based swaps
will trade on the SB SEF or SBS
exchange, respectively, be composed of
majority independent directors, or
require participation by other groups on
such committee. Should the ROC be
required to oversee decisions regarding
access to the SB SEF and regarding
which security-based swaps are made
available to trade on the SB SEF?
4. Disciplinary Process
As noted above, the Commission
historically has required that national
securities exchanges’ disciplinary
panels be balanced and include industry
member representation.182 Proposed
Rule 702(g) under Regulation MC would
require that any disciplinary process of
a SB SEF and SBS exchange shall
preclude any group or class of persons
that is a SB SEF participant or SBS
exchange member from dominating or
exercising disproportionate influence.
181 As discussed above, Section 763(c) of the
Dodd-Frank Act sets forth 14 core principles that
SB SEFs must satisfy, including one relating to
conflicts of interest, and provides the Commission
with rulemaking authority with respect to
implementation of these core principles. As the
Commission has not yet proposed rules regarding
the requirements and operation of a SB SEF,
including the scope of trading on and which
entities would be allowed to directly access a SB
SEF, the Commission may determine that it is more
appropriate to propose participant representation
requirements, if any, in its broader rulemaking
relating to SB SEFs.
182 See supra Section III.B.
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In other words, to the extent that there
is more than one type of group or class
of persons that are participants or
members in a SB SEF or SBS exchange,
as applicable, the composition of any
disciplinary panel should not allow one
group or class to have representation on
the disciplinary panel that is out of
proportion as compared to other groups
or classes of persons that are
participants in the SB SEF or SBS
exchange. In addition, any panel that is
responsible for disciplinary decisions,
and any appeals body, must include at
least one independent director.183 These
proposed provisions should help
mitigate conflicts of interest in the SB
SEF’s and SBS exchange’s disciplinary
process. This requirement also would
apply to a national securities exchange
that posts or makes available for trading
a security-based swap through its
facility.184
The Commission seeks comment on
the proposal relating to requirements of
the disciplinary process, including the
compositional requirements. Should
any disciplinary panel also be required
to include representatives selected by
SB SEF participants or SBS exchange
members, as applicable? Would the
proposed provisions help to mitigate the
identified conflicts of interest? Should
any other persons be precluded from
dominating the disciplinary process?
Are there any additional provisions that
should be proposed to mitigate conflicts
of interest in the disciplinary
process? 185 The Commission also
requests comment on whether the
Commission’s proposal would
meaningfully supplement or enhance
the requirements that SBS exchanges, as
national securities exchange, already
have in place with respect to the
disciplinary process.
VI. Discussion of Exemptive Authority
Pursuant to Section 36 of the Exchange
Act
The Commission pursuant to Section
36 of the Exchange Act may grant an
exemption from any rule or any
provision of any rule under Regulation
MC. Any such exemption could be
subject to conditions and could be
revoked by the Commission at any time.
183 See
proposed Rule 702(h) under Regulation
MC.
184 See supra note 173. Similar to the requirement
pertaining to the ROC, the exchange, not the
facility, bears the responsibility of disciplining its
members. See Section 6 of the Exchange Act.
Consequently, proposed Rule 702(h) does not
explicitly mention SBS exchange facility. However,
a national securities exchange that posts or makes
available for trading a security-based swap through
its facility must also comply with the requirements
of proposed Rule 702(h) under Regulation MC.
185 See supra note 181.
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Generally, the Commission would
consider granting an exemption where
the exemption is necessary or
appropriate in the public interest and
consistent with the protection of
investors. For example, the SBS
exchange, SB SEF, or security-based
swap clearing agency might be unable,
on a temporary basis and for reasons
beyond its control, to comply with one
of the rules under Regulation MC. The
Commission could also grant an
exemption where the SBS exchange, SB
SEF, or security-based swap clearing
agency demonstrated that it established
alternative means to effectively mitigate
conflicts of interest as contemplated
under Regulation MC and that it would
otherwise be unable to comply with the
requirements under Regulation MC,
including as a start-up SB SEF, SBS
exchange, or security-based swap
clearing agency. The Commission in its
sole discretion would determine
whether to grant or deny a request for
an exemption. In addition, the
Commission could revoke an exemption
at any time, including if the SBS
exchange, SB SEF, or security-based
swap clearing agency could no longer
demonstrate that such exemption is
necessary or appropriate in the public
interest, or is consistent with the
protection of investors.
The Commission requests comment
on all aspects of the exemptive
authority. Would such exemptive
authority be useful to facilitate the
purposes of Section 765? If so, in what
circumstances should the Commission
grant exemptions? Should exemptions
only be granted in limited
circumstances? Should the Commission
potentially consider granting
exemptions from all rules under
Regulation MC or are exemptions only
warranted for specific rules or specific
entities? For example, should
exemptions only be available with
respect to the voting interest restrictions
applicable to security-based swap
clearing agencies? What specific factors
should the Commission consider in
determining whether to grant an
exemption? Are there cases where
exemptions may not be appropriate and
should not be considered?
VII. Effective and Compliance Date
The Commission is required to adopt
rules under Section 765 within 180 days
of enactment of Title VII. However,
certain of the rules the Commission is
proposing today would apply to SB
SEFs, which will be the subject of new
definitional rules that are required
under the Dodd-Frank Act to be
completed by July 15, 2011.
Accordingly, the Commission is
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proposing that provisions of Regulation
MC as applicable to SB SEFs would
become effective sixty (60) days after
July 15, 2011. All other provisions of the
rules under Regulation MC would
become effective sixty (60) days after the
final rules are published in the Federal
Register.
The Commission recognizes that
existing entities may need a transitional
period to implement any final rules.
Accordingly, the Commission is
proposing to permit the phase-in
implementation of the rules under
Regulation MC over two (2) years or two
regularly-scheduled Board elections.
The phase-in implementation would
apply to existing exchanges, clearing
agencies, or other institutions that apply
to register as a SBS exchange, SB SEF,
or security-based swap clearing agency.
However, the Commission expects that
entities that are newly created in order
to establish a SBS exchange, SB SEF, or
security-based swap clearing agency
would fully comply with the final rules.
The Commission requests comment
on (i) the timing of effectiveness for the
final rules, and (ii) the length and
applicability of the implementation
period.
VIII. General Request for Comments
The Commission seeks comment on
the proposed rules that are intended to
mitigate conflicts of interest with
respect to security-based swap clearing
agencies, SB SEFs, SBS exchanges, and
SBS exchange facilities, on any
additional or different provisions that
would mitigate conflicts of interest for
these entities, and on any other matters
that might have an implication on the
proposals. The Commission particularly
requests comment from the point of
view of entities that plan to register as
security-based swap clearing agencies or
SB SEFs and from national securities
exchanges that plan to become SBS
exchanges or create SBS exchange
facilities; entities operating platforms
that currently trade or clear securitybased swaps; broker-dealers, financial
institutions, major security-based swap
participants, and other persons that
trade security-based swaps; and endusers generally.
The Commission invites commenters
to address whether the proposed rules
are appropriately tailored to achieve the
goal of mitigating conflicts of interest in
the ownership and governance of
security-based swap clearing agencies,
SB SEFs, SBS exchanges, and SBS
exchange facilities, including with
respect to the administration of these
entities’ regulatory activities. The
Commission also requests comment on
the necessity and appropriateness of
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65913
mandating ownership and voting
limitations for security-based swap
clearing agencies, SB SEFs, SBS
exchanges, and SBS exchange facilities
and on whether there are other means
to achieve the statutory mandate of
Section 765 of the Dodd-Frank Act.
The Commission is proposing
governance requirements for securitybased swap clearing agencies, SB SEFs,
SBS exchanges, and SBS exchange
facilities that are designed to mitigate
conflicts of interest. The Commission
requests comment on whether the
governance requirements, by
themselves, would be enough to
mitigate conflicts.
The Commission requests comment
on the two alternative proposals for
security-based swap clearing agencies.
Are there other alternatives that would
more effectively mitigate conflicts of
interest? Should security-based swap
clearing agencies be permitted to choose
between alternatives at all? The
Commission may determine to adopt
only one of the proposed alternatives as
a final rule. If only one alternative were
to be adopted as a final rule, which one
should it be? Should any of the
provisions of the proposed alternatives
be revised? The Commission may
combine aspects of each proposed
alternative rule (with or without
modifications) and adopt them as a
single final rule. If that approach is
taken, which aspects of each alternative
should be combined? For example,
should the voting interest restrictions in
Rule 701(a) be combined with the
governance restrictions in Rule 701(b) to
create a stronger rule to mitigate
conflicts of interest at security-based
swap clearing agencies? As compared to
each other, how is each alternative
likely to affect access and risk
management at security-based swap
clearing agencies? How will each
alternative affect and be affected by
developments in the market, including
the prospect of future competition?
The Commission also requests
comment on the impact on competition
the two alternative proposals might
have. The Voting Interest Focus
Alternative and the Governance Focus
Alternative are designed to address the
unique conflict of interest issues at
security-based swap clearing agencies.
The Commission requests comment on
whether imposing voting interest and
governance limitations could have the
unintended consequence of deterring
new, competitive security-based swap
clearing agencies at a time when central
clearing for security-based swaps is still
developing. A security-based swap
clearing agency that currently clears
security-based swaps but would not
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meet the proposed voting interest limits
would need to revise its ownership
structure. There could be costs and
delays as the security-based swap
clearing agency seeks to find one or
more additional owners to satisfy the
proposed limits, with a possible
diminution in the value of the original
owner(s)’ investment.
The Commission is sensitive to
arguments against imposing ownership
and voting limits for security-based
swap clearing agencies, some of which
were articulated at the Conflicts
Roundtable. However, it also
understands that the OTC derivatives
market is highly concentrated and
dealer dominated. As a result, voting
interest and governance restrictions may
be necessary at security-based swap
clearing agencies where they have not
been necessary at other securities
clearing agencies. Access to central
clearing services will be crucial for most
firms that will actively trade in securitybased swaps that are required to be
cleared. Although the proposed
restrictions may have the effect of
creating barriers to potential securitybased swap clearing agencies (and thus
market participants could have fewer
clearing agencies to choose from) the
incentives of independent directors will
likely promote increased access to
central clearing for market participants.
In contrast, although ownership and
voting limits may more directly affect
the ability of SB SEFs and SBS
exchanges to start up, the lack of market
characteristics to promote competing
trading venues for security-based swaps
may emphasize the greater need for
ownership and voting limits. If the
market characteristics for security-based
swaps naturally promote dealer
domination without robust competing
trading venues, there is more need to
mitigate the types of concerns that
underlie Section 765, such as by
imposing ownership and voting
limits.186
The CFTC is adopting rules to
mitigate conflicts of interest for
derivatives clearing organizations that
186 In the equities market a small group of brokerdealers or single-dealer proprietary firms can and
do own alternative trading systems (‘‘ATSs’’) and
thus it can be argued that SB SEFs and SBS
exchanges should be permitted to operate similarly.
See Securities Exchange Act Release No. 60997
(November 13, 2009), 74 FR 61208 (November 23,
2009) (as of November 2009, there were
approximately 73 ATSs that are subject to
Regulation ATS). However, ATSs exist in the
context of a marketplace with robust competition
among numerous trading venues. Therefore, ATSs
that are owned by one broker-dealer or a small
group of broker-dealers, by virtue of their
ownership structure alone, generally do not present
a concern that they could lessen price competition
or market efficiency.
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clear swaps, swap execution facilities
and boards of trade designated as a
contract markets that post swaps or
make swaps available for trading as
required under Section 726 of the DoddFrank Act. Understanding that the
Commission and the CFTC regulate
different products and markets and, as
such, appropriately may be proposing
alternative regulatory requirements, the
Commission requests comments on the
impact of any differences between the
Commission and CFTC approaches to
the mitigation of conflicts of interest.
Specifically, would the regulatory
approaches under the Commission’s
proposed rulemaking pursuant to
Section 765 of the Dodd-Frank Act and
the CFTC’s proposed rulemaking
pursuant to Section 726 of the DoddFrank Act result in duplicative or
inconsistent efforts on the part of market
participants subject to both regulatory
regimes or result in gaps between those
regimes? If so, in what ways do
commenters believe that such
duplication, inconsistencies, or gaps
should be minimized? Do commenters
believe the approaches proposed by the
Commission and the CFTC to mitigate
conflicts of interest are comparable? If
not, why? Do commenters believe there
are approaches that would make the
mitigation of conflicts of interest more
comparable? If so, what? Do
commenters believe that it would be
appropriate for the Commission to adopt
an approach proposed by the CFTC that
differs from the Commission’s proposal?
Is so, which one? The Commission
requests commenters to provide data, to
the extent possible, supporting any such
suggested approaches.
In addition, the Commission seeks
comment regarding any potential
implication of the proposals on users of
any security-based swap clearing
agencies, SB SEFs, and SBS exchanges,
other market participants, and the
public generally. The Commission seeks
comment on the proposals as a whole,
including their interaction with the
other provisions of the Dodd-Frank Act.
The Commission seeks comment on
whether the proposals would help
achieve the broader goals of increasing
transparency and accountability in the
OTC derivatives market.
Commenters should, when possible,
provide the Commission with empirical
data to support their views. Commenters
suggesting alternative approaches
should provide comprehensive
proposals, including any conditions or
limitations that they believe should
apply, the reasons for their suggested
approaches, and their analysis regarding
why their suggested approaches would
satisfy the statutory mandate contained
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in Section 765 of the Dodd-Frank Act
regarding mitigation of conflicts of
interest.
IX. Paperwork Reduction Act
The proposed rules contain
‘‘collection of information’’ requirements
within the meaning of the Paperwork
Reduction Act of 1995 (‘‘PRA’’).187 The
titles for these collections are Rule 701
of Regulation MC, both in the Voting
Interest Focus Alternative and the
Governance Focus Alternative, and Rule
702 of Regulation MC.
The Commission has submitted the
information to the Office of
Management and Budget (‘‘OMB’’) for
review in accordance with 44 U.S.C.
3507 and 5 CFR 1320.11.
A. Summary of Collection of
Information
1. Security-Based Swap Clearing
Agencies
Proposed alternative Rule 701(a)(2)
under Regulation MC would require
security-based swap clearing agencies to
have rules that would: (1) Provide for an
effective mechanism to divest any
participant of any interest owned in
excess of the proposed 20% ownership
limit; (2) not give effect to the portion
of any voting interest held by one
participant in excess of the proposed
20% voting limit; (3) not give effect to
the portion of any voting interest among
all security-based swap clearing agency
participants owned in the aggregate in
excess of the proposed 40% ownership
limit; and (4) provide an effective
mechanism for the security-based swap
clearing agency to obtain information
relating to the voting interests in such
entity. Alternative Rule 701(b)(2) under
Regulation MC would require securitybased swap clearing agencies to have
rules that would: (1) Provide for an
effective mechanism to divest any
participant of any interest owned in
excess of the proposed 5% ownership
limit; (2) not give effect to the portion
of any voting interest held by one
participant in excess of the proposed
5% voting limit; and (3) provide an
effective mechanism for the securitybased swap clearing agency to obtain
information relating to the voting
interests in such entity. Each securitybased swap clearing agency must
comply with one of the alternatives.
Establishing such rules would result in
a paperwork burden for a security-based
swap clearing agency. In addition, if the
security-based swap clearing agency
was to request to receive ownership and
voting information from participants
187 44
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pursuant to Rule 701(a) or (b), the
request would be a collection of
information.
2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
Proposed Rule 702(c) under
Regulation MC would require SB SEFs,
SBS exchanges, and SBS exchange
facilities to have rules that would: (1)
Provide for an effective mechanism to
divest any participant or member, as
applicable, of any interest owned in
excess of the proposed 20% ownership
limit; (2) not to give effect to the portion
of any voting interest help by one or
more participants or members, as
applicable, in excess of the proposed
20% voting limit; and (3) provide an
effective mechanism for the SB SEF,
SBS exchange or SBS exchange facility
to obtain information relating to
ownership and voting interests in such
entity. Establishing such rules would
result in a paperwork burden for a SB
SEF, SBS exchange, or SBS exchange
facility, as applicable. In addition, if a
SB SEF, SBS exchange, or SBS exchange
facility were to request to receive
ownership and voting information from
participants or members pursuant to
Rule 702(c) that would be a collection
of information.
Proposed Rule 702(e) under
Regulation MC would require SB SEFs
and SBS exchanges to establish a ROC
that is composed solely of independent
directors,188 to oversee the SB SEF’s and
SBS exchange’s obligations under
Section 763(c) of the Dodd-Frank Act
and Section 6 of the Exchange Act,
respectively.189 The proposed rule
would require that any recommendation
of the ROC that is not adopted or
implemented by the SB SEF’s or SBS
exchange’s Board be reported promptly
to the Commission.
B. Proposed Use of Information
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1. Security-Based Swap Clearing
Agencies
The purpose of the collection of
information in proposed Rule 701(a) or
(b) under Regulation MC is to enable a
security-based swap clearing agency to
monitor voting interests with respect to
188 Proposed Rule 702(e) under Regulation MC
does not explicitly include SBS exchange facilities
because the exchange whose facility posts or makes
available for trading a security-based swap must
itself establish the requisite ROC. See supra note
173.
189 See Section 763(c) of the Dodd-Frank Act,
Public Law 111–203, Section 763(c). Specifically,
the ROC would oversee the SBS exchange’s and SB
SEF’s regulatory program on behalf of the Board
and the Board would be required to delegate
sufficient authority, dedicate sufficient resources,
and allow sufficient time for the ROC to fulfill its
mandate.
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the security-based swap clearing agency,
and enable the security-based swap
clearing agency to take necessary action
if the voting interests by a participant or
group of participants in the securitybased swap clearing agency exceed
those allowed under proposed Rule
701(a) or (b).
2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
The purpose of the collection of
information in proposed Rule 702(c)
under Regulation MC is to enable a SB
SEF, SBS exchange, or SBS exchange
facility to monitor voting interests with
respect to such entity, and enable the SB
SEF, SBS exchange, or SBS exchange
facility, as applicable, to take necessary
action if the ownership or voting rights
by a participant or member or group of
participants or members, as applicable,
exceed those allowed under proposed
Rule 702(b).
The purpose of the collection of
information in proposed Rule 702(e)
under Regulation MC is to provide the
Commission with information regarding
the instances in which the SB SEF or
SBS exchange does not adopt or
implement a recommendation of the
ROC, which would help the
Commission in its oversight of SB SEFs
and SBS exchanges. The information
collection also should promote sound
regulatory policies and foster the
effectiveness of the ROC by putting the
SB SEF or SBS exchange on notice that
the Commission must be apprised
promptly of any recommendation that is
made by the ROC that is not adopted or
implemented.
C. Respondents
1. Security-Based Swap Clearing
Agencies
The collection of information
associated with the proposed Rule
701(a) and (b) under Regulation MC
would apply to security-based swap
clearing agencies. Currently, four
clearing agencies are authorized to clear
credit default swaps, including securitybased swaps,190 pursuant to temporary
conditional exemptions under Section
36 of the Exchange Act.191 The
obligation to centrally clear securitybased swap transactions is a new
requirement under Title VII of the
Dodd-Frank Act. Based on the fact that
there are currently four clearing
agencies authorized to clear securitybased swaps and that there could
190 Of the four clearing agencies granted
temporary exemptions from registration, only three
have cleared products that are classified as securitybased swaps under Title VII of the Dodd-Frank Act.
191 15 U.S.C. 78mm.
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65915
conceivably be one or two more in the
future,192 the Commission preliminarily
estimates that four to six clearing
agencies may seek to clear securitybased swaps and be subject to the
information collection requirements in
proposed Rule 701(a) or (b). The
Commission is using the higher estimate
of six for the PRA analysis.
2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
The collection of information
associated with the proposed Rule
702(c) under Regulation MC would
apply to SB SEFs, SBS exchanges, and
SBS exchange facilities. In the DoddFrank Act, Congress defined for the first
time a SB SEF and mandated the
registration of these new facilities.193
Based on conversations with the CFTC
and industry sources, the Commission
preliminarily believes that
approximately 10–20 entities could seek
to become SB SEFs and thus be subject
to the collection of information
requirement of proposed Rule 702(c).
The Commission is using the higher
estimate of 20 SB SEFs for this PRA
analysis. In addition, there are currently
15 national securities exchanges that
could be subject to the collection of
information requirement of Rule
702(c).194 To provide an estimate that is
not under-inclusive, the Commission
preliminarily estimates that all 15 of the
currently registered national securities
exchanges could become SBS exchanges
or could create a separate legal entity
that would be a facility of the exchange
to trade security-based swaps.
The collection of information
associated with the proposed Rule
702(e) under Regulation MC would
apply to SB SEFs and SBS exchanges.
Based on the estimates noted above, to
provide an estimate that is not underinclusive, the Commission preliminarily
believes that 20 SB SEFs and 15 SBS
exchanges or SBS exchange facilities
would be subject to the collection of
information requirement of Rule 702(e).
