Authority To Designate Financial Market Utilities as Systemically Important, 17047-17062 [2011-7003]

Agencies

• Financial Stability Oversight Council

[Federal Register Volume 76, Number 59 (Monday, March 28, 2011)]
[Proposed Rules]
[Pages 17047-17062]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-7003]


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FINANCIAL STABILITY OVERSIGHT COUNCIL

12 CFR Part 1320

RIN 4030-AA01


Authority To Designate Financial Market Utilities as Systemically 
Important

AGENCY: Financial Stability Oversight Council.

ACTION: Notice of proposed rulemaking.

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SUMMARY: Section 804 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the ``DFA'') provides the Financial Stability Oversight 
Council (the ``Council'') the authority to designate a financial market 
utility (an ``FMU'') the Council determines is or is likely to become 
systemically important--that is, the failure of or a disruption to the 
functioning of which could create, or increase, the risk of significant 
liquidity or credit problems spreading among financial institutions or 
markets and thereby threaten the stability of the United States 
financial

[[Page 17048]]

system. This notice of proposed rulemaking (NPR) describes the criteria 
that will inform, and the processes and procedures established under 
the DFA for, the Council's designation of FMUs as systemically 
important under the DFA. The Council, on December 21, 2010, published 
an advance notice of proposed rulemaking regarding the designation 
criteria in section 804.

DATES: Comments must be received on or before May 27, 2011.

ADDRESSES: Interested persons are invited to submit comments regarding 
this notice of proposed rulemaking according to the instructions below. 
All submissions must refer to the document title. The Council 
encourages the early submission of comments.
    Electronic submission of Comments. Interested persons may submit 
comments electronically through the Federal eRulemaking Portal at 
https://www.regulations.gov. Electronic submission of comments allows 
the commenter maximum time to prepare and submit a comment, ensures 
timely receipt, and enables the Council to make them available to the 
public. Comments submitted electronically through the https://www.regulations.gov Web site can be viewed by other commenters and 
interested members of the public. Commenters should follow the 
instructions provided on that site to submit comments electronically.
    Mail: Send comments to Financial Stability Oversight Council, Attn: 
Lance Auer, 1500 Pennsylvania Avenue, NW., Washington, DC 20220.

    Note:  To receive consideration as public comments, comments 
must be submitted through the method specified. Again, all 
submissions must refer to the title of the notice.

    Public Inspection of Public Comments. All properly submitted 
comments will be available for inspection and downloading at https://www.regulations.gov.
    Additional Instructions. In general comments received, including 
attachments and other supporting materials, are part of the public 
record and are available to the public. Do not submit any information 
in your comment or supporting materials that you consider confidential 
or inappropriate for public disclosure.

FOR FURTHER INFORMATION CONTACT: Lance Auer, Deputy Assistant Secretary 
(Financial Institutions), Treasury, at (202) 622-1262, Kirsten J. 
Harlow, Senior Policy Advisor, Treasury, at (202) 622-2612, or Steven 
D. Laughton, Senior Counsel, Office of the General Counsel, Treasury, 
at (202) 622-8413. All responses to this Notice should be submitted via 
https://www.regulations.gov to ensure consideration.

SUPPLEMENTARY INFORMATION:

I. Background

    The DFA generally defines an FMU as any person that manages or 
operates a multilateral system for the purposes of transferring, 
clearing, or settling payments, securities, or other financial 
transactions among financial institutions or between financial 
institutions and that person. Section 803(6)(B) of the DFA specifically 
excludes a number of entities, such as designated contract markets and 
national securities exchanges meeting certain criteria, from the 
definition of an FMU. FMUs form a critical part of the nation's 
financial infrastructure and their smooth functioning is integral to 
the soundness of the financial system and the overall economy. The 
importance of these utility-like arrangements has been highlighted by 
the recent period of market stress. FMUs exist in many financial 
markets to support and facilitate the transferring, clearing or 
settlement of financial transactions. Their function, however, as well 
as their interconnectedness also concentrates a significant amount of 
risk in the market. The payment and settlement processes of these 
systems are highly interdependent, either directly through operational, 
contractual or affiliation linkages, or indirectly through liquidity 
flows or common participants. Problems at one system could spill over 
to other systems or financial institutions in the form of liquidity and 
credit disruptions.
    Section 111 of the DFA established the Council. Among the purposes 
of the Council under section 112 is to ``(J) identify systemically 
important FMUs * * * (as that term is defined in title VIII).'' Section 
804 of the DFA gives the Council the authority to identify and 
designate an FMU that is, or is likely to become, systemically 
important if the Council determines that a failure of or disruption to 
an FMU could create, or increase, the risk of significant liquidity or 
credit problems spreading across financial institutions and markets and 
thereby threaten the stability of the U.S. financial system. Any 
designation of an FMU requires a two-thirds vote of serving members 
(including an affirmative vote by the Chairperson), after consultation 
with the Federal Reserve Board of Governors (the ``Board of 
Governors'') and the relevant federal agency that has primary 
jurisdiction over a designated FMU under Federal banking, securities, 
or commodity futures laws (``Supervisory Agency'').
    The designation of an FMU as systemically important by the Council 
then subjects the designated FMU to the requirements of Title VIII. In 
particular, section 805(a) authorizes the Board of Governors, the CFTC, 
and the SEC, in consultation with the Council and one or more 
Supervisory Agencies, to prescribe risk management standards governing 
the operations related to the payment, clearing, and settlement 
activities of systemically important FMUs. The objective and principles 
for the risk management standards prescribed under section 805(a) shall 
be to promote robust risk management and safety and soundness, reduce 
systemic risk, and support the stability of the broader financial 
system. These standards may address areas, as outlined in section 
805(c), such as risk management policies and procedures, margin and 
collateral requirements, participant or counterparty default policies 
and procedures, the ability to complete timely clearing and settlement 
of financial transactions, capital and financial resource requirements 
for designated FMUs and other areas that are necessary to achieve these 
objectives and principles. In addition, as set forth in section 806(a), 
the Board of Governors may authorize a Federal Reserve Bank to 
establish and maintain an account for a designated FMU and provide the 
services listed in section 11A(b) of the Federal Reserve Act to the 
designated FMU. Designation further subjects the designated FMU to 
additional examinations, enforcement actions and reporting 
requirements.
    On December 21, 2010, the Council published an advance notice of 
proposed rulemaking (an ``ANPR'') with 10 questions to invite public 
comment on the statutory criteria, as laid out in section 804(a)(2), 
and the analytical framework that should be applied by the Council in 
designating FMUs under the DFA. This comment period closed on January 
20, 2011. This NPR describes the criteria that will inform, and the 
processes and procedures established under the DFA for, the Council's 
designation of FMUs under the DFA. This NPR does not address the 
designation criteria and analytical framework for payment, clearing, or 
settlement activities carried out by financial institutions, as defined 
in section 803(7) of the DFA, which the Council is considering 
separately.

II. Public Responses to ANPR

    The Council received 12 comments in response to the ANPR from 
industry groups, advocacy and public interest

[[Page 17049]]