192 The Commission does not expect there to be
a large number of clearing agencies that clear
security-based swaps, based on the significant level
of capital and other financial resources necessary
for the formation of a clearing agency.
193 See Sections 763(a) and 763(c) of the DoddFrank Act, Public Law 111–203, Section 763(a) and
(c).
194 The 15 national securities exchanges are:
BATS Exchange, Inc.; BATS Y–Exchange, Inc.;
Chicago Board Options Exchange, Incorporated;
Chicago Stock Exchange, Inc.; C2 Options
Exchange, Incorporated, EDGA Exchange, Inc.,
EDGX Exchange, Inc., International Securities
Exchange, LLC; The NASDAQ Stock Market LLC;
NASDAQ OMX BX, Inc.; NASDAQ OMX PHLX,
Inc.; National Stock Exchange Inc.; New York Stock
Exchange LLC; NYSE Amex LLC; and NYSE Arca,
Inc.
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D. Total Annual Reporting and
Recordkeeping Burdens
1. Security-Based Swap Clearing
Agencies
Proposed Rule 701(a) would require
security-based swap clearing agencies to
have rules that would: (1) Provide for an
effective mechanism to divest any
participant of any interest owned in
excess of the proposed 20% ownership
limit; (2) not give effect to the portion
of any voting interest held by one
participant in excess of the proposed
20% voting limit; (3) not give effect to
the portion of any voting interest among
all security-based swap clearing agency
participants owned in the aggregate in
excess of the proposed 40% ownership
limit; and (4) provide an effective
mechanism for the security-based swap
clearing agency to obtain information
relating to the voting interests in such
entity. Proposed Rule 701(b) would
require security-based swap clearing
agencies to have rules that would: (1)
Provide for an effective mechanism to
divest any participant of any interest
owned in excess of the proposed 5%
ownership limit; (2) not give effect to
the portion of any voting interest held
by one participant in excess of the
proposed 5% voting limit; and (3)
provide an effective mechanism for the
security-based swap clearing agency to
obtain information relating to the voting
interests in such entity. Each securitybased swap clearing agency must
comply with one of the alternatives.
Establishing such rules would result
in a paperwork burden for a securitybased swap clearing agency. The
Commission preliminarily believes that
there would be a one-time paperwork
burden of 15 hours per entity associated
with the drafting and implementation of
any such rules by the security-based
swap clearing agency for a total of 90
hours (15 hours × 6 respondents).
Any collection of information by a
security-based swap clearing agency
from a participant that has a voting
interest in the security-based swap
clearing agency would differ depending
upon the number of shareholders or
other owners of voting interests that are
participants in the security-based swap
clearing agency. Accordingly, the
number of responses per year that
would be generated by proposed Rule
701(a) or (b) under Regulation MC
would vary by security-based swap
clearing agency. At this point, however,
currently only the largest fourteen
dealer firms are participants that clear
security-based swaps at such clearing
agencies. The Commission believes that
it would be reasonable for securitybased swap clearing agencies to collect
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information related to the voting
interests held by participants on a
quarterly basis. This would provide the
security-based swap clearing agency
with sufficiently current information
regarding participants’ voting interests
in the security-based swap clearing
agency and allows the security-based
swap clearing agency to review the
information at a single point in time.
Accordingly, the Commission
preliminarily estimates that each
security-based swap clearing agency
would request information
approximately 4 times per year from
approximately 14 participants.
The Commission also estimates that
the preparation and sending of each of
the 4 requests for information would
require approximately 4 hours and
reviewing the responses to each of the
4 requests for information would require
10 hours. This would result in a total
annual reporting and recordkeeping
burden of 56 hours ((4 requests × 4
hours) + (4 requests × 10 hours)) for
each security-based swap clearing
agency, and a total annual burden for all
security-based swap clearing agencies of
336 hours (56 hours × 6 clearing
agencies). The Commission
preliminarily estimates that each
participant would require 1 hour to
prepare and send the security-based
swap clearing agency its response to the
request, for a total annual reporting and
recordkeeping burden for each
participant of each security-based swap
clearing agency of 4 hours (4 requests ×
1 hour) and a total annual burden for all
participants in all 6 security-based swap
clearing agencies of 336 hours (14
participants × 4 hours × 6 security-based
swap clearing agencies) thereby
resulting in a total estimated annual
burden for all security-based swap
clearing agencies and participants of
672 hours (336 hours for all participants
+ 336 hours for all security-based swap
clearing agencies). The Commission
requests comment on these estimates.
The Commission estimates that the
total paperwork burden resulting from
the proposals relating to security-based
swap clearing agencies is 762 hours for
an initial paperwork burden and 672
hours thereafter.195
195 The aggregate initial paperwork burden is
calculated as follows: 90 hours (one time paperwork
burden for security-based swap clearing agencies to
establish rules to divest any ownership interest in
excess of the limit and not to give effect to any
portion of the voting interests in excess of the limit)
+ 336 hours (annual burden for security-based swap
clearing agencies to prepare and send requests for
voting information) + 336 hours (annual burden for
participants of security-based swap clearing
agencies to prepare and send responses to requests
for voting information) = 762 hours. After the initial
year, the paperwork burden is calculated as follows:
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2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
Proposed Rule 702(c) would require
SB SEFs, SBS exchanges, and SBS
exchange facilities to have rules that
would provide for an effective
mechanism to divest any participant or
member, as applicable, of any interest
owned in excess of the proposed 20%
ownership limit; that would not give
effect to the portion of any voting
interest held by one or more
participants or members, as applicable,
in excess of the proposed 20% voting
limit; and that would provide an
effective mechanism for the SB SEF,
SBS exchange, or SBS exchange facility
to obtain information relating to
ownership and voting interests in such
entity. Establishing such rules or
policies and procedures, as applicable,
would result in a paperwork burden for
a SB SEF, SBS exchange, or SBS
exchange facility, as applicable. The
Commission preliminarily believes that
there would be a one-time paperwork
burden of 15 hours per entity associated
with the drafting and implementation of
any such rules by the SB SEF, SBS
exchange, or SBS exchange facility, as
applicable, for a total of 525 hours (15
hours × 35 respondents).
The number of responses per year that
would be generated by requests by a SB
SEF, SBS exchange, or SBS exchange
facility, as applicable, for ownership or
voting information from participants or
members that are owners of securities
entitled to vote or otherwise have a
voting interest in the SB SEF, SBS
exchange, or SBS exchange facility
would depend upon the number of
owners of voting securities that are
participants or members. Assuming that
all classes of securities entitled to vote
are owned or otherwise controlled by
participants or members, the minimum
number per SB SEF, SBS exchange, or
SBS exchange facility would be 5. Based
on the Commission’s understanding of
the ownership structures and voting
rights of existing entities that may
register as SB SEFs, and its
understanding of the ownership
structures and voting rights of existing
national securities exchanges, the
Commission preliminarily estimates
that each SB SEF, SBS exchange, or SBS
exchange facility on average would
request information from approximately
20 participants or members, as
applicable. The Commission believes
that it would be reasonable for a SB
762 hours (total paperwork burden resulting from
the proposals relating to security-based swap
clearing agencies) ¥ 90 hours (one-time paperwork
burden for security-based swap clearing agencies) =
672 hours.
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Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules
SEF, SBS exchange, or SBS exchange
facility to collect information on
ownership and voting rights on a
quarterly basis. Accordingly, the
Commission preliminarily estimates
that each SB SEF, SBS exchange, or SBS
exchange facility would request
information approximately 4 times per
year from approximately 20 participants
or members.
The Commission estimates that the
preparation and sending of each of the
4 requests for information would require
approximately 4 hours, and reviewing
the responses to each of the 4 requests
for information would require 10 hours.
This would result in a total annual
reporting and recordkeeping burden of
56 hours ((4 requests × 4 hours) + (4
requests × 10 hours)) for each SB SEF,
SBS exchange, or SBS exchange facility,
as applicable, and a total annual burden
for all SB SEFs, SBS exchanges, and
SBS exchange facilities of 1,960 hours
(56 hours × 35 respondents). The
Commission preliminarily estimates
that each participant or member would
require 1 hour to prepare and send the
response to the request, for a total
annual reporting and recordkeeping
burden for each participant or member
of 4 hours (4 requests × 1 hour) and a
total annual burden for all participants
or members of 2,800 hours (700
participants or members × 4 hours). The
Commission requests comment on these
estimates.
The Commission preliminarily
believes that the collection of
information burden imposed by
proposed Rule 702(e) under Regulation
MC would be minimal. The Commission
estimates that a representative of the
Board of a SB SEF or SBS exchange
would spend no more than one hour to
complete the required notice to the
Commission. This figure includes the
time to prepare, review, and
electronically submit such notice to the
Commission. The Commission expects
to establish an electronic mailbox for
these notices and would identify the
address if the Commission were to
adopt this specific proposal. Although
the Commission preliminarily believes
that the Board of a SB SEF or SBS
exchange often would adopt or
implement the recommendations of its
ROC, the Commission preliminarily
believes that the Board of a SB SEF or
SBS exchange could occasionally decide
not to adopt such recommendations.
Although the Commission expects that
this would be an infrequent occurrence,
the Commission preliminarily estimates
that a Board could decide not to adopt
a ROC recommendation up to 12 times
per year. This estimate assumes that the
Board of a SB SEF or SBS exchange
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would meet at least once per month and
would decide each time that it meets
not to adopt a ROC recommendation.
Therefore, the Commission estimates
that the total reporting burden under the
proposed Rule 702(e) for all SB SEFs
and SBS exchanges combined would be
420 hours.196
The Commission estimates that the
total paperwork burden resulting from
the proposals relating to SB SEFs, SBS
exchanges or SBS exchange facilities is
5,705 for an initial paperwork burden
and 5,180 thereafter.197
E. Retention Period of Recordkeeping
Requirements
1. Security-Based Swap Clearing
Agencies
Security-based swap clearing agencies
will be required to be registered with
the Commission following the effective
date of Title VII of the Dodd-Frank
Act.198 Accordingly, once registered
with the Commission, security-based
swap clearing agencies would be
required to retain any collection of
information pursuant to proposed Rules
701(a) or (b) under Regulation MC as
applicable, in accordance with, and for
the periods specified in Rule 17a–1
under the Exchange Act.199 Retention
and recordkeeping requirements have
not been established for security-based
swap clearing agencies before the
196 (20 (estimated number of SB SEFs subject to
the collection of information under the proposed
Rule 702(e)) + 15 (estimated number of SBS
exchanges subject to the collection of information
under the proposed Rule 702(e))) × 12 (estimated
number of notices prepared annually by each SB
SEF pursuant to the proposed Rule 702(e)) × 1 hour
(estimate of total time to complete, review, and
prepare required notice) = 420 hours.
197 The aggregate initial paperwork burden is
calculated as follows: 525 hours (one-time
paperwork burden for SB SEFs, SBS exchanges and
SBS exchange facilities to establish rules to divest
any ownership interest in excess of, and to not give
effect to any portion of voting interests in excess of,
the proposed 20% limit) + 1,960 hours (annual
burden for SB SEFs, SBS exchanges and SBS
exchange facilities to prepare and send requests for
ownership and voting information) + 2,800 hours
(annual burden for participants to prepare and send
responses to requests for ownership and voting
information) + 420 hours (annual burden for SB
SEFs and SBS exchanges to prepare and submit
notices pursuant to proposed Rule 702(e)(2)) =
5,705 hours. After the initial year, the paperwork
burden is calculated as follows: 5,705 hours (total
paperwork burden resulting from the proposals
relating to SB SEFs, SBS exchanges and SBS
exchange facilities)—525 hours (one-time
paperwork burdens for SB SEFs, SBS exchanges
and SBS exchange facilities) = 5,180 hours.
198 New Exchange Act Section 17A(g) provides
that it shall be unlawful for a clearing agency,
unless registered with the Commission, directly or
indirectly to make use of the mails or any means
or instrumentality of interstate commerce to
perform the functions of a clearing agency with
respect to a security-based swap. 15 U.S.C. 78q–
1(g).
199 17 CFR 240.17a–1.
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65917
effective date of Title VII; however,
security-based swap clearing agencies
may be required to retain records and
information collected pursuant to
proposed Rules 701(a) or (b) similar to
the current recordkeeping requirements
in Rule 17a–1.
2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
Although recordkeeping and retention
requirements have not yet been
established for SB SEFs under new
Exchange Act provisions added by the
Dodd-Frank Act, the Commission is
authorized to adopt such rules.200 In
addition, the recordkeeping and
reporting core principle applicable to
SB SEFs, as set forth in Section 763(c)
of the Dodd-Frank Act, requires a SB
SEF to maintain records of all activities
relating to the business of the facility,
including a complete audit trail, in a
form and manner acceptable to the
Commission for a period of five
years.201 Therefore, for purposes of this
PRA, the Commission assumes that a SB
SEF would be required to retain any
collection of information pursuant to
proposed Rules 702(c) and 702(e) under
Regulation MC, as applicable, for a
period of not less than five years.
Should the Commission propose rules
to implement the recordkeeping and
reporting core principle for SB SEFs, it
would include any collection of
information burden with respect to any
proposed recordkeeping and retention
rules for SB SEFs in such rulemaking.
All registered national securities
exchanges must currently comply with
the recordkeeping and reporting
requirements in Rule 17a–1 under the
Exchange Act.202 Therefore, SBS
exchanges would be required to retain
any collection of information pursuant
to proposed Rules 702(c) and 702(e), as
applicable, in accordance with, and for
the periods specified in, Rule 17a–1
under the Exchange Act.
F. Collection of Information Is
Mandatory
1. Security-Based Swap Clearing
Agencies
The collection of information under
proposed alternative Rules 701(a) and
(b) under Regulation MC would be
200 As discussed above, Section 763(c) of the
Dodd-Frank Act sets forth 14 core principles that
SB SEFs must satisfy, including one relating to
recordkeeping and reporting, and provides the
Commission with rulemaking authority with
respect to implementation of these core principles.
See Section 763(c) of the Dodd-Frank Act, Public
Law 111–203, Section 763(c).
201 See Section 763(c) of the Dodd-Frank Act,
Public Law 111–203, Section 763(c).
202 17 CFR 240.17a–1.
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mandatory. The collection of
information under proposed Rules
701(a) and (b) would be required from
participants in a security-based swap
clearing agency upon request from the
security-based swap clearing agency.
The collection of information would
allow the security-based swap clearing
agency and the Commission to
determine whether the requirements in
proposed Rules 701(a) and (b) regarding
limitations on voting interests are met.
2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
The collection of information under
proposed Rule 702(c) under Regulation
MC would be mandatory. The collection
of information would allow the SB SEF,
SBS exchange, or SBS exchange facility
as applicable, and the Commission to
determine whether the requirements in
proposed Rule 702(c) regarding
limitations on ownership and voting
rights are met and enable the SB SEF,
SBS exchange, or SBS exchange facility,
as applicable, to take necessary action if
the ownership or voting rights by a
participant or group of participants
exceed those allowed under proposed
Rule 702(b).
The collection of information under
proposed Rule 702(e) under Regulation
MC would be mandatory and permit the
Commission to collect accurate
information about the regulatory
program of SB SEFs and SBS exchanges.
Specifically, the collection of
information would allow the
Commission to stay informed about the
recommendations of the ROC that are
not followed by the SB SEF or SBS
exchange and the SB SEF’s or SBS
exchange’s reasons for not adopting
such recommendations.
G. Responses to Collection of
Information Will Not Be Kept
Confidential
srobinson on DSK8KYBLC1PROD with PROPOSALS2
1. Security-Based Swap Clearing
Agencies
Other than information for which a
security-based swap clearing agency
requests confidential treatment and
which may be withheld from the public
in accordance with the provisions of 5
U.S.C. 522, the collection of information
pursuant to the proposed Rules 701(a)
and (b) would not be confidential and
would be publicly available.
2. SB SEFs, SBS Exchanges, and SBS
Exchange Facilities
Other than information for which a
SB SEF, SBS exchange or SBS exchange
facility requests confidential treatment
and which may be withheld from the
public in accordance with the
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provisions of 5 U.S.C. 522, the
collection of information pursuant to
the proposed Rules 702(c) and (e) would
not be confidential and would be
publicly available.
H. Request for Comment
Pursuant to 44 U.S.C. 3505(c)(2)(B),
the Commission solicits comment to:
1. Evaluate whether the proposed
collection of information is necessary
for the performance of the functions of
the agency, including whether the
information shall have practical utility;
2. Evaluate the accuracy of the
agency’s estimate of the burden of the
proposed collection of information;
3. Enhance the quality, utility, and
clarity of the information to be
collected; and
4. Minimize the burden of collection
of information on those who are to
respond, including through the use of
automated collection techniques or
other forms of information technology.
Persons wishing to submit comments
on the collection of information
requirements should direct them to the
following persons: (1) Desk Officer for
the Securities and Exchange
Commission, Office of Information and
Regulatory Affairs, OMB, Room 3208,
New Executive Office Building,
Washington, DC 20503; and (2)
Secretary, Securities and Exchange
Commission, Station Place, 100 F Street,
NE., Washington, DC 20549–1090 with
reference to File No. S7–27–10. OMB is
required to make a decision concerning
the collection of information between 30
and 60 days after publication, so a
comment to OMB is best assured of
having its full effect if OMB receives it
within 30 days of publication. The
Commission has submitted the
proposed collection of information to
OMB for approval. Requests for the
materials submitted to OMB by the
Commission with regard to this
collection of information should be in
writing, refer to File No. S7–27–10, and
be submitted to the Securities and
Exchange Commission, Office of
Investor Education and Advocacy,
Station Place, 100 F Street, NE.,
Washington, DC 20549–0213.
X. Cost-Benefit Analysis
Congress has required the
Commission to implement rules under
Section 765 of the Dodd-Frank Act to
mitigate conflicts of interest in the
security-based swaps market. The
proposed rules under Regulation MC are
designed to enhance, through mitigation
of conflicts of interest, the benefits of
having security-based swaps cleared
through a security-based swap clearing
agency and traded on a SB SEF or SBS
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exchange. The proposed rules, however,
are also likely to impose costs on
security-based swap clearing agencies,
SB SEFs, and SBS exchanges. The
Commission is sensitive to the costs and
benefits that would result from the
proposed rules and has identified
certain costs and benefits of these
proposals, as described below.
A. Background
The proposed governance and
ownership and voting rules are intended
to reduce conflicts of interest in
security-based swap clearing agencies,
SB SEFs, and SBS exchanges.
Ownership and voting limitations and
other governance rules are designed to
limit the influence of any single market
participant or a group of participants in
the operation of security-based swap
clearing agencies, SB SEFs, and SBS
exchanges and thus reduce the risk that
conflicts of interest would negatively
affect the operation of these entities and
the security-based swaps market.203
However, since the OTC swaps
marketplace regulated under Title VII
likely would change significantly after
the effective date of the Dodd-Frank Act
and the Commission’s rules
promulgated thereunder, it is difficult to
quantify the costs and benefits that the
proposed rules may create. These issues
are discussed more fully below.
B. Security-Based Swap Clearing
Agencies
The Commission has granted
exemptions from Section 17A of the
Exchange Act to five entities to act as
clearing agencies for security-based
swaps.204 The first cleared CDS
transaction pursuant to the exemptive
orders was cleared on March 9, 2009.
Security-based swap clearing is,
therefore, in an emergent stage and
empirical evidence on how the securitybased swaps market will develop
following the effective date of the DoddFrank Act and rules thereunder is
scarce. However, the number of
security-based swap clearing agencies
may converge in the long run to a very
small number or even a single securitybased swap clearing agency.205 This is
203 The Commission pursuant to Section 36 of the
Exchange Act may grant an exemption from any
rule or any provision of any rule under Regulation
MC. Any such exemption could be subject to
conditions and could be revoked by the
Commission at any time. See supra Section VI for
a discussion of the Commission’s exemptive
authority under Section 36 of the Exchange Act.
204 See CDS Clearing Exemption Orders, supra
note 17.
205 See, e.g., Darrell Duffie and Haoxiang Zhu,
‘‘Does a Central Clearing Counterparty Reduce
Counterparty Risk?’’ Stanford University Working
Paper, March 2010; Craig Pirrong, 2009, ‘‘The
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because of the potential for efficiency
gains through convergence given that
central clearing of securities is
characterized by large fixed costs and
benefits to participants associated with
consolidating portfolios. Alternatively,
competitive forces may result in use of
a larger number of security-based swap
clearing agencies, particularly if the
security-based swap clearing agencies
specialize in clearing particular types of
security-based swaps or if they clear
security-based swaps only in certain
jurisdictions.206
srobinson on DSK8KYBLC1PROD with PROPOSALS2
1. Costs and Benefits Related to
Ownership Restrictions in SecurityBased Swap Clearing Agencies
Restrictions on the voting interests
held by clearing participants may affect
the number of potential clearing
participants and may also affect the
level of their participation in clearing
security-based swaps. The 20%
individual voting limitation on securitybased swap clearing agencies and the
40% aggregate voting limitation on
security-based swap clearing agencies,
under the proposed Voting Interest
Focus Alternative, and the 5%
individual voting limitation under the
Governance Focus Alternative, are
intended to keep participants from
exercising undue influence over the
security-based swap clearing agency and
to lessen the likelihood of anticompetitive behavior. One particular
concern is that without a limitation on
voting interests, large dealers may
control a security-based swap clearing
agency and set standards—such as a
heightened capital threshold for
participation or a requirement that
participants have execution
capabilities—to limit participation by
non-owner dealers or brokers and
increase or protect their market share
and potentially influence market prices.
Hence, a potential benefit of voting
limitations may be the preservation of
non-owner dealers’ access to central
clearing and promotion of competition
that results in lower costs to market
participants. The proposed limitations
in both the Voting Interest Focus
Alternative and the Governance Focus
Alternative are designed to achieve this
result.
Economics of Clearing in Derivatives Markets:
Netting, Asymmetric Information, and the Sharing
of Default Risks Through a Central Counterparty,’’
Working paper, University of Houston.
206 The central clearing of security-based swaps is
still developing and the Commission has not made
any determinations about the number of securitybased swap clearing agencies that may be used by
market participants. However, it is important that
emerging security-based swap clearing agencies
have the opportunity to compete with existing
security-based swap clearing agencies.
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Another potential benefit of the
imposition of a limitation on voting
interests is the chance that a broader
group of participants would have the
ability to reduce their risk exposure as
greater levels of central clearing is
encouraged if the risks at the clearing
agency are managed appropriately.
Clearing agencies decrease systemic risk
by mutualizing losses 207 and netting
otherwise bilateral obligations. There
may, however, at times be a trade-off
between a clearing agency’s risk
management and its participation
standards. It likely would be beneficial
if the voting restrictions proposed by
Rules 701(a) and (b) under Regulation
MC in each of the Voting Interest Focus
Alternative and the Governance Focus
Alternative lead to increased market
participation. Conversely though, to the
extent that such market participation
goes beyond prudent levels, it may
create more systemic risk at the
security-based swap clearing agency.
For example, lessening capital
requirements to increase participation
beyond a prudent level may increase the
overall risk of clearing operations, while
increasing capital requirements for
clearing members without an adequate
basis may needlessly exclude some
smaller dealers or other firms from
participation and thereby create market
inefficiencies.208
Non-participant shareholders may
also have an incentive to permit more
clearing agency participation than
clearing agency participant shareholders
would. Non-participant shareholders
benefit from increased membership to
the extent that additional revenues are
generated and therefore have an
incentive to promote increased use of
central clearing both in terms of number
of participants and the scope of
products cleared. This could potentially
reduce systemic risk by making more
OTC products eligible for central
clearing. In addition, non-shareholder
participants have an incentive to
promote appropriate risk management
because a financial loss to the clearing
agency would devalue their investment.
For example, security-based swap
clearing agencies may put their own
capital or surplus funds at risk in the
event of a default. In addition, clearing
agencies face reputational risk
associated with a member default that
would likely negatively affect the value
of shareholders’ shares. This aligns the
interests of shareholders with
appropriate risk management of a
207 See, e.g., Ice Trust Overview, p. 7 (available
at https://www.theice.com/publicdocs/clear_us/
ICE_Trust_Overview.pdf).
208 See supra Section II.A.2.a.
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65919
clearing agency. However, nonparticipant shareholders may not face
the same potential of downside risk as
clearing agency participants. For
example, non-participant shareholders
do not bear certain costs associated with
increased risk since the clearing agency
losses are shared by the clearing agency
participants. To the extent that nonparticipant shareholders use their
control to maximize revenues of the
clearing agency without full
consideration of the total clearing
agency risks, the potential cost is that
suboptimal clearing agency
participation standards will be
developed. All directors have a
fiduciary duty to the security-based
swap clearing agency and its
shareholders, however, they also have a
duty to oversee the security-based swap
clearing agency’s compliance with the
requirements in the Exchange Act and
the rules and regulations thereunder. In
certain circumstances, independent
directors could give greater emphasis to
profit-maximizing initiatives and fail to
give sufficient consideration to the
related risk management issues.
Another potential cost of ownership
and voting limitations, notwithstanding
the fact that the market structure may
converge in the long-run to a single
security-based swap clearing agency, is
the potential effect on competition
among alternative security-based swap
clearing agency venues. Under the
Voting Interest Focus Alternative, a 20%
individual participant voting limit and
a 40% aggregate participant voting limit
restricts the ability of any single dealer
or small group of dealers to own a
security-based swap clearing agency,
but it may also reduce the potential
number of investors that would be
willing to devote resources to form a
security-based swap clearing agency.
This potentially diminishes the
likelihood for a long-term market
structure with multiple clearing
agencies. Conversely, the Governance
Focus Alternative would not impose an
aggregate cap and would allow the
voting interests in a security-based swap
clearing agency to be owned entirely by
participants. This would facilitate the
formation of security-based swap
clearing agencies by potential users and
promote greater competition among
security-based swap clearing agencies.
In addition, if a participant is subject
to restrictions regarding the amount of
voting interest it may own in a securitybased swap clearing agency, then it may
forgo a potential investment
opportunity, unless it is willing to
invest in non-voting shares of the
security-based swap clearing agency.
The effect of these restrictions is
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srobinson on DSK8KYBLC1PROD with PROPOSALS2
different with respect to individual
participants under the Governance
Focus Alternative, which limits any one
participant’s voting interest in a
security-based swap clearing agency to
5%, than it is under the Voting Interest
Focus Alternative, which limits any one
participant’s voting interests to 20% and
has an aggregate voting interest limit of
40%. In the case of an ownership
position in excess of regulator’s
restrictions, the owner would have to
divest a portion of its voting shares in
order to meet the regulatory
requirement. The potential foregone
benefits include profits generated from
clearing activities that are distributed to
owners as well as any private ownership
benefits from directing the clearing
operations, which include activities
discussed above with respect to
conflicts of interest. While it is difficult
to assess the value of these investment
opportunities, the 2010 six-month data
from consolidated reports of condition
and income from the Federal Financial
Institutions Examinations Council of the
largest security-based swap clearing
agency provides a snapshot of the
magnitude of current profits being
generated.209
Moreover, as previously discussed in
the PRA section, proposed Rules 701(a)
and (b) under Regulation MC would
require a security-based swap clearing
agency to have an effective mechanism
to obtain information relating to voting
interests in the security-based swap
clearing agency by any participant in
the security-based swap clearing agency.
It was estimated that these obligations
would result in a total annual burden
for all security-based swap clearing
agencies of 336 hours plus a total
annual reporting and recordkeeping
burden for all participants of 336 hours.
It was also estimated that there would
be a 90 hour one-time paperwork
burden for security-based swap clearing
agencies to establish rules to divest any
ownership interest in excess of the limit
and not to give effect to any portion of
the voting interests in excess of the
limit. Assuming an hourly cost of $291
for a compliance attorney 210 to meet
these requirements, this would result in
an overall estimated initial annual cost
of $221,742 and an annual cost
thereafter of $195,552 for participants
209 ICE Trust’s profits for the first six months of
2010 were $1,325,000, which would represent an
annual profit of $2,650,000. FFIEC Central Data
Repository’s Public Data Distribution, https://
cdr.ffiec.gov/public/Default.aspx.
210 The hourly rate for the compliance attorney is
from SIFMA’s Management & Professional Earnings
in the Securities Industry 2009, modified by the
Commission’s staff to account for an 1,800-hour
work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead.
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2. Costs and Benefits Related to
Independence Requirements for
Security-Based Swap Clearing Agencies
Potential conflicts of interest also
exist between participants of a securitybased swap clearing agency and the
public interest. Even when the influence
of any single dealer is limited through
voting restrictions, economic incentives
could align several dealer participants
in a way that may be costly to investors.
For instance, in order for a product to
be required to trade through an SB SEF
or SBS exchange, it must be deemed
eligible for clearing at a clearing agency.
A dealer-controlled security-based swap
clearing agency may have an incentive
to limit the products deemed eligible for
clearing because then such a product
would remain viable in the OTC
markets, in which the dealers have a
significant financial stake.212 Products
that are eligible for clearing that are not
cleared do not have the price
transparency or investor accessibility
that they would otherwise have,
increasing market participant costs paid
by investors. As a result, there are
potential incentives for security-based
swap clearing agency participants to
coordinate in ways that voting
restrictions cannot address.
Representation by independent
directors would provide views and
influence that by design are not subject
to these conflicts.
Proposed Rule 701(b)(3) in Regulation
MC of the Governance Focus Alternative
would require that a majority of
directors must be independent. As a
result, participants could not directly
control the Board regardless of their
voting interests. To further the goal of
majority independence on the Board,
proposed Rule 701(b)(4) under
Regulation MC in the Governance Focus
Alternative would require a securitybased swap clearing agency to establish
a nominating committee composed
solely of independent directors. Since
many of the Board decisions come from
committees and conflicts may be
prevalent or even more pronounced in
these situations, proposed Rule
701(b)(5) under Regulation MC in the
Governance Focus Alternative would
require that if any committee, including
but not limited to a risk committee, has
authority to act on behalf of the Board,
that committee must also be composed
of a majority of independent directors.
This would help prevent important
decisions from escaping the view of a
majority of independent directors. To
the extent that independent directors
reduce the likelihood that one group of
participants coordinate decision-making
in such a way that is detrimental to the
security-based swap clearing agency as
a whole, it would serve to benefit the
security-based swap clearing agency and
the market generally.
The Voting Interest Focus Alternative
would require 35%, rather than a
majority, of the Board be composed of
independent directors. While director
independence is widely believed to be
a catalyst for improved governance,
there is no conclusive empirical
evidence to support the view that a
majority of independent directors
benefits shareholder profits.213 It also is
often argued that the presence of inside
211 Overall initial annual cost for participants and
clearing agencies information requirements = (336
hours + 336 hours + 90 hours) × $291 = $221,742.
Overall subsequent annual cost for participants and
clearing agencies information requirements = (336
hours + 336 hours) × $291 = $195,552.
212 See, generally, Darrell Duffie, ‘‘How Should
We Regulate Derivatives Markets?’’ Pew Financial
Reform Project, Briefing Paper #5, 2009.
213 However, the Commission recognizes that the
industry widely accepts a majority of independent
directors as ‘‘best practices.’’ See supra note 122.
and security-based swap clearing
agencies collectively.211
Under the Voting Interest Focus
Alternative, proposed Rule 701(a) in
Regulation MC would require the
security-based swap clearing agency to
have rules requiring a participant to
divest voting interest greater than the
20% threshold and rules reasonably
designed not to give effect to a voting
interest of a participant greater than the
20% threshold or voting interests of
participants considered in the aggregate
with any other participants greater than
the 40% threshold. This proposed rule
would impose a cost on the securitybased swap clearing agency to initiate
the divestiture or not give effect to the
voting rights that surpass the stated
threshold. Particularly in the case of the
aggregate participant voting limitation,
the security-based swap clearing agency
would have to develop standards
regarding how to allocate the voting
interest for which it will give effect if
the aggregate voting interest is above the
40 percent threshold.
Similarly, under the Governance
Focus Alternative, proposed Rule 701(b)
in Regulation MC would impose a cost
on the security-based swap clearing
agency to require the divestiture or not
give effect to the voting rights that
surpass the stated threshold of 5
percent. However, because there is not
a proposed limit on participants’
aggregate voting interests under the
Governance Focus Alternative, the
security-based swap clearing agency
would not have to adopt rules for
allocating voting interests in the case of
a divestiture.
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affiliated board members is important in
facilitating the flow of material
information to independent directors so
that they may come to informed
decisions.214 This may be especially
important for a security-based swap
clearing agency because it provides
highly specialized and technical
services. The imposition of a Board
structure that precludes the likely
owners of a security-based swap
clearing agency—dealers—from gaining
a majority may have a negative effect on
the operations of the security-based
swap clearing agency if independent
directors do not have commensurate
qualifications or skills as participant
directors. There could be significant
costs associated with educating
independent directors about the
clearance and settlement process and
the complex risk management issues
that must be considered by the Board.
This could slow the Board or committee
processes, at least initially. Clearing and
settlement is a highly specialized area
and it may be difficult to find
independent directors with relevant
experience. As a result, independent
directors may defer to industry directors
or to the officials of the clearing agency,
who have more knowledge and
experience, thereby undermining the
benefits of requiring independence.
In the context of wholly independent
committees, such as a nominating
committee, the independent directors
may become reliant on executive
directors and other employees of the
security-based swap clearing agency to
inform their decision-making due to
their lack of expertise in clearing and
settlement. If management fails to keep
the directors on wholly independent
committees fully informed, the
independent directors on such
committees fail to seek sufficient
information from management to make
informed decisions, or management fails
to give independent directors adequate
resources to make effective decisions,
there could be costs to the securitybased swap clearing agency. On the
other hand, if management fully
apprises the directors on wholly
independent committees of necessary
information and the independent
directors have sufficient resources and
are fully engaged with respect to their
duties, there would be benefits to the
security-based swap clearing agency.
In addition, the effectiveness of the
Board can depend on the personalities
and personal traits, as well as the
214 See M. Harris and A. Raviv, 2007, ‘‘A Theory
of Board Control and Size,’’ The Journal of Finance;
R. Adams and D. Fererria, 2008, ‘‘A Theory of
Friendly Boards,’’ The Journal of Finance, vol. 62(1)
pp. 217–250.
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qualifications, of the persons serving on
the Board. Independent directors that
take the time to understand the
operations and programs of a securitybased swap clearing agency and to ask
probing questions of management are
more likely to be effective independent
directors. However, independent
directors would unlikely be able to
acquire the specific risk management
expertise related to clearance and
settlement if they do not have relevant
experience prior to serving on the
Board. In addition, because independent
directors would not be employed by or
participants in the security-based swap
clearing agency, they may often need to
rely on management or other directors
to keep fully informed. There could be
costs to the security-based swap clearing
agency if one or more independent
directors is ineffectual because he or she
did not fully understand the operations
or risk management procedures of the
security-based swap clearing agency.
Thus, imperfect decisions by
independent directors could result in
costs to the security-based swap clearing
agency. This may potentially be more
likely where the majority of the Board
is required to be independent. On the
other hand, independent directors who
have relevant expertise, are engaged in
carrying out their director duties, and
who grasp the issues confronting the
security-based swap clearing agency
could be very beneficial to the securitybased swap clearing agency because
they could bring an outside perspective
and fresh insights and ideas to the
security-based swap clearing agency.
The proposed governance
requirements under both the Voting
Interest Focus Alternative and the
Governance Focus Alternative could
impose other costs on security-based
swap clearing agencies. An entity that
plans to register as a security-based
swap clearing agency may need to revise
the composition of its Board if the Board
currently is not composed of 35% or a
majority of independent directors.
Moreover, security-based swap clearing
agencies may have to restructure their
nominating committees as well as other
committees that are authorized to act for
the Board. In this regard, security-based
swap clearing agencies could face
difficulties locating qualified
individuals to serve as independent
directors, particularly because securitybased swaps trading is complex and the
pool of qualified candidates may be
limited. There also may be costs in
educating independent directors to
become familiar with the manner in
which these security-based swaps are
traded and the new regulatory structure
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governing security-based swaps, which
could slow Board processes at least
initially. These costs would be greater
under the Governance Focus
Alternative, which requires a higher
percentage of independent directors on
the Board and on the committees.
The proposed governance
requirements could impose other costs
on security-based swap clearing
agencies. A security-based swap
clearing agency may incur costs as a
result of the requirement to include
35% or a majority of independent
directors on its Board and a similar or
heightened requirement with respect to
committees authorized to act on behalf
of the Board. Any such costs are likely
to be incurred in connection with
conducting a search for independent
directors with the necessary
qualifications and expertise to serve on
the Board of a security-based swap
clearing agency. The actual cost for each
security-based swap clearing agency
may vary based on the current
governance arrangements and practices
of the security-based swap clearing
agencies. In addition, if a security-based
swap clearing agency is required to
conduct a search for independent
directors, the costs incurred by the
security-based swap clearing agency
may vary based on whether it has the
resources to conduct its own search or
has to retain an outside consultant. The
Commission preliminarily estimates
that those security-based swap clearing
agencies that must rely on a recruitment
specialist to secure an independent
director could incur a cost of
approximately $68,000 per director.215
C. SB SEFs and SBS Exchanges
Currently, there are no trading venues
that are registered with the Commission
as SB SEFs, and no national securities
exchanges that currently post or make
available for trading security-based
swaps. Based on the Dodd-Frank Act’s
definition, a SB SEF could include a
trading platform with participating
dealers.216 SB SEFs are conceptually
215 The Commission is basing this estimate on a
recent study noting that the retainer fee for outside
directors is on average $67,624. See https://
www.hewittassociates.com/
_MetaBasicCMAssetCache_/Assets/Articles/2010/
2010_Outside_Director_Compensation.pdf. The
Commission believes that this amount could serve
as a proxy for the amount of any fee to be charged
by a recruitment firm that would conduct a national
search for an independent director.
216 Section 763(c) of the Dodd-Frank Act sets
forth 14 core principles that SB SEFs must satisfy
and provides the Commission with rulemaking
authority with respect to implementation of these
core principles. The Commission expects to address
the issue of what is a SB SEF in a separate
rulemaking under Section 763(c) of the Dodd-Frank
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similar to alternative trading systems
and national securities exchanges in the
equity and options markets and
designated contract markets in the
futures markets in that they will provide
a centralized trading facility for the
trading of security-based swaps. To the
extent that SB SEFs would organize and
form in a similar manner to these
structures, the Commission
preliminarily anticipates that SB SEFs
and SBS exchanges would be
significantly more competitive than
security-based swap clearing agencies.
In particular, barriers to entry in terms
of capital are likely to be lower, and
many existing dealers, national
securities exchanges and other entities
of various sizes currently have
electronic trading capabilities that could
allow them to enter this market readily.
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1. Costs and Benefits Related to
Ownership Requirements of SB SEFs
and SBS Exchanges
The 20% ownership and voting limits
contained in proposed Rule 702(b)
under Regulation MC would prohibit
any SB SEF participant or SBS exchange
member or small group thereof from
owning or otherwise controlling any
class of voting securities or other
interests of a SB SEF, SBS exchange or
SBS exchange facility, as applicable.
The intent of this requirement, as with
security-based swap clearing agencies,
is to limit the influence of any single
dealer or a small group of dealers in a
single SB SEF, SBS exchange or SBS
exchange facility and thus reduce the
likelihood that smaller non-owner
dealers would be unfavorably treated
and the ability of dealer-owners to
influence market prices of securitybased swaps. It is hard to predict,
however, what entities will be SB SEFs
or SBS exchanges or whether there will
be any market power from owning or
controlling a SB SEF or SBS exchange
as discussed above. If the concern, as
with central clearing, is that a single SB
SEF or SBS exchange emerges as the
dominant trading platform, then
ownership and voting restrictions may
be an important consideration. For
example, the NYSE was the dominant
exchange for trading equity securities
for a long period, and even today U.S.
futures markets are characterized by a
dominant exchange connected to a
single clearing agency.
However, evidence from the current
cash equity and options markets shows
that several trading platforms with
different business models and clienteles
Act. See Section 763(c) of the Dodd-Frank Act,
Public Law 111–203, Section 763(c).
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often emerge.217 Hence, SB SEFs, SBS
exchanges, and SBS exchange facilities
that are controlled by a single dealer
may not necessarily result in unfair
trading practices if market participants
have alternative comparable venues to
execute the same security-based swaps
and those venues are able to compete
effectively with single dealer platforms.
Allowing SB SEFs, SBS exchanges and
SBS exchange facilities that are
controlled by a single dealer may in fact
increase the level of competition, which
would benefit investors. A 20%
restriction on ownership of voting
securities could require a dealer to
partner with either other dealers or a
non-dealer majority owner, or to hold a
non-voting ownership interest, which
could reduce incentives to start up a
new venue, potentially limiting
innovative alternatives to security-based
swap execution and security-based
swap products.218
The Commission anticipates that the
proposed ownership and voting
limitations may impose costs on SB
SEFs, SBS exchanges and SBS exchange
facilities. Entities planning to register as
SB SEFs and SBS exchanges would have
to ensure that they are in compliance
with the proposed ownership and
voting limitations and thus would need
to spend time and incur costs to design
or modify their ownership structure and
internal processes, as well as take the
necessary steps to draft or amend their
governing documents and rules to
comply with such ownership and voting
limitations. Designing or modifying
internal processes and drafting or
revising governing documents and rules
would impose costs on SB SEFs, SBS
exchanges and SBS exchange facilities.