groups, individual FMUs and financial institutions.\1\ These comments 
addressed the Council's specific questions, as well as a range of other 
issues. Commenters generally encouraged the development of metrics and 
an analytical framework as laid out under section 804(a)(2) emphasizing 
the need for the Council to apply consistent standards that incorporate 
both qualitative and quantitative factors across all FMUs under 
consideration for designation. Some commenters provided specific 
feedback on particular metrics and considerations that should be used 
in the designation process, while many also commented more broadly on 
the analytical framework that should be applied by the Council. In 
addition, a few commenters asked for the Council to apply a transparent 
and clear communication strategy surrounding all designation decisions. 
The questions asked by the Council in the ANPR are provided below, 
along with an overview of the comments received in response to each 
question.
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    \1\ Comments were received from: American Bankers Association, 
Better Markets, The Clearing House, Debevoise & Plimpton, The 
Depository Trust & Clearing Corporation, The Financial Services 
Roundtable, International Swaps and Derivatives Association, 
LCH.Clearnet Group Limited, NACHA--The Electronic Payments 
Association, The Pew Charitable Trusts, TIAA-CREF, and Visa. 
Comments are available at https://www.regulations.gov.
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    1. What quantitative and qualitative information should the Council 
use to measure the factors it is required to consider in Section 
804(a)(2) when making determinations under Section 804 of the DFA? How 
should quantitative and qualitative considerations be incorporated into 
the determination process?
    The majority of comments stressed the need to apply consistent 
standards that incorporate both qualitative and quantitative factors 
that are not overly mechanical across all FMUs.\2\ Most commenters 
stated that while there could be no ``one-size-fits-all'' approach, all 
criteria should be used to measure each FMU under consideration, with 
the relative importance of each criterion varying depending upon the 
FMU under consideration. Considerations such as the differences in the 
type of market served by the FMU, the nature and size of the 
counterparties, and the complexity and liquidity of products accepted 
should be taken into account. Furthermore, one commenter in particular 
cautioned the Council to ensure that FMUs that serve the same market 
are provided identical treatment, so as not to affect competition.\3\ 
One commenter, however, emphasized the need for the flexible 
application of each criterion within the framework due to the different 
types and concentrations of risk, different market structures, 
different governance and risk management standards across FMUs, and 
differences in the potential impact of an FMU's disruption on markets, 
households, and the financial system.\4\
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    \2\ See, e.g. comment letter from International Swaps and 
Derivatives Association, Inc. (Jan. 20, 2011) (hereinafter the 
``ISDA letter''), pp. 2-3, and comment letter from Depository Trust 
& Clearing Corporation (Jan. 20, 2011) (hereinafter the ``DTCC 
letter''), pp. 2-4.
    \3\ See the DTCC letter, p. 3.
    \4\ See comment letter from TIAA-CREF (Jan. 20, 2011) 
(hereinafter the ``TIAA-CREF letter''), p. 9.
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    In addition, there was widespread consensus on the primary factors 
that should be used for consideration by the Council to assist in the 
assessment of systemic importance. Notably, these factors included: The 
level of interdependence of an FMU and its participants, the 
characteristics of the participants in an FMU, the type of market 
served by the FMU, the availability of substitute services, whether the 
FMU operates under finality of settlement, the risk management 