The Commission estimates that it would
take a compliance attorney
approximately 15 hours to revise the
relevant governing documents and to
file them with the appropriate
authorities. Assuming an hourly cost of
217 For example, there are currently 15 registered
national securities exchanges with varying
platforms and business models that compete for
clients and order flow in the equities and/or options
markets.
218 As noted above, Section 763(c) of the DoddFrank Act sets forth 14 core principles that SB SEFs
must satisfy, including one relating to conflicts of
interest, and provides the Commission with
rulemaking authority with respect to
implementation of these core principles. The
Commission may determine that it is appropriate to
propose additional rules to mitigate conflicts of
interest with respect to SB SEFs, including
incorporating ownership and/or voting limits and
other requirements with respect to ownership of a
SB SEF by persons other than SB SEF participants.
The Commission also may consider proposals such
as providing for the fair representation of SB SEF
participants in the selection of the SB SEF’s
directors and the administration of its affairs as part
of its broader rulemaking relating to SB SEFs.
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$291 for a compliance attorney,219 these
requirements would result in an overall
annual cost per SB SEF, SBS exchange
or SBS exchange facility of $4,365, or
$152,775 in the aggregate for all SB
SEFs, SBS exchanges, and SBS
exchange facilities.220
As previously discussed in the PRA
section, proposed Rule 702(c) would
require SB SEFs, SBS exchanges, or SBS
exchange facilities, as applicable, to
have an effective mechanism to obtain
information relating to ownership and
voting interest in the SB SEF, SBS
exchange, or SBS exchange facility, by
any participant or member of the SB
SEF, SBS exchange or SBS exchange
facility.221 It was estimated that these
obligations would result in a total
annual burden for all SB SEFs, SBS
exchanges, and SBS exchange facilities
of 1,960 hours. It was also estimated
that there would be a total annual
reporting and recordkeeping burden for
all participants or members of 2,800
hours. Assuming an hourly cost of $291
for a compliance attorney 222 to meet
these requirements, this would result in
an overall annual cost of $1,385,160 for
participants or members and SB SEFs,
SBS exchanges, and SBS exchange
facilities collectively.223 To the extent
that certain participants or members
may be required to file ownership or
voting information with a domestic or
international government authority
pursuant to securities laws, and such
information is made available to the SB
SEF, SBS exchange, or SBS exchange
facility, this cost would be reduced.
Proposed Rule 702(c) under
Regulation MC also would require a SB
SEF, SBS exchange or SBS exchange
facility to have rules to divest a
participant or member of an ownership
interest that violates the proposed
ownership limits, and to not give effect
to a voting interest of a participant or
member that violates the proposed
voting limits. As previously discussed
in the PRA section, this requirement is
estimated to result in an initial
paperwork burden for all SB SEFs, SBS
exchanges, or SBS exchange facilities of
525 hours. Assuming an hourly cost of
$291 for a compliance attorney 224 to
meet these requirements, this would
219 See
supra note 210.
annual cost per SB SEF, SBS
exchange, or SBS exchange facility = 15 hours ×
$291 = $4,365; aggregate annual cost for all SB
SEFs, SBS exchanges, and SBS exchange facilities
= $4,365 × 35 = $152,775.
221 See supra Section IX.
222 See supra note 210.
223 Overall annual cost for participants or
members and SB SEFs, SBS exchanges and SBS
exchange facilities = (1,960 hours + 2,800 hours) ×
$291 = $1,385,160.
224 See supra note 210.
220 Overall
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result in an initial cost of $152,775 for
all SB SEFs, SBS exchanges, and SBS
exchange facilities.225
This proposed rule also would impose
costs on SB SEFs, SBS exchanges, or
SBS exchange facilities to initiate the
divestiture or not give effect to the
voting rights that surpass the stated
threshold. For example, a SB SEF, SBS
exchange, or SBS exchange facility
could incur costs involved with
redeeming shares held in excess of the
proposed limits if such entity chooses to
provide in its rules that any such excess
shares would be purchased by the
entity. A SB SEF, SBS exchange, or SBS
exchange facility also could adopt rules
to limit voting by any participant or
member that owns more than 20% of
outstanding interests. Thus, a SB SEF,
SBS exchange, or SBS exchange facility
also could incur costs associated with
monitoring votes cast at any shareholder
meeting to determine that no SB SEF
participant or SBS exchange member
and its related persons subject to the
voting limits exceeds those limits.
The Commission recognizes that
entities that are currently in existence
and plan to become SB SEFs, SBS
exchanges or SBS exchange facilities
could incur costs if they do not meet the
proposed ownership and voting
limitations. For example, if a single or
small group of market participants that
would be direct participant(s) in a SB
SEF plans to register a platform as a SB
SEF, it or they potentially would need
to secure additional owners to meet the
20% limitation on ownership of voting
securities of a SB SEF. This could
impose costs on an entity that has a
single owner-participant or a small
number of owner-participants and that
plans to register a platform as a SB SEF,
from the costs of finding other owners
or the sharing of potential profits with
a larger group of owners. As noted
above, currently there are no trading
venues that are registered with the
Commission as SB SEFs. Based on
initial discussions with market
participants that have indicated an
interest in registering as a SB SEF, the
Commission preliminarily believes that
few entities that may register as a SB
SEF currently have ownership
structures that would conflict with the
proposed ownership and voting
limitations for SB SEFs. In addition, as
discussed above, national securities
exchanges that may potentially register
as SBS exchanges or create a facility that
will be a SBS exchange facility should
already be in compliance with the
proposed ownership and voting
225 This initial cost is estimated as follows: 15
hours × 35 respondents × $291 per hour = $152,775.
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limitations. Based on these factors, the
Commission preliminarily believes that
the aggregate costs imposed by the
ownership and voting limitations on
entities initially seeking to register as SB
SEFs, SBS exchanges or SBS exchange
facilities would not be significant.
2. Costs and Benefits Related to
Independence Requirements in SB SEFs
and SBS Exchanges
Proposed Rule 702(d) under
Regulation MC would require the
Boards of SB SEFs and SBS exchanges
or SBS exchange facilities to be
composed of at least a majority of
independent directors to mitigate
conflicts of interest and help ensure that
the entity does not advance the interests
of its owners, some of which may be
dealer-participants or their affiliates. By
mandating a structure that would
require a majority of Board members to
be independent, the governance of SB
SEFs, SBS exchanges and SBS exchange
facilities should be less susceptible to
promoting the self-interests of such
participants. The majority independent
directors should help foster a greater
degree of independent decision-making
consistent with the objectives of the
Dodd-Frank Act and the Exchange Act.
Further, a Board whose independent
directors constitute at least a majority of
the Board should help ensure that the
views of independent directors are
taken into account and should help
strengthen the hand of independent
directors when dealing with
management. In the Commission’s
preliminary view, requiring the Boards
of SB SEFs, SBS exchanges and SBS
exchange facilities to have a majority of
independent directors should help
reduce the possibility of damaging
conflicts of interest that otherwise might
arise when persons who do not meet the
definition of independent director at the
SB SEF, SBS exchange or SBS exchange
facility are involved in key decisions,
such as which products will be made
available for trading and the access
levels of potential market participants.
To the extent that independent directors
would reduce the likelihood that one
group of participants could coordinate
decision-making in such a way that
would be detrimental to the SB SEF,
SBS exchange or SBS exchange facility
as a whole, this would be a benefit.
In addition, proposed Rule 702(f)
under Regulation MC would require that
the nominating committee of a SB SEF,
SBS exchange or SBS exchange facility
be composed solely of independent
directors. This proposed requirement
should foster a process for nominating
independent directors that would help
to assure that such directors are
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65923
independent and not likely to be unduly
influenced by an owner of the SB SEF,
SBS exchange or SBS exchange facility
who is possibly a SB SEF participantdealer or SBS exchange member or
affiliate thereof. In addition, the
requirement in proposed Rule 702(g)
under Regulation MC that any
committee that would have the
authority to act on behalf of the Board
be composed of a majority of
independent directors is designed to
prevent important decisions from
escaping the view of a majority of
independent directors. Many Board
decisions come from committees and
conflicts may be similarly prevalent or
even more pronounced in these
situations.
Proposed Rule 702(e) under
Regulation MC also would require the
Board of any SB SEF and SBS exchange
to establish a ROC consisting solely of
independent directors to oversee the
entity’s regulatory obligations.226 The
Commission preliminarily believes that
this requirement should be effective in
managing the conflicts of interest
inherent in the Board’s oversight of
whether a SB SEF or SBS exchange
satisfies its regulatory obligations. The
proposed provision relating to the
establishment of an independent ROC
should help promote greater
accountability on the part of SB SEFs
and SBS exchanges with respect to the
obligations placed on them by the
Exchange Act, including as amended by
the Dodd-Frank Act, and strengthen
their ability to meet those obligations. A
ROC composed solely of independent
directors should result in a greater
degree of objective decision-making
with respect to the SB SEF’s or SBS
exchange’s regulatory obligations.
Vigilant and informed oversight by a
strong, effective and independent ROC
may increase investor confidence in the
operation of SB SEFs and SBS
exchanges, and the security-based
swaps market generally. National
securities exchanges that currently have
a ROC composed of independent
directors have noted the benefits of such
a governance mechanism.227 In
226 Proposed Rule 702(e) under Regulation MC
does not explicitly include SBS exchange facilities
because the exchange whose facility posts or makes
available for trading a security-based swap must
itself establish the requisite ROC. See supra note
173.
227 See CBOE Comment Letter, supra note 165
(‘‘CBOE also implemented other changes that are
similar to the proposals contained in the Release,
for example establishing a Regulatory Oversight
Committee, composed solely of public directors
* * *. As a result, CBOE believes that its existing
governance structure and practices serve not only
to protect investors and the public interest and
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addition, requiring the Board to report
promptly to the Commission any
recommendation of the ROC that the
Board does not implement should
provide the Commission with
information on a timely basis regarding
the Board’s decision not to take certain
actions.
The governance proposals for SB
SEFs, SBS exchanges and SBS exchange
facilities would complement the
proposed ownership and voting limits
for these entities. Five or more dealerparticipants or members could still own
100% of the voting securities of a SB
SEF, SBS exchange or SBS exchange
facility, as applicable, under the
proposed voting and ownership limits.
In addition, even when the influence of
any single dealer is limited through
ownership and voting restrictions,
economic incentives can align several
dealer participants in a way that may be
costly to investors. As a result, there are
potential incentives for SB SEF
participant-dealers and SBS exchange
member-dealers to coordinate in ways
that ownership and voting restrictions
could not address. Requiring
independence on the Board and certain
key Board committees should further
reduce the ability of the participantowners of the SB SEF or memberowners of the SBS exchange or SBS
exchange facility to unduly influence
decision-making at the Board level in a
way that advances their interests.
Representation by independent
directors would provide views and
influence that by design are not subject
to these conflicts.
As noted in the discussion relating to
security-based swap clearing agencies,
while director independence is widely
believed to be a catalyst for improved
governance and the Commission
recognizes that the industry widely
accepts a majority of independent
directors as ‘‘best practices,’’ 228 there is
no conclusive empirical evidence to
support the view that a majority of
independent directors benefits
shareholder profits. However, the Model
Business Corporation Act recognizes the
assure the integrity of CBOE’s regulatory activities,
but also to enhance the ability of CBOE to develop
and implement sound business strategies’’); NYSE
Comment Letter, supra note 165 (‘‘As an important
part of the reform process of 2003, the NYSE
formalized the effective functional separation of
regulatory programs from the competitive business
functions, under a Chief Regulatory Officer (‘‘CRO’’)
reporting to a Regulatory Oversight Committee
(‘‘ROC’’) of the Board of Directors consisting of all
independent directors * * *. We agree with the
Commission that this structure, with a separate
regulatory executive reporting to an empowered,
qualified and independent board, amply funded
and professionally staffed, assures the integrity of
the regulatory process.’’)
228 See supra note 122.
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important role of independent
directors.229
The proposed governance
requirements could impose costs on SB
SEFs, SBS exchanges and SBS exchange
facilities. Entities planning to register as
SB SEFs and SBS exchanges may need
to draft or amend their governing
documents and design or modify their
governance processes to comply with
the proposed governance requirements,
which would impose costs on SB SEFs,
SBS exchanges and SBS exchange
facilities. The Commission estimates
that it would take a compliance attorney
approximately 15 hours to revise the
relevant governing documents and to
file them with the appropriate
authorities, for a total estimated cost per
SB SEF, SBS exchange or SBS exchange
facility of $4,365, or $152,775 in the
aggregate for all SB SEFs or SBS
exchanges, and SBS exchange
facilities.230
An entity that plans to register as a SB
SEF or a SBS exchange may need to
revise the composition of its Board (or
that of its SBS exchange facility, in the
case of an exchange that posts or makes
available for trading security-based
swaps through a facility with a separate
governance structure), if the Board
currently is not composed of a majority
of independent directors. SB SEFs and
SBS exchanges or SBS exchange
facilities also would need to establish
wholly independent nominating
committees, and SB SEFs and SBS
exchanges would need to establish
wholly independent ROCs. In this
regard, SB SEFs, SBS exchanges and
SBS exchange facilities could face
difficulties in locating qualified
individuals to serve as independent
directors, particularly because securitybased swaps trading is complex and
some potential candidates may decline
to serve as a director if they believe that
they lack sufficient expertise.
The Commission preliminarily
believes that the cost of securing
independent directors to serve on the
Board of the SB SEF, SBS exchange or
SBS exchange facility could range from
a relatively low cost for those entities
that have the contacts and resources to
be able to search for one or more
independent directors on their own; to
a moderate cost for those entities that
229 MODEL BUS. CORP. ACT § 8.01(c) (4th ed.
2008).
230 Assuming an hourly cost of $291 for a
compliance attorney, the overall annual cost per SB
SEF, SBS exchange or SBS exchange facility and
aggregate cost for all SB SEFs, SBS exchanges, and
SBS exchange facilities was calculated as follows:
per entity annual cost = 15 hours × $291 = $4,365;
aggregate annual cost = $4,365 × 35 = $152,775. See
supra note 210.
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can undertake the search on their own
but would incur some expenditures,
such as placing advertisements in
national media; to a higher cost for
those entities that must secure the
services of a recruitment firm that
specializes in the placement of
independent directors. The Commission
preliminarily estimates that those SB
SEFs, SBS exchanges or SBS exchange
facilities that must rely on a recruitment
specialist to secure an independent
director could incur a cost of
approximately $68,000 per director.231
The Commission preliminarily
estimates that 10–20 entities could seek
to register as SB SEFs and notes that
there are 15 national securities
exchanges; however, the number of
Board members could vary widely
among SB SEFs, SBS exchanges and
SBS exchange facilities. Therefore, the
Commission provides an estimate of a
maximum recruitment cost of $68,000
per independent director.232
The imposition of a Board structure
that precludes the likely participants in
SB SEFs, SBS exchanges or SBS
exchange facilities—dealers—from
gaining a majority or having
representation on certain Board
committees may have a negative effect
on the operations of the SB SEF, SBS
exchange or SBS exchange facility if
independent directors do not have
commensurate qualifications or skills as
affiliated directors or do not engage
actively in their Board or committee
duties. There could be costs in
educating independent directors to
become familiar with the manner in
which security-based swaps are traded
and in the new regulatory structure that
would govern them, which could slow
Board or committee processes at least
initially. In addition, independent
directors may yield to industry directors
who have more knowledge and
experience, thereby undermining the
benefits of requiring independence. In
the context of wholly independent
committees, such as a nominating
231 The Commission is basing this estimate on a
recent study noting that the retainer fee for outside
directors is on average $67,624. See https://
www.hewittassociates.com/
_MetaBasicCMAssetCache_/Assets/Articles/2010/
2010_Outside_Director_Compensation.pdf. The
Commission believes that this amount could serve
as a proxy for the amount of any fee to be charged
by a recruitment firm that would conduct a national
search for an independent director.
232 As discussed above, since 2004 when the
Commission proposed rules to promote the fair
administration and governance of, and to impose
ownership and voting limitations on, national
securities exchanges, a number of exchanges have
adopted governance structures which meet many of
the requirements of proposed Rule 702. Thus, the
costs for complying with the proposed governance
rules would be decreased for some SBS exchanges.
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committee or ROC, the independent
directors may become reliant on
executive officers and other employees
of the SB SEF or SBS exchange to
inform their decision-making due to
their lack of expertise in the industry. If
management fails to keep the directors
on wholly independent committees
fully-informed, if the independent
directors on such committees fail to
seek sufficient information from
management to make informed
decisions or if management fails to give
independent directors adequate
resources to make effective decisions,
there could be costs to the SB SEF, SBS
exchange or SBS exchange facility. On
the other hand, if management fully
apprises the directors on wholly
independent committees of necessary
information and the independent
directors have sufficient resources and
are fully engaged with respect to their
duties, there would be benefits to the SB
SEF, SBS exchange or SBS exchange
facility.
In addition, the effectiveness of
majority independent Boards can
depend on the personalities and
personal traits, as well as the
qualifications, of the persons serving on
the Board. Independent directors that
take the time to understand the
operations and programs of a SB SEF,
SBS exchange or SBS exchange facility
and to ask probing questions of
management are more likely to be
effective independent directors.
However, because independent
directors would not be employed by the
SB SEF, SBS exchange, or SBS exchange
facility or be participants or members of
such entity, they often may need to rely
on management or other directors to
keep them fully informed. There could
be costs to the SB SEF, SBS exchange,
or SBS exchange facility if one or more
independent directors is ineffectual
because he or she did not fully
understand the operations of the SB SEF
or SBS exchange, either because the
independent directors did not take the
necessary initiative or management
failed to keep the independent directors
fully apprised of information that would
lead to their effective decision-making.
Thus, imperfect decisions by
independent directors could result in
costs to the SB SEF, SBS exchange, or
SBS exchange facility. On the other
hand, independent directors who have
expertise in areas that could be helpful
to the SB SEF, SBS exchange or SBS
exchange facility, who are engaged in
carrying out their director duties, and
who grasp the issues confronting the SB
SEF, SBS exchange or SBS exchange
facility could be very beneficial to the
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SB SEF, SBS exchange or SBS exchange
facility because they could bring fresh
insights and ideas to these entities.
Finally, under the proposed Rule
702(e)(2) under Regulation MC, SB SEFs
and SBS exchanges would need to
report promptly to the Commission any
recommendation of the ROC that the
Board does not adopt or implement,
which would result in costs to SB SEFs
and SBS exchanges. As discussed above,
the Commission preliminarily estimates
that the annual information collection
burden for each SB SEF or SBS
exchange under this provision of the
proposed rules would be 12 hours.233
Accordingly, the Commission’s staff
estimates that it would cost each SB SEF
or SBS exchange $3,492 annually to
comply with this provision of the
proposed rules.234
D. Request for Comments
The Commission requests that
commenters provide views and
supporting information regarding the
costs and benefits associated with the
proposals. The Commission seeks
estimates of these costs and benefits, as
well as any costs and benefits not
already identified. The Commission also
requests comment regarding the relative
costs and benefits of pursuing
alternative regulatory approaches that
are consistent with Section 765 of the
Dodd-Frank Act. In addition, the
Commission requests comment on
whether other provisions of the DoddFrank Act for which Commission
rulemaking is required are likely to have
an effect on the costs and benefits of the
proposed rules.
XI. Consideration of Burden on
Competition, and Promotion of
Efficiency, Competition, and Capital
Formation
Section 3(f) of the Exchange Act 235
requires the Commission, whenever it
engages in rulemaking and is required to
consider or determine whether an action
is necessary or appropriate in the public
interest, to consider, in addition to the
protection of investors, whether the
action would promote efficiency,
competition, and capital formation. In
addition, Section 23(a)(2) of the
233 See
supra Section IX.D.
hours (estimated annual information
collection burden for each SB SEF and SBS
exchange) × $291 (hourly cost for a compliance
attorney) = $3,492. The hourly rate for the
compliance attorney is from SIFMA’s Management
& Professional Earnings in the Securities Industry
2009, modified by the Commission’s staff to
account for an 1,800-hour work-year and multiplied
by 5.35 to account for bonuses, firm size, employee
benefits and overhead.
235 15 U.S.C. 78c(f).
234 12
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65925
Exchange Act 236 requires the
Commission, when adopting rules
under the Exchange Act, to consider the
effect such rules would have on
competition. Section 23(a)(2) of the
Exchange Act also prohibits the
Commission from adopting any rule that
would impose a burden on competition
not necessary or appropriate in
furtherance of the purposes of the
Exchange Act.
Security-based swaps are currently
executed and traded in the OTC market,
with five large commercial banks
representing 97% of the total U.S.
banking industry national amounts
outstanding of derivatives.237 The gross
notional amount of CDS as of the end
of 2009 was approximately $30
trillion.238
As discussed above, the Commission
has granted exemptions to five entities
to act as security-based swap clearing
agencies for CDS.239 Four of the
exemptions are currently active. SB
SEFs and SBS exchanges are expected to
register to trade security-based swaps in
connection with the implementation of
rules under Title VII of the Dodd-Frank
Act.
As discussed above, the intent of the
ownership and voting limitations and
governance proposed rules is to mitigate
potential conflicts of interests of market
participants in the clearing and trading
of security-based swaps. These
proposed rules may have a significant
effect on the level of competition within
the marketplace.
The voting restrictions on securitybased swap clearing agencies that limit
the influence of any single participant
or group of participants could increase
the level of competition at the
participant level if they preserve access
to central clearing and trading by other
participants. Without these voting
restrictions, it may be possible for a
dominant participant owner to use its
voting interest to set rules, fees, or
capital requirements that engender an
uncompetitive environment. For
instance, a heightened capital threshold
for participation might prevent some
firms from qualifying as participants
and thus deny them access to clearing.
However, the proposed voting
limitations among participants may also
impede competition at the securitybased swap clearing agency level, since
236 15
U.S.C. 78w(a)(2).
Office of the Comptroller of the Currency,
Quarterly Report on Bank Trading and Derivatives
Activities, First Quarter 2010.
238 Data available at https://www.isda.org/
statistics/pdf/ISDA-Market-Survey-results1987present.xls.
239 See CDS Clearing Exemption Orders, supra
note 17.
237 See
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there are likely a limited number of
firms with the expertise, resources and
desire to have an ownership interest in
a security-based swap clearing
agency.240
As previously noted, evidence from
the securities markets suggests that
clearing agencies over the long-run tend
to converge to a small number of entities
or even a single entity. Clearing
activities are characterized by high startup costs and low marginal costs such
that there are large economies of scale.
For example, all trades executed on the
eight U.S. based options exchanges are
cleared at the Options Clearing
Corporation, and trades executed on the
U.S. equity markets, composed of
exchanges, alternative trading platforms,
and OTC trading, are cleared at the
National Securities Clearing
Corporation, a wholly-owned subsidiary
of the Depository Trust and Clearing
Corporation.241 A single security-based
swap clearing agency may also be more
efficient in that it would facilitate the
fungibility of contracts across multiple
execution facilities and exchanges.
Whether the differences in the Voting
Interest Focus Alternative and the
Governance Focus Alternative would
result in substantially different effects
on efficiency, capital formation, and
competition remains uncertain.
Preliminarily, the Commission believes
that the aggregate cap on participant
voting interests may limit the formation
of new clearing agencies and,
consequently, limit the opportunity for
competition among security-based swap
clearing agencies. However, the
aggregate cap under the Voting Interest
Focus Alternative may also be more
effective at mitigating conflicts of
interest than the rules proposed under
the Governance Focus Alternative, and
could result in greater access to central
clearing and a higher volume of
security-based swap products made
eligible for clearing. As discussed
previously, central clearing would
facilitate improved transparency, risk
management, and competition in the
security-based swaps market. This in
turn should have a positive effect on
efficiency, capital formation, and
competition.
The Commission preliminarily
believes that the start-up costs for a SB
SEF, SBS exchange or SBS exchange
240 The Commission pursuant to Section 36 of the
Exchange Act may grant an exemption from any
rule or any provision of any rule under Regulation
MC. See supra Section VI.
241 The central clearing of security-based swaps is
still developing and the Commission has not made
any determinations about the number of securitybased swap clearing agencies that may be used by
market participants.
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facility, or for an existing national
securities exchange to post or make
available for trading security-based
swaps, will be low. If a SB SEF, SBS
exchange or SBS exchange facility
would not provide the desired level of
access to a market participant, and the
start-up costs of setting up a competing
SB SEF, SBS exchange or SBS exchange
facility are low, then this would
encourage the entrance of alternate
trading venues for market participants
and allow competition to discipline
harmful practices by any single SB SEF,
SBS exchange, or SBS exchange facility.
However, if ownership restrictions are
such that dealers must coordinate
ownership among a group, then there
may be fewer potential owners
available, and thus there could be less
incentive to form competing SB SEFs,
SBS exchanges, or SBS exchange
facilities. In this case, ownership
limitations would impede
competition.242
The proposed rules under Regulation
MC relating to Board and committee
independence may also increase the
level of participant competition by
making it more difficult for a small
group of dealer-owners to influence a
security-based swap clearing agency, SB
SEF or SBS exchange even in light of
the proposed ownership and voting
restrictions. This is necessary because
economic incentives could align the
interests of participants against the
interest of the security-based swap
clearing agency, SB SEF or SBS
exchange as a whole irrespective of
whether those participants are owners.
For example, if the Board of a dealercontrolled security-based swap clearing
agency determines to refuse to clear a
proposed security-based swap product,
then such a product would not be
required to be traded on a SB SEF or
SBS exchange and would likely trade
OTC, reducing price transparency and
likely resulting in higher revenue for the
dealers in the OTC market than if the
product was available through a SB SEF,
SBS exchange or SBS exchange facility.
Majority independence requirements for
the Board and committees that have the
authority to act on behalf of the Board
are an additional tool to address this
potential conflict of interest. Given the
size of the security-based swaps market
and its non-competitive tendencies, the
benefits with respect to efficiency and
competition that ownership, voting, and
director representation requirements
would provide are likely to be
substantial.
The Commission requests comment
on the possible effects of the proposed
242 See
PO 00000
supra note 240.
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rules under Regulation MC on
efficiency, competition, and capital
formation. The Commission requests
that commenters provide views and
supporting information regarding any
such effects. The Commission notes that
such effects are difficult to quantify. The
Commission seeks comment on possible
anti-competitive effects of the proposed
rules under Regulation MC not already
identified. The Commission also
requests comment regarding the
competitive effects of pursuing
alternative regulatory approaches that
are consistent with Section 765 of the
Dodd-Frank Act. In addition, the
Commission requests comment on how
the other provisions of the Dodd-Frank
Act for which Commission rulemaking
is required will interact with and
influence the competitive effects of the
proposed rules under Regulation MC.
XII. Consideration of Impact on the
Economy
For purposes of the Small Business
Regulatory Enforcement Fairness Act of
1996, or ‘‘SBREFA,’’ 243 the Commission
must advise the OMB as to whether
proposed Regulation MC and the rules
proposed thereunder constitute a
‘‘major’’ rule. Under SBREFA, a rule is
considered ‘‘major’’ where, if adopted, it
results or is likely to result in: (1) An
annual effect on the economy of $100
million or more (either in the form of an
increase or a decrease); (2) a major
increase in costs or prices for consumers
or individual industries; or (3)
significant adverse effect on
competition, investment or innovation.
The Commission requests comment
on the potential impact of proposed
Regulation MC and the rules proposed
thereunder on the economy on an
annual basis. Commenters are requested
to provide empirical data and other
factual support for their view to the
extent possible.
XIII. Regulatory Flexibility Act
Certification
Section 603(a) of the Regulatory
Flexibility Act 244 (‘‘RFA’’) requires the
Commission to undertake an initial
regulatory flexibility analysis of the
proposed rules under Regulation MC on
small entities, unless the Commission
certifies that the proposed rules, if
adopted, would not have a significant
economic impact on a substantial
number of small entities.245
243 Public Law 104–121, Title II, 110 Stat. 857
(1996) (codified in various sections of 5 U.S.C., 15
U.S.C. and as a note to 5 U.S.C. 601).
244 5 U.S.C. 603(a).
245 5 U.S.C. 605(b).
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A. Security-Based Swap Clearing
Agencies
C. SBS Exchanges
Proposed Rule 701 under Regulation
MC would apply to all security-based
swap clearing agencies. Four entities are
currently exempt from registration as a
clearing agency under section 17A of
the Exchange Act to provide central
clearing services for CDS, a class of
security-based swaps.246 The
Commission believes, based on its
understanding of the market, that likely
no more than six security-based swap
clearing agencies could be subject to the
requirements of proposed Rule 701.
For purposes of Commission
rulemaking in connection with the RFA,
an issuer or person, other than an
investment company, is a small
business if its total assets on the last day
of its most recent fiscal year were $5
million or less.247 The Commission
believes that the entities likely to
register as security-based swap clearing
agencies will not be small entities, but
rather part of large business entities that
have assets in excess of $5 million and
total capital in excess of $500,000.248
B. SB SEFs
Proposed Rule 702 under Regulation
MC would apply to all SB SEFs. In the
Dodd-Frank Act, Congress defined for
the first time what activity would
constitute a SB SEF and mandated the
registration of these new facilities. The
Commission preliminarily believes that
approximately 10 to 20 SB SEFs could
be subject to the requirements of
proposed Rule 702.
For purposes of Commission
rulemaking in connection with the RFA,
an issuer or person, other than an
investment company, is a small
business if its total assets on the last day
of its most recent fiscal year were $5
million or less.249 The Commission
preliminarily believes that the entities
likely to register as SB SEFs will not be
considered small entities because most,
if not all, of the SB SEFs will be part of
large business entities, and that all SB
SEFs will have assets in excess of $5
million.250
246 See
CDS Clearing Exemptions, supra note 17.
CFR 230.157. See also 17 CFR 240.0–10(a).
248 Commission staff based this determination on
its review of various public sources of financial
information about the current registered clearing
agencies and entities currently exempt from
clearing agency registration under Section 17A of
the Exchange Act.
249 17 CFR 230.157. See also 17 CFR 240.0–10(a).
250 Commission staff based this determination on
its review of various public sources of financial
information about the entities likely to register as
SB SEFs.
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Proposed Rule 702 under Regulation
MC would apply to all SBS exchanges.
All of the 15 currently registered
national securities exchanges could
become SBS exchanges, and therefore,
subject to the requirements of Rule
702.251
For purposes of Commission
rulemaking in connection with the RFA,
a national securities exchange is a small
business if it has been exempted from
the reporting requirements of Rule 601
of Regulation NMS 252 (Dissemination of
Transaction Reports and Last Sale Data
with Respect to Transactions in NMS
Stocks) and is not affiliated with any
person (other than a natural person) that
is not a ‘‘small business.’’ 253 None of the
currently registered national securities
exchanges is a small entity. Therefore,
the Commission preliminarily believes
that none of the SBS exchanges will be
considered small entities.
D. Certification
XIV. Statutory Basis and Rule Text
Pursuant to the Exchange Act, 15
U.S.C. 78a et seq., and particularly,
Sections 3, 3D, 6, 11A, 17A, 19, and
23(a) thereof, and Section 765 of the
Dodd-Frank Act, the Commission is
proposing to adopt Regulation MC
under the Exchange Act.
List of Subjects in 17 CFR Part 242
Reporting and recordkeeping
requirements, Securities.
Text of Proposed Rule Amendments
For the reasons stated in the
preamble, the Commission is proposing
to amend Title 17, Chapter II of the
Code of the Federal Regulations as
follows:
251 See
supra note 194.
CFR 242.601.
253 17 CFR 240.0–10(e).
252 17
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PART 242—REGULATIONS M, SHO,
ATS, AC, NMS, AND MC AND
CUSTOMER MARGIN REQUIREMENTS
FOR SECURITY FUTURES
1. The authority citation for part 242
is amended by adding authorities for
Sections 242.700, 242.701 and 242.702
to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a),
78b, 78c, 78f, 78g(c)(2), 78i(a), 78j, 78k–1(c),
78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 78q–1,
78q(a), 78q(h), 78w(a), 78dd–1, 78mm, 80a–
23, 80a–29, and 80a–37.
*
*
Sfmt 4702
*
*
*
Section 242.700 is also issued under sec.
943, Public Law 111–203, Section 765.
Section 242.701 is also issued under sec.
943, Public Law 111–203, Section 765.
Section 242.702 is also issued under sec.
943, Public Law 111–203, Sections 763 and
765.
2. The part heading for part 242 is
revised to read as set forth above.
3. Sections 242.700, 242.701 and
242.702 are added to read as follows:
§ 242.700
For the reasons stated above, the
Commission certifies that the proposed
rules under Regulation MC would not
have a significant economic impact on
a substantial number of small entities.
The Commission requests comments
regarding this certification. The
Commission requests that commenters
describe the nature of any impact on
small entities, including national
securities exchanges, clearing agencies
or other small businesses or small
organizations that may register as SB
SEFs, SBS exchanges or security-based
swap clearing agencies, and provide
empirical data to support the extent of
the impact.
65927
Definitions.
(a) The term affiliate means any
person that, directly or indirectly,
controls, is controlled by, or is under
common control with, the person.
(b) The terms beneficial ownership,
beneficially owns or any derivative
thereof shall have the same meaning,
with respect to any security or other
ownership interest, as set forth in
§ 240.13d–3, as if (and whether or not)
such security or other ownership
interest were a voting equity security
registered under section 12 of the
Exchange Act (15 U.S.C. 78l); provided
that to the extent any person
beneficially owns any security or other
ownership interest solely because such
person is a member of a group within
the meaning of section 13(d)(3) of the
Exchange Act (15 U.S.C. 78m(d)(3)),
such person shall not be deemed to
beneficially own such security or other
ownership interest for purposes of this
section, unless such person has the
power to direct the vote of such security
or other ownership interest.
(c) The term Board means the Board
of Directors or Board of Governors of the
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or any equivalent
body.
(d) The term clearing agency has the
same meaning as set forth in section
3(a)(23) of the Exchange Act (15 U.S.C.
78c(a)(23)).
(e) The term control means the
possession, direct or indirect, of the
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power to direct or cause the direction of
the management and policies of a
person, whether through the ownership
of voting securities, by contract, or
otherwise. A person is presumed to
control another person if the person:
(1) Is a director, general partner or
officer exercising executive
responsibility (or having similar status
or functions);
(2) Directly or indirectly has the right
to vote 25 percent or more of a class of
voting securities or has the power to sell
or direct the sale of 25 percent or more
of a class of voting securities; or
(3) In the case of a partnership, has
the right to receive, upon dissolution, or
has contributed, 25 percent or more of
the capital.
(f) The term director means any
member of the Board.
(g) The term Exchange Act means the
Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(h) The term facility has the same
meaning as set forth in section 3(a)(2) of
the Exchange Act (15 U.S.C. 78c(a)(2)).
(i) The term immediate family
member means a person’s spouse,
parents, children and siblings, whether
by blood, marriage or adoption, or
anyone residing in such person’s home.
(j) The term independent director
means:
(1) A director who has no material
relationship with:
(i) The security-based swap execution
facility or national securities exchange
or facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable;
(ii) Any affiliate of the security-based
swap execution facility or national
securities exchange or facility thereof
that posts or makes available for trading
security-based swaps, or security-based
swap clearing agency, as applicable;
(iii) A security-based swap execution
facility participant, a member of a
national securities exchange that posts
or makes available for trading securitybased swaps, or a participant in the
security-based swap clearing agency, as
applicable; or
(iv) Any affiliate of a security-based
swap execution facility participant, a
member of a national securities
exchange that posts or makes available
for trading security-based swaps, or a
participant in the security-based swap
clearing agency, as applicable.
(2) A director is not an independent
director if any of the following
circumstances exists:
(i) The director, or an immediate
family member, is employed by or
otherwise has a material relationship
with the security-based swap execution
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facility or national securities exchange
or facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or any affiliate
thereof, or within the past three years
was employed by or otherwise had a
material relationship with the securitybased swap execution facility or
national securities exchange or facility
thereof that posts or makes available for
trading security-based swaps, or
security-based swap clearing agency, as
applicable, or any affiliate thereof;
(ii) (A) The director is a securitybased swap execution facility
participant, a member of a national
securities exchange that posts or makes
available for trading security-based
swaps, or a participant in the securitybased swap clearing agency, as
applicable, or within the past three
years was employed by or affiliated with
such participant or member or any
affiliate thereof; or
(B) The director has an immediate
family member that is, or within the
past three years was, an executive
officer of a security-based swap
execution facility participant, a member
of a national securities exchange that
posts or makes available for trading
security-based swaps, or a participant in
the security-based swap clearing agency,
as applicable, or any affiliate thereof;
(iii) The director, or an immediate
family member, has received during any
twelve month period within the past
three years payments that reasonably
could affect the independent judgment
or decision-making of the director from
the security-based swap execution
facility or national securities exchange
or facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or any affiliate
thereof or from a security-based swap
execution facility participant, a member
of a national securities exchange that
posts or makes available for trading
security-based swaps, or a participant in
the security-based swap clearing agency,
as applicable, or any affiliate thereof,
other than the following:
(A) Compensation for Board or Board
committee services;
(B) Compensation to an immediate
family member who is not an executive
officer of the security-based swap
execution facility or national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps, or security-based swap
clearing agency, as applicable, or any
affiliate thereof or of a security-based
swap execution facility participant, a
member of a national securities
exchange that posts or makes available
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for trading security-based swaps, or a
participant in the security-based swap
clearing agency, as applicable, or any
affiliate thereof; or
(C) Pension and other forms of
deferred compensation for prior
services, not contingent on continued
service.
(iv) The director, or an immediate
family member, is a partner in, or
controlling shareholder or executive
officer of, any organization to or from
which the security-based swap
execution facility or national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps, or security-based swap
clearing agency, as applicable, or any
affiliate thereof made or received
payments for property or services in the
current or any of the past three full
fiscal years that exceed two percent of
the recipient’s consolidated gross
revenues for that year, other than the
following:
(A) Payments arising solely from
investments in the securities of the
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or affiliate
thereof; or
(B) Payments under non-discretionary
charitable contribution matching
programs.
(v) The director, or an immediate
family member, is, or within the past
three years was, employed as an
executive officer of another entity where
any executive officers of the securitybased swap execution facility or
national securities exchange or facility
thereof that posts or makes available for
trading security-based swaps, or
security-based swap clearing agency, as
applicable, serve on that entity’s
compensation committee;
(vi) The director, or an immediate
family member, is a current partner of
the outside auditor of the security-based
swap execution facility or national
securities exchange or facility thereof
that posts or makes available for trading
security-based swaps, or security-based
swap clearing agency, as applicable, or
any affiliate thereof, or was a partner or
employee of the outside auditor of
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or any affiliate
thereof who worked on the audit of the
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
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available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or any affiliate
thereof, at any time within the past
three years; or
(vii) In the case of a director that is
a member of the audit committee, such
director (other than in his or her
capacity as a member of the audit
committee, the Board, or any other
Board committee), accepts, directly or
indirectly, any consulting, advisory, or
other compensatory fee from the
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps, or security-based swap clearing
agency, as applicable, or any affiliate
thereof or a security-based swap
execution facility participant, a member
of a national securities exchange that
posts or makes available for trading
security-based swaps, or a participant in
the security-based swap clearing agency,
as applicable, or any affiliate thereof,
other than fixed amounts of pension and
other forms of deferred compensation
for prior service, provided such
compensation is not contingent in any
way on continued service.
(k) The term major security-based
swap participant has the same meaning
as set forth in section 3(a)(65) of the
Exchange Act (15 U.S.C. 78c(a)(65)) or
any rules or regulations thereunder.
(l) The term material relationship
means a relationship, whether
compensatory or otherwise, that
reasonably could affect the independent
judgment or decision-making of the
director.
(m) The term member has the same
meaning as set forth in section 3(a)(3) of
the Exchange Act (15 U.S.C. 78c(a)(30)).
(n) The term national securities
exchange means any exchange
registered pursuant to section 6 of the
Exchange Act (15 U.S.C. 78f).
(o) The term participant when used
with respect to a clearing agency has the
same meaning set forth in section
3(a)(24) of the Exchange Act (15 U.S.C
78c(a)).
(p) The term person has the same
meaning as set forth in section 3(a)(9) of
the Exchange Act (15 U.S.C. 78c(a)(9)).
(q) The term person associated with a
member has the same meaning as set
forth in section 3(a)(21) of the Exchange
Act (15 U.S.C. 78c(a)(21)).
(r) The term person associated with a
participant in a security-based swap
clearing agency means:
(1) Any partner, officer, director, or
branch manager of such security-based
swap dealer or major security-based
swap participant (or any person
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occupying a similar status or performing
similar functions);
(2) Any person directly or indirectly
controlling, controlled by, or under
common control with such securitybased swap dealer or major securitybased swap participant; or
(3) Any employee of such securitybased swap dealer or major securitybased swap participant. This term does
not include any person associated with
a participant in a security-based swap
clearing agency whose functions are
solely clerical or ministerial.
(s) The term person associated with a
security-based swap dealer or major
security-based swap participant has the
same meaning as set forth in section
3(a)(70) of the Exchange Act (15 U.S.C.
78c(a)(70)) or any rules or regulations
thereunder.
(t) The term person associated with a
security-based swap execution facility
participant means any partner, officer,
director, or branch manager of such
security-based swap execution facility
participant (or any person occupying a
similar status or performing similar
functions), any person directly or
indirectly controlling, controlled by, or
under common control with such
security-based swap execution facility
participant, or any employee of such
security-based swap execution facility
participant.