framework, including capital, margin and liquidity practices and 
financial resources available to the FMU, governance arrangements, and 
the extent of existing regulatory oversight. Some commenters also 
proposed that the Council use a matrix of criteria that incorporates 
actual historic measures as a way to interpret metrics based on 
relative thresholds. Please see the discussion of public responses to 
question (5b) of the ANPR below for a more comprehensive discussion of 
these factors.
    A few commenters also noted that the process used for designation 
should be transparent to the public, or at least to the FMUs being 
considered. Many noted the importance for the Council to consider 
ongoing work and developments in the adoption of international 
standards in the area of payments, clearing and settlement 
organizations to ensure that a uniform and consistent cross-border 
approach is established that incorporates existing best practices and 
core principles.
    2. Can the considerations listed in section 804(a)(2) be broken 
down into easily measured factors that the Council should use to 
determine whether financial market utilities are systemically 
important? Are there certain levels of quantitative measures (e.g., for 
value and exposure) or qualitative characteristics (e.g., registered 
clearing agencies versus exempt clearing agencies) that should trigger 
a review for systemic importance by the Council?
    There was significant consensus among commenters expressing support 
for the statutory considerations listed to measure an FMU, with many 
noting that metrics should be relatively easy to develop for these 
considerations.\5\ However, as mentioned in the discussion of public 
response to question (1) of the ANPR above, most commenters emphasized 
the importance for the Council to consider these factors in conjunction 
with qualitative measures and professional judgments.
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    \5\ See, e.g. the ISDA letter, p. 4.
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    3. Which of the considerations listed in section 804(a)(2) are most 
important for the Council to consider? Should the application of the 
considerations differ depending on the type of FMU, and if so how?
    Most commenters believed that all the considerations listed in the 
statute were equally important for the Council to consider. Some 
commenters placed particular emphasis on systemic importance, size, 
interconnectedness, the availability of substitutes, and concentration, 
as well as the need to balance quantitative metrics with qualitative 
judgments for a more accurate assessment.
    4. How should the Council measure and assess the aggregate monetary 
value of transactions processed by financial market utilities?
    One commenter specifically suggested that absolute terms of value 
be considered relative to factors such as an FMU's market share, size, 
importance of the market served, and the number of households affected. 
An FMU, for example, may process a high absolute value of transactions 
but may not be systemically important if there are other FMUs that 
could readily provide an alternative in the event of a disruption, or 
if the market it serves were not systemically important. The idea that 
readily available substitutes for the services of an FMU would reduce 
its systemic importance was a common theme among the majority of 
commenters, although the operational practicality of switching to a 
substitute would have to be considered. This commenter also suggested 
that the value and volume of transactions be considered in light of the 
FMU's potential performance during actual or projected times of 
stress.\6\
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    \6\ See the TIAA-CREF letter, p. 8.
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    One commenter argued that, while the absolute number of contracts 
and aggregate notional value of contracts cleared over a period of time 
are useful indicators for the measuring of value, it