(u) The term related person means:
(1) When used with respect to a
security-based swap clearing agency:
(i) Any affiliate of a security-based
swap clearing agency participant;
(ii) Any person associated with a
security-based swap clearing
participant;
(iii) Any immediate family member of
a security-based swap clearing agency
participant that is a natural person or
any immediate family member of the
spouse of such person, who, in each
case, has the same home as the securitybased swap clearing agency participant
or who is a director or officer of the
security-based swap clearing agency or
any of its parents or subsidiaries; or
(iv) Any immediate family member of
a person associated with a securitybased swap clearing agency participant
that is a natural person or any
immediate family member of the spouse
of such person, who, in each case, has
the same home as the person associated
with the security-based swap clearing
agency participant or who is a director
or officer of the security-based swap
clearing agency or any of its parents or
subsidiaries;
(2) When used with respect to a
security-based swap execution facility:
(i) Any affiliate of a security-based
swap execution facility participant;
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65929
(ii) Any person associated with a
security-based swap execution facility
participant;
(iii) Any immediate family member of
a security-based swap execution facility
participant or any immediate family
member of the spouse of such person,
who, in each case, has the same home
as the security-based swap execution
facility participant or who is a director
or officer of the security-based swap
execution facility or any of its parents
or subsidiaries; or
(iv) Any immediate family member of
a person associated with a securitybased swap execution facility
participant or any immediate family
member of the spouse of such person,
who, in each case, has the same home
as the person associated with the
security-based swap execution facility
participant or who is a director or
officer of the security-based swap
execution facility or any of its parents
or subsidiaries; and
(3) When used with respect to a
national securities exchange or facility
thereof that posts or makes available for
trading security-based swaps:
(i) Any affiliate of a member of the
national securities exchange that posts
or makes available for trading securitybased swaps;
(ii) Any person associated with a
member of the national securities
exchange that posts or makes available
for trading security-based swaps;
(iii) Any immediate family member of
a member of the national securities
exchange that posts or makes available
for trading security-based swaps or any
immediate family member of the spouse
of such person, who, in each case, has
the same home as the member of the
national securities exchange that posts
or makes available for trading securitybased swaps or who is a director or
officer of the national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps, or any of its parents or
subsidiaries; or
(iv) Any immediate family member of
a person associated a member of the
national securities exchange that posts
or makes available for trading securitybased swaps or any immediate family
member of the spouse of such person,
who, in each case, has the same home
as the person associated with the
national securities exchange that posts
or makes available for trading securitybased swaps or who is a director or
officer of the national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps or any of its parents or
subsidiaries.
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(v) The term security-based swap has
the same meaning as set forth in section
3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)) or any rules or regulations
thereunder.
(w) The term security-based swap
dealer has the same meaning as set forth
in section 3(a)(71) of the Exchange Act
(15 U.S.C. 78c(a)(71)) or any rules or
regulations thereunder.
(x) The term security-based swap
clearing agency means a clearing agency
that clears security-based swaps.
(y) The term security-based swap
execution facility has the same meaning
as set forth in section 3(a)(77) of the
Exchange Act (15 U.S.C. 78c(a)(77)) or
any rules or regulations thereunder.
(z) The term security-based swap
execution facility participant means a
person permitted to directly effect
transactions on the security-based swap
execution facility.
srobinson on DSK8KYBLC1PROD with PROPOSALS2
§ 242.701 Mitigation of conflicts of interest
of security-based swap clearing agencies.
Each security-based swap clearing
agency must comply with the provisions
of either paragraphs (a) or (b) this
section, and must have the capacity to
carry out the purposes of paragraphs (a)
or (b) of this section, respectively.
(a)(1) Limits on voting interest. A
security-based swap clearing agency
shall not permit any security-based
swap clearing agency participant, either
alone or together with its related
persons, to:
(i) Beneficially own, directly or
indirectly, any interest in the securitybased swap clearing agency that exceeds
20 percent of any class of securities, or
other ownership interest, entitled to
vote of such security-based swap
clearing agency;
(ii) Directly or indirectly vote, cause
the voting of, or give any consent or
proxy with respect to the voting of, any
interest in the security-based swap
clearing agency that exceeds 20 percent
of the voting power of any class of
securities or other ownership interest of
such security-based swap clearing
agency;
(iii) In the aggregate with any other
security-based swap clearing agency
participants and their related persons,
beneficially own, directly or indirectly,
any interest in the security-based swap
clearing agency that exceeds 40 percent
of any class of securities, or other
ownership interest, entitled to vote of
such security-based swap clearing
agency; or
(iv) In the aggregate with any other
security-based swap clearing agency
participants and their related persons,
directly or indirectly vote, cause the
voting of, or give any consent or proxy
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with respect to the voting of, any
interest in the security-based swap
clearing agency that exceeds 40 percent
of the voting power of any class of
securities or other ownership interest of
such security-based swap clearing
agency.
(2) Divestiture. (i) The rules of the
security-based swap clearing agency
must provide an effective mechanism to
divest any participant of any voting
interest owned in excess of the
limitation in paragraph (a)(1) of this
section.
(ii) The rules of the security-based
swap clearing agency must be
reasonably designed not to give effect to
the portion of any voting interest held
by one or more participants in excess of
the limitations in paragraph (a)(1) of this
section.
(iii) The rules of the security-based
swap clearing agency must provide an
effective mechanism for it to obtain
information relating to voting interests
in the security-based swap clearing
agency by any participant in the
security-based swap clearing agency and
its related persons.
(3) Board. (i) The Board of each
security-based swap clearing agency
must be composed of at least 35 percent
independent directors.
(ii) No director may qualify as an
independent director unless the Board
affirmatively determines that the
director does not have a material
relationship with the security-based
swap clearing agency or any affiliate of
the security-based swap clearing agency,
or a participant in the security-based
swap clearing agency, or any affiliate of
a participant in the security-based swap
clearing agency.
(iii) The security-based swap clearing
agency must establish policies and
procedures to require each director, on
his or her own initiative or upon request
of the security-based swap clearing
agency, to inform the security-based
swap clearing agency of the existence of
any relationship or interest that may
reasonably be considered to bear on
whether such director is an independent
director.
(4) Nominating committee. (i) A Board
of any security-based swap clearing
agency shall establish a nominating
committee composed of a majority of
independent directors.
(ii) The nominating committee of any
security-based swap clearing agency
must identify individuals qualified to
become Board members through a
consultative process with the
participants of the security-based swap
clearing agency consistent with criteria
approved by the Board and consistent
with the provisions of this section, and
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administer a process for the nomination
of individuals to the Board.
(5) Other committees of the Board. A
security-based swap clearing agency
may establish such other committees of
the Board, including a risk committee,
as it deems appropriate. However, if
such committee has the authority to act
on behalf of the Board, the committee
must be composed of at least 35 percent
independent directors.
(6) Disciplinary panels. The
disciplinary processes of a securitybased swap clearing agency shall
preclude any group or class of persons
that is a participant from dominating or
exercising disproportionate influence on
the disciplinary process. Any
disciplinary panel of a security-based
swap clearing agency shall also include
at least one person who would qualify
as an independent director. If the
security-based swap clearing agency
provides for a process of an appeal to
the Board, or to a committee of the
Board, then that appellate body also
shall include at least one person who
would qualify as an independent
director.
(b)(1) Limits on voting interests. A
security-based swap clearing agency
shall not permit any security-based
swap clearing agency participant, either
alone or together with its related
persons, to:
(i) Beneficially own, directly or
indirectly, any interest in the securitybased swap execution facility that
exceeds 5 percent of any class of
securities, or other ownership interest,
entitled to vote of such security-based
swap clearing agency; or
(ii) Directly or indirectly vote, cause
the voting of, or give any consent or
proxy with respect to the voting of, any
interest in the security-based swap
clearing agency that exceeds 5 percent
of the voting power of any class of
securities or other ownership interest of
such security-based swap clearing
agency.
(2) Divestiture. (i) The rules of the
security-based swap clearing agency
must provide an effective mechanism to
divest any participant of any voting
interest owned in excess of the
limitation in paragraph (b)(1) of this
section.
(ii) The rules of the security-based
swap clearing agency must be
reasonably designed not to give effect to
the portion of any voting interest held
by one or more participants in excess of
the limitations in paragraph (b)(1) of
this section.
(iii) The rules of the security-based
swap clearing agency must provide an
effective mechanism for it to obtain
information relating to voting interests
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in the security-based swap clearing
agency or its holding company by any
participant in the security-based swap
clearing agency.
(3) Board. (i) The Board of each
security-based swap clearing agency
must be composed of a majority of
independent directors.
(ii) No director may qualify as an
independent director unless the Board
affirmatively determines that the
director does not have a material
relationship with the security-based
swap clearing agency or any affiliate of
the security-based swap clearing agency,
or a participant in the security-based
swap clearing agency, or any affiliate of
a participant in the security-based swap
clearing agency.
(iii) The security-based swap clearing
agency must establish policies and
procedures to require each director, on
his or her own initiative or upon request
of the security-based swap clearing
agency, to inform the security-based
swap clearing agency of the existence of
any relationship or interest that may
reasonably be considered to bear on
whether such director is an independent
director.
(4) Nominating committee. (i) A Board
of any security-based swap clearing
agency shall establish a nominating
committee composed solely of
independent directors.
(ii) The nominating committee of any
security-based swap clearing agency
must identify individuals qualified to
become Board members through a
consultative process with the
participants of the security-based swap
clearing agency consistent with criteria
approved by the Board and consistent
with the provisions of this section, and
administer a process for the nomination
of individuals to the Board.
(5) Other committees of the Board. A
security-based swap clearing agency
may establish such other committees of
the Board, including a risk committee,
as it deems appropriate. However, if
such committee has the authority to act
on behalf of the Board, the committee
must be composed of a majority of
independent directors.
(6) Disciplinary panels. The
disciplinary processes of a securitybased swap clearing agency shall
preclude any group or class of persons
that is a participant from dominating or
exercising disproportionate influence on
the disciplinary process. Any
disciplinary panel of a security-based
swap clearing agency shall also include
at least one person who would qualify
as an independent director. If the
security-based swap clearing agency
provides for a process of an appeal to
the Board, or to a committee of the
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Board, then that appellate body also
shall include at least one person who
would qualify as an independent
director.
§ 242.702 Mitigation of conflicts of interest
of security-based swap execution facilities
and national securities exchanges that post
or make available for trading security-based
swaps.
(a) General. Each security-based swap
execution facility and national
securities exchange or facility thereof
that posts or makes available for trading
security-based swaps must comply with
the provisions of this section and must
have the capacity to carry out the
purposes of this section.
(b) Limits on ownership and voting.
(1) A security-based swap execution
facility shall not permit any securitybased swap execution facility
participant, either alone or together with
its related persons, to:
(i) Beneficially own, directly or
indirectly, any interest in the securitybased swap execution facility that
exceeds 20 percent of any class of
securities, or other ownership interest,
entitled to vote of such security-based
swap execution facility; or
(ii) Directly or indirectly vote, cause
the voting of, or give any consent or
proxy with respect to the voting of, any
interest in the security-based swap
execution facility that exceeds 20
percent of the voting power of any class
of securities or other ownership interest
of such security-based swap execution
facility.
(2) A national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps shall not permit any member,
either alone or together with its related
persons, to:
(i) Beneficially own, directly or
indirectly, any interest in the national
securities exchange or facility thereof
that posts or makes available for trading
security-based swaps that exceeds 20
percent of any class of securities, or
other ownership interest, entitled to
vote of such national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps; or
(ii) Directly or indirectly vote, cause
the voting of, or give any consent or
proxy with respect to the voting of, any
interest in the national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps that exceeds 20 percent of
the voting power of any class of
securities or other ownership interest of
such national securities exchange or
facility thereof that posts or makes
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65931
available for trading security-based
swaps.
(c) Divestiture. (1) The rules of a
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps must provide an effective
mechanism to divest any security-based
swap execution facility participant or
member, as applicable, of any interest
owned in excess of the ownership
limitations in paragraphs (b)(1)(i) and
(2)(i) of this section.
(2) The rules of a security-based swap
execution facility or national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps must be reasonably
designed not to give effect to the portion
of any voting interest held by one or
more security-based swap execution
facility participant or member, as
applicable, in excess of the limitations
in paragraphs (b)(1)(ii) and (b)(2)(ii) of
this section.
(3) The rules of a security-based swap
execution facility or national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps must provide an effective
mechanism for it to obtain information
relating to ownership and voting
interests in the security-based swap
execution facility or national securities
exchange or facility thereof that posts or
makes available for trading securitybased swaps by any security-based swap
execution facility participant or
member, as applicable.
(d) Board. (1) The Board of any
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps must be composed of a majority
of independent directors.
(2) No director may qualify as an
independent director of a security-based
swap execution facility unless the Board
affirmatively determines that the
director does not have a material
relationship with the security-based
swap execution facility, any affiliate of
the security-based swap execution
facility, a security-based swap execution
facility participant, or any affiliate of a
security-based swap execution facility
participant.
(3) No director may qualify as an
independent director of a national
securities exchange or facility thereof
that posts or makes available for trading
security-based swaps unless the Board
affirmatively determines that the
director does not have a material
relationship with the national securities
exchange or facility thereof, any affiliate
of the national securities exchange or
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srobinson on DSK8KYBLC1PROD with PROPOSALS2
facility thereof, a member of the
national securities exchange, or any
affiliate of such member.
(e) Regulatory oversight committee.
(1) A Board of any security-based swap
execution facility or national securities
exchange that posts or makes available
for trading security-based swaps shall
establish a regulatory oversight
committee, composed solely of
independent directors, to assist it in
minimizing actual and potential
conflicts of interest. The regulatory
oversight committee shall oversee the
security-based swap execution facility’s
obligations under section 3D of the
Exchange Act or the national securities
exchange’s obligation under section 6 of
the Exchange Act (15 U.S.C. 78f), as
applicable, on behalf of the Board. The
Board shall delegate sufficient authority,
dedicate sufficient resources, and allow
sufficient time for the regulatory
oversight committee to fulfill its
mandate.
(2) The Board shall promptly report to
the Commission any recommendations
of the Regulatory Oversight Committee
that the Board does not adopt or
implement.
(f) Nominating committee. (1) The
nominating committee of a securitybased swap execution facility or
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national securities exchange or facility
thereof that posts or makes available for
trading security-based swaps must be
composed solely of independent
directors.
(2) The nominating committee of a
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps must identify individuals
qualified to become directors, consistent
with criteria approved by the Board and
consistent with the provisions of this
section, and administer a process for the
nomination of individuals to the Board.
(g) Other committees of the Board. A
security-based swap execution facility
or national securities exchange or
facility thereof that posts or makes
available for trading security-based
swaps may establish such other
committees of the Board, including an
executive committee, as it deems
appropriate. However, if such
committee has the authority to act on
behalf of the Board, the committee must
be composed of a majority of
independent directors.
(h) Disciplinary panels. The
disciplinary processes of a securitybased swap execution facility or
national securities exchange that posts
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or makes available for trading securitybased swaps shall preclude any group or
class of security-based swap execution
facility participants or group or class of
members of the national securities
exchange that posts or makes available
for trading security-based swaps, as
applicable, from dominating or
exercising disproportionate influence on
the disciplinary process. Any
disciplinary panel of a security-based
swap execution facility or national
securities exchange that posts or makes
available for trading security-based
swaps shall also include at least one
person who would qualify as an
independent director. If the securitybased swap execution facility or
national securities exchange that posts
or makes available for trading securitybased swaps provides for a process of an
appeal to the Board, or to a committee
of the Board, then that appellate body
also shall include at least one person
who would qualify as an independent
director.
Dated: October 14, 2010.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010–26315 Filed 10–25–10; 8:45 am]
BILLING CODE 8011–01–P
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[Federal Register Volume 75, Number 206 (Tuesday, October 26, 2010)]
[Proposed Rules]
[Pages 65882-65932]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-26315]
[[Page 65881]]
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Part IV
Securities and Exchange Commission
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17 CFR Part 242
Ownership Limitations and Governance Requirements for Security-Based
Swap Clearing Agencies, Security-Based Swap Execution Facilities, and
NationalSecurities Exchanges With Respect to Security-Based Swaps Under
Regulation MC; Proposed Rule
Federal Register / Vol. 75 , No. 206 / Tuesday, October 26, 2010 /
Proposed Rules
[[Page 65882]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-63107; File No. S7-27-10]
RIN 3235-AK74
Ownership Limitations and Governance Requirements for Security-
Based Swap Clearing Agencies, Security-Based Swap Execution Facilities,
and National Securities Exchanges With Respect to Security-Based Swaps
Under Regulation MC
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: In accordance with Section 765 (``Section 765'') of Title VII
(``Title VII'') of the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (``Dodd-Frank Act''), the Securities and
Exchange Commission (``SEC'' or ``Commission'') is proposing Regulation
MC under the Securities Exchange Act of 1934 (``Exchange Act'') for
clearing agencies that clear security-based swaps (``security-based
swap clearing agencies'') and for security-based swap execution
facilities (``SB SEFs'') and national securities exchanges that post or
make available for trading security-based swaps (``SBS exchanges'').
Regulation MC is designed to mitigate potential conflicts of interest
that could exist at these entities. Specifically, the Commission seeks
to mitigate the potential conflicts of interest through conditions and
structures relating to ownership, voting, and governance of security-
based swap clearing agencies, SB SEFs, and SBS exchanges.
DATES: Comments should be submitted on or before November 26, 2010.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (https://www.sec.gov/rules/proposed.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-27-10 on the subject line; or
Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F St., NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-27-10. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (https://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F St., NE., Washington, DC
20549 on official business days between the hours of 10 a.m. and 3 p.m.
All comments received will be posted without change; the Commission
does not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly.
FOR FURTHER INFORMATION CONTACT: Proposals relating to security-based
swap clearing agencies: Catherine Moore, Senior Special Counsel, at
(202) 551-5710; and Joseph P. Kamnik, Special Counsel, at (202) 551-
5710; Office of Clearance and Settlement, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-7010; proposals relating to security-based swap
execution facilities and national securities exchanges that post or
make available for trading security-based swaps: Nancy Burke-Sanow,
Assistant Director, at (202) 551-5621; Molly Kim, Special Counsel, at
(202) 551-5644; Steven Varholik, Special Counsel, at (202) 551-5615;
Sarah Schandler, Attorney, at (202) 551-7145; and Iliana Lundblad,
Attorney, at (202) 551-5871; Office of Market Supervision, Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street,
NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is proposing new Regulation
MC under the Exchange Act relating to conflicts of interest with
respect to security-based swap clearing agencies, SB SEFs, and SBS
exchanges.
I. Introduction
On July 21, 2010, the President signed the Dodd-Frank Act into
law.\1\ The Dodd-Frank Act was enacted to, among other purposes,
promote the financial stability of the United States by improving
accountability and transparency in the financial system.\2\ Title VII
of the Dodd-Frank Act provides the Commission and the Commodity Futures
Trading Commission (``CFTC'') with the authority to regulate over-the-
counter (``OTC'') derivatives in light of the recent financial crisis,
which demonstrated the need for enhanced regulation in the OTC
derivatives market. The Dodd-Frank Act is intended to close loopholes
in the existing regulatory structure and to provide the Commission and
the CFTC with effective regulatory tools to oversee the OTC swaps
market, which has grown exponentially in recent years and is capable of
affecting significant sectors of the U.S. economy.
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\1\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act (Pub. L. 111-203, H.R. 4173).
\2\ See Public Law 111-203, Preamble.
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The Dodd-Frank Act provides that the CFTC will regulate ``swaps,''
the Commission will regulate ``security-based swaps,'' and the CFTC and
the Commission will jointly regulate ``mixed swaps.'' \3\ The Dodd-
Frank Act amends the Exchange Act to require, among other things, the
following: (1) Transactions in security-based swaps must be cleared
through a clearing agency if they are of a type that the Commission
determines must be cleared, unless an exemption from mandatory clearing
applies; (2) transactions in security-based swaps must be reported to a
registered security-based swap data repository or
[[Page 65883]]
the Commission; and (3) if a security-based swap is subject to a
clearing requirement, it must be traded on a registered trading
platform, i.e., a SB SEF or SBS exchange, unless no facility makes such
security-based swap available for trading.\4\
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\3\ Section 712(d) of the Dodd-Frank Act provides that the
Commission and the CFTC, in consultation with the Board of Governors
of the Federal Reserve System (``Federal Reserve''), shall jointly
further define the terms ``swap,'' ``security-based swap,'' ``swap
dealer,'' ``security-based swap dealer,'' ``major swap
participant,'' ``major security-based swap participant,'' ``eligible
contract participant,'' and ``security-based swap agreement.'' These
terms are defined in Sections 721 and 761 of the Dodd-Frank Act and,
with respect to the term ``eligible contract participant,'' in
Section 1a(18) of the Commodity Exchange Act (``CEA''), 7 U.S.C.
1a(18), as re-designated and amended by Section 721 of the Dodd-
Frank Act. Further, Section 721(c) of the Dodd-Frank Act requires
the CFTC to adopt a rule to further define the terms ``swap,''
``swap dealer,'' ``major swap participant,'' and ``eligible contract
participant,'' and Section 761(b) of the Dodd-Frank Act permits the
Commission to adopt a rule to further define the terms ``security-
based swap,'' ``security-based swap dealer,'' ``major security-based
swap participant,'' and ``eligible contract participant,'' with
regard to security-based swaps, for the purpose of including
transactions and entities that have been structured to evade Title
VII of the Dodd-Frank Act. Finally, Section 712(a) of the Dodd-Frank
Act provides that the Commission and CFTC, after consultation with
the Federal Reserve, shall jointly prescribe regulations regarding
``mixed swaps'' as may be necessary to carry out the purposes of
Title VII. To assist the Commission and CFTC in further defining the
terms specified above, and to prescribe regulations regarding
``mixed swaps'' as may be necessary to carry out the purposes of
Title VII, the Commission and the CFTC have requested comment from
interested parties. See Securities Exchange Act Release No. 62717
(August 13, 2010), 75 FR 51429 (August 20, 2010) (File No. S7-16-10)
(advance joint notice of proposed rulemaking regarding definitions
contained in Title VII of the Dodd-Frank Act) (``Definitions
Release'').
\4\ See Section 761 of the Dodd-Frank Act, added as Section
3(a)(77) of the Exchange Act, 15 U.S.C. 78(c)(a), which defines the
term ``security-based swap execution facility'' to mean ``a trading
system or platform in which multiple participants have the ability
to execute or trade security-based swaps by accepting bids and
offers made by multiple participants in the facility or system,
through any means of interstate commerce, including any trading
facility that (A) facilitates the execution of security-based swaps
between persons; and (B) is not a national securities exchange.''
See Public Law 111-203, Section 761. The Dodd-Frank Act amends the
CEA to provide for a similar regulatory framework with respect to
transactions in swaps regulated by the CFTC.
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II. Mandated Rulemaking on Mitigating Conflicts of Interest
Section 765 of the Dodd-Frank Act requires the Commission to adopt
rules to mitigate specified conflicts of interest.\5\ Section 765(a)
requires the Commission to adopt rules, which rules may include
numerical limits on the control of, or the voting rights with respect
to, any security-based swap clearing agency, or on the control of any
SB SEF or SBS exchange, by specified entities, such as a bank holding
company with total consolidated assets of $50 billion or more,\6\ a
nonbank financial company,\7\ an affiliate of such bank holding company
or nonbank financial company, a security-based swap dealer,\8\ or a
major security-based swap participant (collectively, ``Specified
Entities'').\9\
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\5\ See Public Law 111-203, Section 765.
\6\ The term ``bank holding company'' has the meaning set forth
in Section 2 of the Bank Holding Company Act of 1956 (12 U.S.C.
1841) (``Bank Holding Company Act''), and generally means any
company that has control over any bank or over any company that is
or becomes a bank holding company by virtue of the Bank Holding
Company Act.
\7\ Under Section 765(a) of the Dodd-Frank Act, the term
``nonbank financial company'' has the meaning set forth in Section
102 of the Dodd-Frank Act, and generally means a company, other than
a bank holding company, national securities exchange, clearing
agency, SB SEF, registered security-based swap data repository,
board of trade designated as a contract market (``DCM''),
derivatives clearing organization, swap execution facility (``SEF'')
or registered swap data repository, that is predominantly engaged in
financial activities (including through a branch in the U.S., if
such company is incorporated or organized in a country other than
the U.S.). See Public Law 111-203, Section 102 for the complete
definition.
\8\ Pursuant to Section 761 of the Dodd-Frank Act, the term
``security-based swap dealer'' is added as Section 3(a)(71) of the
Exchange Act, 15 U.S.C 78c(a), and generally means any person who
(A) holds themselves out as a dealer in security-based swaps; (B)
makes a market in security-based swaps; (C) regularly enters into
security-based swaps with counterparties as an ordinary course of
business for its own account; or (D) engages in any activity causing
it to be commonly known in the trade as a dealer or market maker in
security-based swaps. See Public Law 111-203, Section 761 for the
complete definition. See also Definitions Release, 75 FR 51429,
supra note 3.
\9\ Pursuant to Section 761 of the Dodd-Frank Act, the term
``major security-based swap participant'' is added as Section
3(a)(67) of the Exchange Act, 15 U.S.C 78c(a), and generally means
any person (A) who is not a security-based swap dealer; and (B)(I)
who maintains a substantial position in security-based swaps for any
of the major security-based swap categories, as such categories are
determined by the Commission, excluding positions held for hedging
or mitigating commercial risk; (II) whose outstanding security-based
swaps create substantial counterparty exposure that could have
serious adverse effects on the financial stability of the U.S.
banking system or financial markets; or (III) that is a financial
entity that (a) is highly leveraged relative to the amount of
capital such entity holds and that is not subject to capital
requirements established by an appropriate Federal banking
regulator; and (b) maintains a substantial position in outstanding
security-based swaps in any major security-based swap category, as
such categories are determined by the Commission. See Public Law
111-203, Section 761 for the complete definition. See also
Definitions Release, 75 FR 51429, supra note 3.
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Section 765(b)--captioned ``Purposes''--provides that the
Commission shall adopt such rules if it determines they are necessary
or appropriate to improve the governance of, or to mitigate systemic
risk, promote competition or mitigate conflicts of interest in
connection with a security-based swap dealer's or major security-based
swap participant's conduct of business with, a security-based swap
clearing agency, SB SEF, or SBS exchange and in which such security-
based swap dealer or major security-based swap participant has a
material debt or equity investment.\10\ Section 765(b) sets forth a
number of underlying policy objectives for the Commission's
rulemaking--improving governance, mitigating systemic risk, promoting
competition, and mitigating conflicts of interest with respect to
security-based swap clearing agencies, SB SEFs, and SBS exchanges. In
considering proposed rules to mitigate conflicts of interest, the
Commission is mindful that, in some instances, certain of these diverse
policy objectives may be in tension with others. For example, as
described in Section III.A.2.a below, with respect to security-based
swap clearing agencies, the statutory objective of promoting
competition, which may be furthered through enhanced access to cleared
products and clearing venues, may to some extent be in tension with the
objective of minimizing systemic risk through effective risk management
of the clearing agency.
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\10\ See Public Law 111-203, Section 765(b).
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Section 765(c) of the Dodd-Frank Act also provides that in adopting
rules under Section 765, the Commission shall consider any conflicts of
interest arising from the amount of equity ownership and voting by a
single investor; the ability of owners to vote, cause the vote of, or
withhold votes entitled to be cast on any matters by the holders of the
ownership interest; and the governance arrangements of any derivatives
clearing organization that clears swaps, or swap execution facility or
board of trade designated as a contract market that posts swaps or
makes swaps available for trading.\11\
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\11\ See Public Law 111-203, Section 765(c). Although this
provision refers to swaps and to entities regulated by the CFTC, the
Commission believes that the Congress intended it to refer to
security-based swaps and to security-based swap clearing agencies,
SB SEFs, and SBS exchanges, because Section 765 pertains to
transactions in security-based swaps and persons and entities
related thereto.
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The Commission is cognizant that the proposed rules discussed
herein, as well as other proposals that the Commission may consider in
the coming months to implement the Dodd-Frank Act, if adopted, could
significantly affect--and be significantly affected by--the nature and
scope of the security-based swaps market in a number of ways. For
example, the Commission recognizes that if the measures proposed in
this release are adopted and are too onerous for new entrants, they
could hinder the further development of a market for security-based
swaps by unduly discouraging competition and the formation of new
security-based swap clearing agencies and of new SB SEFs or SBS
exchanges. On the other hand, if the Commission adopts rules that are
too permissive, conflicts of interest may be inadequately mitigated and
such conflicts may incentivize restricting access to centralized
clearing and lack of transparency in the trading of security-based
swaps as described in detail in Section III below. The Commission is
also mindful that the further development of the security-based swaps
market may alter the calculus for future regulation of conflicts of
interest. As commenters review the instant proposals, they are urged to
consider generally the role that regulation may play in fostering or
limiting the development of the market for security-based swaps (or,
vice versa, the role that market developments may play in changing the
nature and implications of regulation) and specifically to focus on
this issue with respect to the proposals to mitigate conflicts of
interest for security-based swap clearing agencies, SB SEFs, and SBS
exchanges.
[[Page 65884]]
The Commission must adopt the rules required by Section 765 of the
Dodd-Frank Act by January 17, 2011, which is 180 days after enactment
of the Dodd-Frank Act.\12\ The Commission therefore is proposing
Regulation MC under the Exchange Act to mitigate conflicts of interest
with respect to security-based swap clearing agencies, SB SEFs, and SBS
exchanges.
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\12\ Section 726 of the Dodd-Frank Act similarly requires the
CFTC to adopt rules designed to mitigate conflicts of interest with
respect to entities under its jurisdiction that clear or trade
swaps. See Public Law 111-203, Section 726. The Commission
preliminarily believes that an entity that registers with the
Commission as either a security-based swap clearing agency or a SB
SEF is likely to register also with the CFTC as a derivatives
clearing organization or swap execution facility, respectively. As a
result, the Commission staff and the CFTC staff have consulted and
coordinated with one another regarding their respective agencies'
proposed rules to mitigate conflicts of interest.
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This proposed rulemaking is among the first that the Commission has
considered in connection with its mandates under the Dodd-Frank Act,
and the Commission is mindful of the considerations raised by this
timing. In particular, under the prescribed timeframes of the Dodd-
Frank Act, the Commission must propose rules required by Section 765
before it has the opportunity to consider proposed rules that also are
likely to affect the development of security-based swap clearing
agencies, SB SEFs, and SBS exchanges, as well as the security-based
swaps market overall. The Commission also notes that the market for
security-based swaps is in a nascent stage of development compared to
the markets for equity securities and listed options and that the
market for security-based swaps could develop further as the Dodd-Frank
Act is fully implemented and these transactions continue to move to
central clearing and trading on organized markets.
III. Discussion of Potential Conflicts of Interest
A. Security-Based Swap Clearing Agencies
1. Current Regulatory Structure
Credit market events from the last few years have demonstrated that
a security-based swaps market operating without meaningful regulation
\13\ and central counterparties \14\ can pose systemic risks. In
November 2008, under the auspices of the President's Working Group on
Financial Markets, the Secretary of the Department of the Treasury, the
Chairs of the Board of Governors of the Federal Reserve, the Office of
the Comptroller of the Currency, the CFTC, and the Commission
established as a policy objective for the OTC derivatives market that
regulators and prudential supervisors require participants in a central
counterparty (``CCP'') arrangement to clear all eligible contracts
through that CCP.\15\ In furtherance of this policy objective, the
Commission, the Federal Reserve, and the CFTC signed a Memorandum of
Understanding that established a framework for consultation and
information sharing on issues related to central counterparties for the
OTC derivatives market.\16\
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\13\ See, generally, Policy Objectives for the OTC Derivatives
Market, The President's Working Group on Financial Markets (November
14, 2008) (available at https://www.ustreas.gov/press/releases/reports/policyobjectives.pdf).
\14\ See The Role of Credit Derivatives in the U.S. Economy
before the H. Agric. Comm., 110th Cong. (2008) (Statement of Erik
Sirri, Director of the Division of Trading and Markets, Commission)
(available at https://agriculture.house.gov/testimony/110/110-49.pdf).
\15\ See supra note 13. See also Policy Statement on Financial
Market Developments, The President's Working Group on Financial
Markets (March 13, 2008) (available at https://www.treas.gov/press/releases/reports/pwgpolicystatemktturmoil_03122008.pdf) and
Progress Update on March Policy Statement on Financial Market
Developments, The President's Working Group on Financial Markets
(October 2008) (available at https://www.treas.gov/press/releases/reports/q4progress%20update.pdf).
\16\ See Memorandum of Understanding Between the Board of
Governors of the Federal Reserve System, the U.S. Commodity Futures
Trading Commission, and the U.S. Securities and Exchange Commission
Regarding Central Counterparties for Credit Default Swaps (November
14, 2008) (available at https://www.treas.gov/press/releases/reports/finalmou.pdf).
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The Commission has taken steps to help foster the prompt
development of CCPs. In particular, the Commission acted to authorize
the clearing of OTC security-based swaps by permitting certain clearing
agencies to clear credit default swaps (``CDS'') on a temporary
conditional basis.\17\ Today, a significant volume of CDS transactions
is cleared centrally and the Commission monitors the activities of
these clearing agencies.\18\
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\17\ The Commission authorized five entities to clear credit
default swaps. See Securities Exchange Act Release Nos. 60372 (July
23, 2009), 74 FR 37748 (July 29, 2009) and 61973 (April 23, 2010),
75 FR 22656 (April 29, 2010) (CDS clearing by ICE Clear Europe
Limited); 60373 (July 23, 2009), 74 FR 37740 (July 29, 2009) and
61975 (April 23, 2010), 75 FR 22641 (April 29, 2010) (CDS clearing
by Eurex Clearing AG); 59578 (March 13, 2009), 74 FR 11781 (March
19, 2009), 61164 (December 14, 2009), 74 FR 67258 (December 18,
2009) and 61803 (March 30, 2010), 75 FR 17181 (April 5, 2010) (CDS
clearing by Chicago Mercantile Exchange Inc.); 59527 (March 6,
2009), 74 FR 10791 (March 12, 2009), 61119 (December 4, 2009), 74 FR
65554 (December 10, 2009) and 61662 (March 5, 2010), 75 FR 11589
(March 11, 2010) (CDS clearing by ICE Trust US LLC); 59164 (December
24, 2008), 74 FR 139 (January 2, 2009) (temporary CDS clearing by
LIFFE A&M and LCH.Clearnet Ltd.) (collectively, ``CDS Clearing
Exemption Orders''). LIFFE A&M and LCH.Clearnet Ltd. allowed their
order to lapse without seeking renewal.
\18\ To date most cleared CDS transactions have cleared at ICE
Trust US LLC (``ICE Trust'') or ICE Clear Europe Limited (``ICE
Clear Europe''). As of October 8, 2010, ICE Trust had cleared
approximately $7.1 trillion notional amount of CDS contracts based
on indices of securities and approximately $490 billion notional
amount of CDS contracts based on individual reference entities or
securities. As of October 8, 2010, ICE Clear Europe had cleared
approximately [euro]3.09 trillion notional amount of CDS contracts
based on indices of securities and approximately [euro]560 billion
notional amount of CDS contracts based on individual reference
entities or securities. See https://www.theice.com/marketdata/reports/ReportCenter.shtml.
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The Exchange Act does not impose specific requirements regarding
the ownership structure of a clearing agency. As a result, clearing
agencies may operate under a variety of appropriate organizational
structures provided that they have the capacity to meet the standards
in Section 17A of the Exchange Act.\19\ Certain clearing agencies
registered with the Commission are owned either by participants or by
securities exchanges.\20\ Other clearing agencies, such as the
security-based swap clearing agencies that, once registered, would be
required to comply with proposed Regulation MC, are subsidiaries of or
partly-owned by publicly traded companies.\21\ These entities are not
wholly-owned by participants or exchanges and may have different
governance related issues than the securities clearing agencies
currently registered with the Commission.
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\19\ See 78q-1(b)(3)(A).
\20\ The Depository Trust and Clearing Corporation (``DTCC'') is
participant-owned and has three separate subsidiaries that are
registered clearing agencies which function as quasi-utilities. The
Options Clearing Corporation is owned by five unaffiliated options
exchanges.
\21\ These clearing agencies include ICE Trust US LLC, ICE Clear
Europe Limited, Eurex Clearing AG, and Chicago Mercantile Exchange
Inc.
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Upon the effective date of Title VII of the Dodd-Frank Act,
clearing agencies that clear and settle security-based swap
transactions will be subject to a number of regulatory obligations that
are intended to promote the policy objectives of the Dodd-Frank Act,
including increased clearing of security-based swaps and effective risk
management. Accordingly, security-based swap clearing agencies will be
required to be registered with, and regulated by, the Commission under
Section 17A.\22\ In addition, all registered
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clearing agencies must comply with the standards in Section 17A, which
include, but are not limited to, maintaining rules for promoting the
prompt and accurate clearance and settlement of securities
transactions, assuring the safeguarding of securities and funds which
are in the custody or control of the clearing agency or for which it is
responsible, fostering cooperation and coordination with persons
engaged in the clearance and settlement of securities transactions,
removing impediments to and perfecting the mechanism of a national
system for the prompt and accurate clearance and settlement of
securities transactions, and, in general, protecting investors and the
public interest.\23\ A registered clearing agency is also required to
provide fair access to clearing and to have the capacity to facilitate
the prompt and accurate clearance and settlement of securities
transactions and derivative agreements, contracts, and transactions for
which it is responsible, as well as to safeguard securities and funds
in its custody or control or for which it is responsible.\24\
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\22\ Section 763(b) of the Dodd-Frank Act adds new Section
17A(k) to the Exchange Act, which authorizes the Commission to
exempt, conditionally or unconditionally, a security-based swap
clearing agency from registration if the Commission determines it is
subject to comparable, comprehensive supervision and regulation by
the CFTC or appropriate government authorities in the home country
of the security-based swap clearing agency. See Public Law 111-203,
Section 763(b).
\23\ See 15 U.S.C. 78q-1(b)(3)(F). Section 17A of the Exchange
Act also includes standards that help to mitigate conflicts of
interest. See infra Section IV.C. for a discussion of these
standards.
\24\ 15 U.S.C. 78q-1(b)(3)(A), (B), and (F).
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Pursuant to Section 765 of the Dodd-Frank Act, the Commission must
identify the nature and sources of any conflicts of interest relating
to the voting interests in and governance of a security-based swap
clearing agency that may interfere with achieving the policy objectives
described above or with the clearing agency complying with the
regulatory mandates of Section 17A of the Exchange Act described above,
including the obligation to adopt rules consistent with the protection
of investors and the public interest.
2. Sources of Conflicts of Interest
The Commission's experience in monitoring the activities of the
clearing agencies engaged in clearing CDS has provided it with insight
into the potential sources of conflicts of interest that may exist at
security-based swap clearing agencies. Since shortly after the
enactment of the Dodd-Frank Act, the Commission staff and staff from
the CFTC have met with interested persons to learn more about potential
conflicts. Moreover, on August 20, 2010, the staff of the Commission
and CFTC held a joint public roundtable in part to gain further insight
into the sources of conflicts of interest at security-based swap
clearing agencies, SB SEFs, and SBS exchanges, as well as methods for
mitigating conflicts of interest (``Conflicts Roundtable'').\25\
Panelists from this roundtable included industry and non-industry
participants.\26\
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\25\ See Securities Exchange Act Release No. 62725, 75 FR 51305
(August 19, 2010). The Commission solicited comments on the
Conflicts Roundtable (comments received by the Commission are
available at https://sec.gov/cgi-bin/ruling-comments?ruling=4-609&rule_path=/comments/4-609&file_num=4-609&action=Show_Form&title=SEC%2DCFTC Roundtable on Swaps and Security%2DBased
Swaps%3A Notice of roundtable discussion and request for comment).
\26\ The transcript of the Conflicts Roundtable is available on
the CFTC's Web site at https://cftc.gov/ucm/groups/public/@newsroom/documents/file/derivative9sub082010.pdf.
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Drawing on these experiences, the Commission has reviewed the
potential for conflicts of interest at security-based swap clearing
agencies in accordance with Section 765 of the Dodd-Frank Act and has
identified those conflicts that could affect access to clearing agency
services, products eligible for clearing, and risk management practices
of the clearing agencies. Preliminarily, the Commission believes that
the most significant conflicts of interest that may have an adverse
effect on statutory goals in Section 765 of the Dodd-Frank Act are
those that arise when a small number of participants,\27\ including
participants that are Specified Entities and including related persons
of the participants,\28\ exercise undue control or influence over a
security-based swap clearing agency.
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\27\ The term ``participant'' when used with respect to a
clearing agency has the meaning set forth in Section 3(a)(24) of the
Exchange Act, 15 U.S.C 78c(a), and shall include Specified Entities.
See proposed Rule 700(o) under Regulation MC.
\28\ See infra Section IV.A.3. for a discussion of ``related
person'' in the context of a security-based swap clearing agency.
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The Commission has identified three key areas where it believes a
conflict of interest of participants who exercise undue control or
influence over a security-based swap clearing agency could adversely
affect the central clearing of security-based swaps. First,
participants could limit access to the security-based swap clearing
agency, either by restricting direct participation in the security-
based swap clearing agency or restricting indirect access by
controlling the ability of non-participants to enter into correspondent
clearing arrangements.\29\ Second, participants could limit the scope
of products eligible for clearing at the security-based swap clearing
agency, particularly if there is a strong economic incentive to keep a
product traded in the OTC market for security-based swaps. Third,
participants could use their influence to lower the risk management
controls of a security-based swap clearing agency in order to reduce
the amount of collateral they would be required to contribute and
liquidity resources they would have to expend as margin or guaranty
fund to the security-based swap clearing agency.
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\29\ See, generally, Matthew Leising and Shannon D. Harrington,
``Wall Street Dominance of Swaps Must End, Brokers Say (Update 1),''
Bloomberg (March 16, 2010).
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Each of these potential conflicts of interest could limit the
benefits of a security-based swap clearing agency in the security-based
swaps market, and even potentially cause substantial harm to that
market and the broader financial markets, as described below. Conflicts
of interest in these areas could also potentially undermine the
mandatory clearing requirement in Section 763 of the Dodd-Frank Act,
thereby affecting transparency, investor protection, risk management,
efficiency, and competition in the security-based swaps market.\30\
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\30\ See Public Law 111-203, Section 763(a). Section 763(a) of
the Dodd-Frank Act adds new Section 3C to the Exchange Act, which
requires clearing for certain security-based swaps. Specifically,
Section 3C(a)(1) provides that ``It shall be unlawful for any person
to engage in a security-based swap unless that person submits such
security-based swap for clearing to a clearing agency that is
registered under the Exchange Act or a clearing agency that is
exempt from registration under the Exchange Act if the security-
based swap is required to be cleared.''
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a. Limitations on Open Access to Security-Based Swap Clearing Agencies
The Commission believes that the increased use of central clearing
for security-based swaps should help to promote robust risk management,
foster greater efficiencies, improve investor protection, and promote
transparency in the market for security-based swaps. For these reasons,
the Commission has encouraged the use of central clearing for security-
based swaps.\31\ A consequence of increased use of central clearing
services, however, is that participants that control or influence a
security-based swap clearing agency may gain a competitive advantage in
the security-based swaps market by restricting access to the clearing
agency. If that occurred, financial institutions and marketplaces that
do not have access to central clearing would have limited ability to
trade in or list security-based swaps. This problem would continue to
exist after the mandatory clearing requirement under Section 763 of the
Dodd-Frank Act becomes effective, because financial institutions may be
required either to submit security-based swaps for central
[[Page 65886]]
clearing or face heightened capital or margin requirements associated
with bilateral agreements.
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\31\ See CDS Clearing Exemption Orders, supra note 17.
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Market participants generally obtain access to a clearing agency in
one of two ways: (1) Directly, by becoming a participant in a clearing
agency or (2) indirectly, by entering into a correspondent clearing
arrangement with a participant in a clearing agency.\32\ There are
several ways that both direct and indirect access to a security-based
swap clearing agency could be restricted if persons who make decisions
for or act on behalf of the clearing agency have a conflict of interest
because of their incentives to further their own business interests
outside of the security-based swap clearing agency. Participants may
seek to limit the number of other direct participants in a security-
based swap clearing agency in order to limit competition and increase
their ability to maintain higher profit margins. A security-based swap
clearing agency that is controlled by a limited number of participants
might also adopt policies and procedures that are designed to unduly
restrict access, or have the effect of unduly restricting access, to
the clearing agency by other participants in ways that are unrelated to
sound risk management practices.\33\ At the same time, affording
greater access to the clearing agency at some point may come at the
expense of sound risk management practices.
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\32\ Correspondent clearing is an arrangement between a current
participant of a clearing agency and a non-participant that desires
to use the clearing agency for clearance and settlement services.
\33\ An example of such restrictive policies and procedures
would be a clearing agency establishing prohibitively high
participation standards so that only the largest financial
institutions qualify as participants.
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The Commission recognizes that security-based swap clearing
agencies must establish reasonable participation standards in order to
ensure the participants in the clearing agency do not expose it to
unacceptable risk or otherwise adversely affect the performance of the
clearing agency, particularly during periods of market stress. However,
participant standards may have the effect of restricting access to the
clearing agency. On the one hand, panelists at the Conflicts Roundtable
and others have raised the concern that participation requirements
could be unnecessarily restrictive and primarily designed to limit the
number of entities that are permitted to become direct participants in
the clearing agency.\34\ While appropriate participation standards are
necessary for the sound operation of the security-based swap clearing
agency, unduly high standards may needlessly exclude persons who are
otherwise qualified to clear security-based swaps. On the other hand,
some panelists at the Conflicts Roundtable also suggested that
increasing access can come at the expense of sound risk management
practices.\35\
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\34\ See, generally, Swaps and Derivatives Market Association,
``Lessening Systemic Risk: Removing Final Hurdles to Clearing OTC
Derivatives'' (available at https://media.ft.com/cms/fe51a538-78d7-11df-a312-00144feabdc0.pdf) (``SDMA Letter''). See also Public
Roundtable on Governance and Conflicts of Interest in the Clearing
and Listing of Swaps, comments of Darrell Duffie (``[W]e want to be
very careful that the members of a central clearing counterparty
that determine what gets cleared * * * are the members that have * *
* the right social incentives to create competition.'') (available
at https://cftc.gov/ucm/groups/public/@newsroom/documents/file/derivative9sub082010.pdf at 62).
\35\ See supra note 25.
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Access could also be restricted by the way that clearing members
determine executable end-of-day settlement prices. Since there is
currently no exchange or other venue that publishes security-based swap
prices, the Commission has required security-based swap clearing
agencies to publish end-of-day settlement prices and any other prices
with respect to cleared security-based swaps that the security-based
swap clearing agency may use to calculate mark-to-market
requirements.\36\ To ensure that end-of-day settlement prices are
reliable and consistent, a security-based swap clearing agency may
require that the price submission be executable.\37\ The security-based
swap clearing agency, however, might not permit an entity to rely on a
third party to provide an executable end-of-day settlement price. This
could potentially prevent all but the largest dealer firms from having
direct access to the clearing agency as they may be the only firms that
have the processes to determine executable end-of-day settlement
prices.\38\
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\36\ See, e.g., CDS Clearing Exemption Orders, supra note 17.
\37\ As part of their internal processes, security-based swap
clearing agencies generally calculate end-of-day settlement prices
for each product in which they hold a cleared interest each business
day. See, e.g., Letter from Kevin McClear, ICE Trust, to Elizabeth
Murphy, Secretary, Commission, December 4, 2009, and letter from Ann
K. Shuman, Managing Director and Deputy General Counsel, CME, to
Elizabeth Murphy, Secretary, Commission, December 14, 2009. One
method for calculating an end-of-day settlement price for open
positions is based on prices submitted by participants. As part of
this mark-to-market process, the security-based swap clearing agency
may periodically require participants to execute certain security-
based swap trades at the applicable end-of-day settlement price.
This is designed to ensure that participants' submitted prices
reflect their best assessment of the value of their open positions
on a daily basis. Id.
\38\ See SDMA Letter, supra note 34.
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In situations where direct access is limited by reasonable
participation standards, non-participant firms may be able to access
the security-based swap clearing agency through correspondent clearing
arrangements with direct participants. Correspondent clearing is common
in securities markets as well as in futures markets. However, the non-
participant firms ultimately would be required to enter into a
correspondent clearing arrangement with a participant in order to have
the transactions submitted to the security-based swap clearing agency.
Thus, the success of correspondent clearing arrangements depends on the
willingness of security-based swap participants to enter into such
arrangements with non-participant firms that may act as direct
competitors to the participants. Given that current participants may
have an incentive to restrict access to potential competitors,
correspondent clearing arrangements may not be readily established
while only the large dealer firms are direct participants in the
security-based swap clearing agency.
In addition, procedural barriers may prohibit a firm from having
indirect access to a security-based swap clearing agency. For example,
although there are no overt restrictions on indirect access at the
currently exempted security-based swap clearing agencies, many of the
processing platforms by which participants submit transactions to the
security-based swap clearing agency do not have the functionality to
allow a non-participant firm to submit a trade with a customer to the
security-based swap clearing agency through a correspondent arrangement
with a direct member.
Prohibitively burdensome or restrictive direct participation
standards and lack of availability of correspondent clearing
arrangements effectively deny non-participant firms access to the
security-based swap clearing agency's services and, accordingly, create
a substantial competitive advantage for those firms that are direct
participants in the security-based swap clearing agency. As previously
noted, this competitive advantage would become even more significant
after the mandatory clearing requirement for security-based swaps in
the Dodd-Frank Act becomes effective.
b. Limitations on the Scope of Products Eligible for Clearing
As discussed above, Congress found and the Commission believes that
increased use of central clearing would provide significant benefits to
the security-based swaps market and mitigate systemic risk,
particularly
[[Page 65887]]
during times of financial crisis. Central clearing of security-based
swaps likely would result in lower spreads and lower transaction costs
for end-users. A participant in a security-based swap clearing agency
might, however, derive greater revenues from its activities in the OTC
market for security-based swaps than it would from sharing in the
profits of a security-based swap clearing agency in which it holds a
financial interest. As a result, the increased use of central clearing
may be contrary to the economic interests of some participants to a
security-based swap clearing agency. Such participants or their related
persons could therefore seek to have the security-based swap clearing
agency limit the types of security-based swaps that are eligible for
clearing at a security-based swap clearing agency over which they
exercise influence or control.\39\
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\39\ Representative Barney Frank, who chaired the conference
committee that reconciled the House Bill and the Senate Bill,
referred to this specific concern when discussing the amendment
adding Section 765 to the Dodd-Frank Act. Chairman Frank stated,
``The purpose of this in part is to get many more derivatives
cleared. But the clearing houses have the right to refuse them if
they say the transactions aren't suitable for clearing. We believe
that some banks have an interest in not having them cleared. So we
don't want entities that have an interest and [sic] there being no
clearing, owning the clearing houses. That's why this is an
important amendment to us, and it was passed after considerable
debate on the House floor.'' House-Senate Conf. Comm. Holds Markup
on HR 4173, Financial Regulatory Overhaul Bill, June 24, 2010,
reprinted in CQ Congressional Transcripts, 111th Cong. 182 (2010)
(statement of Barney Frank, Chairman, House Comm. on Fin. Serv.).
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A further incentive for a clearing agency controlled by
participants to restrict the products that are eligible for clearing at
the security-based swap clearing agency may be to control a security-
based swap's price transparency. Trading in the OTC derivatives market
is currently dominated by a small number of firms.\40\ Prior to the use
of clearing agencies to clear security-based swaps, end-users had to
transact directly with a small number of firms to trade in security-
based swaps without the benefit of publicly available pricing data.
Security-based swap clearing agencies provide greater price
transparency by making certain price data available to the public and
thereby helping to reduce the information asymmetry that benefits firms
in the OTC market.\41\ Publicly available pricing data may result in
reducing the spreads and reduce the profit per trade for firms that
have dominated the OTC market.
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\40\ See Office of the Comptroller of the Currency, Quarterly
Report on Bank Trading and Derivatives Activities, First Quarter
2010. (``Derivatives activity in the U.S. banking system continues
to be dominated by a small group of large financial institutions.
Five large commercial banks represent 97% of the total banking
industry notional amounts * * *.'')
\41\ See Darrell Duffie, Ada Li, and Theo Lubke, ``Policy
Perspectives on OTC Derivatives Market Infrastructure,'' Federal
Reserve Bank of New York Staff Report No. 424, dated January 2010,
as revised March 2010 (``Even after an OTC derivatives product has
achieved relatively active trading * * * dealers have an incentive
to maintain the wide bid-ask spreads that they can obtain in the OTC
market * * *. Thus, from the viewpoint of profits, dealers may
prefer to reduce the migration of derivatives trading from the OTC
market to central exchanges.'').
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While certain security-based swaps may be suitable for central
clearing, the Commission recognizes the possibility that some security-
based swaps may not be suitable for clearing if their risks cannot be
adequately managed by the security-based swap clearing agency. Clearing
products whose risks cannot be adequately managed may increase the
potential of a default of a participant or even the failure of the
security-based swap clearing agency.\42\ This in turn could adversely
affect systemic risk, as participants and their customers would likely
have significant funds and securities tied to the clearing agency and
would be dependent on the continued operations of a security-based swap
clearing agency in order to enter into new transactions in security-
based swaps. This again highlights the potential tensions between sound
risk management and the increased use of central clearing services.
Expanding the number and scope of products cleared would in some cases
be in the best interests of the security-based swap clearing agency and
the security-based swaps market generally, because it provides
processing efficiencies and replaces bilateral counterparty risk.
However, allowing a greater number and scope of products to be
centrally cleared would in some cases be harmful to the security-based
swap clearing agency and the security-based swaps market, if sound risk
management standards are compromised in order to clear those products.
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\42\ Section 763(a) adds new Section 3C(d)(3)(A) to the Exchange
Act, which prohibits the Commission from requiring any clearing
agency to accept a security-based swap for central clearing. See
Public Law 111-203, Section 763(a).
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The Commission is mindful of the need to balance goals associated
with promoting the central clearing of security-based swaps and
assuring that proposed rules are designed to increase the number of
products eligible for central clearing with the goals associated with
effective risk management. The Commission is also aware that any rules
that it may ultimately adopt relating to conflicts of interest may
affect this balance. The Commission believes, however, that decisions
regarding the products that are eligible for clearing by a security-
based swap clearing agency should not be subject to undue influence by
parties that have a financial interest in keeping such products from
being centrally cleared, while also noting that non-participants may
have an interest in increasing access, which potentially could serve to
compromise effective risk management.
c. Reduced Risk Management Controls
Security-based swap clearing agencies will perform a critical
function in mitigating financial risk for market participants. The
Commission believes that through uniform margining and other risk
controls, including controls over market-wide concentrations that
cannot be implemented effectively when counterparty risk management is
decentralized, security-based swap clearing agencies would help to
prevent a single market participant's failure from destabilizing other
market participants and, ultimately, the broader financial system.
Although participants may seek to raise risk management controls in
order to restrict access to the clearing agency or protect their
financial stake in the clearing agency, they might also seek to lower
certain risk management controls such as margin requirements in order
to release collateral that they may wish to use for other purposes.
Furthermore, as security-based swap clearing agencies become more
established and the mandatory clearing requirement under Section 763 is
implemented, more security-based swaps will likely be centrally cleared
and clearing participants will be required to provide a substantially
larger amount of liquid collateral to security-based swap clearing
agencies in the form of margin. As a result, participants may be
willing to accept greater risk than is prudent for the security-based
swap clearing agency in order to reduce the amount of their margin
contributions. A reduction in risk management controls ultimately could
function to increase systemic risk by increasing the potential for a
financial loss that must be borne by the participants of the security-
based swap clearing agency.\43\
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\43\ Such a scenario would arise, for example, where a
defaulting participant has contributed insufficient margin to meet
its obligations to the security-based swap clearing agency.
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The Commission recognizes that participants generally have a
financial incentive to ensure that the security-based swap clearing
agency collects sufficient margin from each participant.
[[Page 65888]]
A clearing agency's rules and procedures typically provide that in the
event of a participant default, losses exceeding a participant's
individual margin contribution may be satisfied from a guaranty fund
composed of contributions from all participants. As a result,
participants have a unique financial incentive to ensure that the
security-based swap clearing agency has sufficient collateral from each
participant to withstand a participant default in almost all market
conditions. However, participant defaults occur infrequently and the
incentive for participants to protect their guaranty fund contributions
may have less weight than the incentive to reduce margin requirements
in order to release margin collateral for immediate use.
A non-participant does not contribute to a guaranty fund and may
not have the same incentives as a participant with respect to
establishing and maintaining sufficiently robust participant margin
requirements. Non-participants' incentives may be to focus less on risk
management and focus more on allowing more participants to be admitted
to the clearing agency and more products to be made eligible for
central clearing.
d. Implications for Ownership and Governance
As described above, conflicts of interest may arise if participants
exercise undue control or influence over a security-based swap clearing
agency. This influence, typically acquired through an ownership stake
in the clearing agency, generally may be exercised by participants
through either (i) voting interests in the security-based swap clearing
agency or (ii) participation in the governance of the security-based
swap clearing agency, such as by selecting (or influencing the
selection of) the directors of the security-based swap clearing
agency.\44\ In either case, undue control or influence may be
particularly acute if (i) the participants are part of the process for
nominating the directors, even if such participants are not themselves
directors, or (ii) the election of directors is subject to concentrated
voting power in a small number of participants, especially if such
participants also dominate much of the trading in security-based swaps
and could use their controlling position to maintain or extend their
dominant market position.
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\44\ Section 765 of the Dodd-Frank Act authorizes the Commission
to adopt rules regarding conflicts of interest of Specified Entities
at security-based swap clearing agencies in general. However, the
Commission preliminarily believes that those entities that are
participants in a security-based swap clearing agency will have a
conflict of interest that could be acted upon to adversely affect
the development of the market for security-based swaps consistent
with the policy objectives of Section 765 of the Dodd-Frank Act.
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In addition, it is important to consider the likely incentives of
individual directors, once they are on the Board, when they are
governing the security-based swap clearing agency.\45\ Directors of a
security-based swap clearing agency owe a fiduciary duty to the
security-based swap clearing agency and all of its shareholders. In
addition, among other obligations, the Board as a whole is ultimately
responsible for overseeing the clearing agency's compliance with the
regulatory obligations of security-based swap clearing agencies under
the Dodd-Frank Act and the Exchange Act, including the open and fair
access requirements. At the same time, however, directors may be
subject to different perspectives when fulfilling these duties and
roles. Although the Commission recognizes that incentives and
motivations may vary among directors and over time for a range of
reasons--and therefore it is not possible to predict precisely how any
individual director will address a particular matter--directors who are
appointed by or related to participants (``participant-related
directors'') may on balance be more likely to reflect the views of
participants than would directors who are not appointed by or related
to participants (``non-participant-related directors'').\46\
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\45\ The Commission's discussion in this Release of the
motivations or incentives of directors of a clearing agency, SB SEF,
or SBS exchange comes in the context of requiring modes of
governance that permit consideration of a variety of perspectives.
As noted throughout this Release, a company's directors have a duty
to all the company's shareholders, and the Commission does not
regard any directors as simply surrogates for a particular group of
shareholders. The Commission's discussion is intended to forestall
possible conflicts and does not reflect findings that particular
conflicts are present.
\46\ This distinction between participant-related and non-
participant-related directors may be most significant where the
clearing agency is (i) a publicly owned corporation, or part of a
publicly owned corporation, or (ii) otherwise owned by persons other
than participants. The Commission recognizes that ownership
structures for clearing agencies may take other forms, including
ownership solely by participants, in which case the incentives and
perspectives of the directors may be somewhat different.
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In light of these dynamics, as between the two categories of
directors, participant-related directors, like participants themselves,
may on balance be more likely to favor reducing or minimizing the risk
exposure of the clearing agency, potentially at the expense of more
open access. In addition, participant-related directors may also be
more likely to favor restricting access to the clearing agency, which
as discussed above would serve to preserve profits that participants
earn through trading security-based swaps in the OTC markets.
In contrast, non-participant-related directors may, on balance, be
more likely to seek to maximize the value of the enterprise, which, in
addition to sound risk management, may involve increasing the revenues
of the security-based swap clearing agency, such as by expanding the
number and scope of products being cleared. Moreover, at a minimum it
would seem less likely that non-participant-related directors would
favor unduly restricting access to the clearing agency and its
services. Thus, non-participant-related directors may be inclined to
favor expanded access to products and services, which may increase the
amount of risk that the clearing agency must successfully manage. The
interest in expanded access to products and services may be especially
relevant in the early stages of a clearing agency's development, when
establishing a new entity as a viable clearing agency is especially
important.
The Commission recognizes that other factors may also affect
director incentives and behavior. For example, it may be argued that
participant-related directors may in general have greater risk
management expertise and experience than non-participant-related
directors, and that non-participant-related directors may tend to defer
to the views or judgment of participants or participant-related
directors on risk matters, with the effect that open access may be
unduly compromised in favor of risk management. On the other hand, it
may be argued that qualified non-participant-related directors with
sufficient risk management expertise can be readily found, and in any
event these directors' independence of participants would justify their
heightened involvement on the Board.
In addition, directors may face other conflicts of interest. For
example, there may be conflicts between the competing interests of
different shareholders--whether or not participants--which could have
implications for director behavior, as discussed more fully below.
There also may be a tension between the directors' incentives to
maximize profits and their duties to oversee the security-based swap
clearing agency's compliance with applicable legal restrictions which,
although not necessarily unique to clearing agencies, may nevertheless
affect how they decide any particular matter.
As described more fully below, the proposed rules are intended to
strike a balance among these various
[[Page 65889]]
considerations by allowing participants to maintain a significant voice
within a security-based swap clearing agency while also imposing
ownership limitations and independent director requirements to mitigate
the potential influences of participant owners and participant-related
directors.
e. Request