[[Page 17050]]

is important to consider average and peak daily levels of open interest 
to have a more comprehensive analysis. Furthermore, the commenter 
suggested the importance of also considering risk and liquidity in 
conjunction with any measures of value. To do so, risk should be 
measured using the average and peak daily levels of posted margin as 
well as the day-over-day change in margin levels using gross margin 
calls. For liquidity, the commenter suggested measuring the size and 
historic volatility of bid/ask spreads, the number of members that 
actively trade the contracts cleared, and the diversity of member 
trading volumes.\7\
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    \7\ See comment letter from Better Markets (Jan. 20. 2011) 
(hereinafter the ``Better Markets letter''), p. 7.
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    a. For each type of financial market utility (e.g., central 
counterparty, funds transfer system), what is the best approach for 
measuring value (e.g., notional values, margin flows, net versus gross 
values)?
    As noted, most commenters stated that regardless of the type of 
FMU, the same criteria and metrics should be applied to each FMU under 
consideration for designation.
    One commenter indicated that for central counterparties (``CCPs''), 
daily variation margin flow--the changes in values of securities and 
derivatives contracts that are cleared--and initial margin 
requirements, should be the primary quantitative references used. In 
addition, the commenter suggested that the assessment also separately 
examine the value of securities and commodities that are delivered 
between a CCP and its members upon maturity of contracts. This 
commenter also noted that there are two different conventions used by 
CCPs to process changes in mark-to-market values. Revaluations of 
derivatives positions tend to result in daily payments and collection 
of cash, while mark-to-market changes in cash markets affect collateral 
requirements but not cash obligations. To make assessments of 
transactional values, both conventions must be covered. The commenter 
also noted that for both types of conventions used by CCPs to process 
changes in mark-to-market values, it is important to consider how 
netting impacts such values.\8\
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    \8\ See comment letter from LCH.Clearnet (Jan. 20, 2011) 
(hereinafter the ``LCH.Clearnet letter''), p. 4.
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    To assess the systemic importance of the aggregate monetary value 
of transactions, one commenter suggested looking at the size of an FMU 
at both the aggregate and transaction level.\9\ Another commenter 
maintained that the aggregate monetary value of transactions between an 
FMU and its members is a rough measure of the exposure of the rest of 
the financial system to an FMU. This commenter lays out a framework, as 
outlined in response to question (9) of the ANPR that considers credit, 
liquidity, portfolio and fire-sale exposures, as well as the value of 
positions held in a depositary, the value of credit lines available to 
the FMU, and the gross flow between an FMU and its members.\10\
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    \9\ See the TIAA-CREF letter, p. 8.
    \10\ See comment letter from The Pew Charitable Trust (Jan. 19, 
2011) (hereinafter the ``Pew letter''), p. 8.
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    b. What time horizon/statistic should be used when assessing value 
(e.g., daily, monthly or annual averages; daily, monthly, or annual 
peaks?). Should the Council consider historical values, projected 
future values, or both?
    There was some difference in opinion expressed by commenters in 
response to this question with regard to the time horizons that should 
be used to assess value. One commenter believed that the most 
significant consideration is an FMU's performance during times of 
actual or projected market stress, arguing that no single time horizon 
would effectively capture this performance in all cases. The number of 
measures should be looked at together with one another and in 
conjunction with periodic stress tests that are tailored in volume and 
time horizon to be situation specific and contain qualitative factors. 
The commenter argued that a measure such as an annual peak will only 
show an FMU's ability to handle that volume at a given moment, but not 
whether it would be adequate to handle this same volume under different 
market conditions or whether it could absorb additional transactions if 
needed.\11\
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    \11\ See the TIAA-CREF letter, pp. 8-9.
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    In contrast, a different commenter argued that annual peaks, 
calculated on the basis of a rolling 365 days rather than on the 
previous calendar year, would be the most appropriate and conservative 
estimates that would ensure that periods of stress are captured.\12\ 
Another commenter also argued that annual historical values were the 
most verifiable and readily available form of information and should be 
used when assessing value. The commenter argued that the time horizon 
need not be shorter to better capture the importance of an FMU to the 
financial system, noting that this level of importance is unlikely to 
change from month to month or quarter to quarter.\13\
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    \12\ See the Pew letter, p. 10.
    \13\ See comment letter from The Financial Services Roundtable 
(Jan 20, 2011) (hereinafter the ``Financial Services Roundtable 
letter''), p. 3.
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    One commenter argued that consideration should be given to both the 
maximum daily value of transactions processed within a given timeframe 
(at least one year) and, in the case of CCPs, this measure should be 
stress-tested using the same scenarios as required by supervisors to 
measure the adequacy of the FMU's default backing and liquidity 
resources. This would mean that if a CCP's financial resource 
requirement is greater than a specified value, then it should be 
designated. The commenter also argued that the Council should also 
consider whether the FMU processes a significant share of transactions 
of a specific type and the extent to which the FMU's major participants 
are domiciled, or have parent companies that are domiciled, in the 
U.S.\14\
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    \14\ See the LCH.Clearnet letter, p. 5.
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    c. Should different measures be applied to different types of 
financial market utilities based on their activities, products, or 
markets?
    As already mentioned, the majority of commenters argued that the 
same framework of criteria should be applied equally to each FMU under 
consideration.\15\ However, it was also widely emphasized that the 
Council must employ flexibility and qualitative judgment in its 
application of the criteria to evaluate each FMU under consideration in 
light of differences in the activities, products and markets served by 
FMUs.
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    \15\ See, e.g. the TIAA-CREF letter, p. 9.
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    d. What is the best approach for measuring potential aggregate 
monetary values for start-up financial market utilities?
    One commenter argued that in light of the lack of data that would 
be available in the case of a start-up and the lack of reliable 
estimates of projected volumes, the Council would have to give greater 
weight to other qualitative factors, such as the sophistication of risk 
management techniques in the market.\16\ Another commenter said that 
credible forecasts would be possible and should be considered by 
supervisors in addition to factors such as stress scenarios and the 
potential markets to be served.\17\
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    \16\ See the TIAA-CREF letter, p. 9.
    \17\ See the LCH.Clearnet letter, pp. 5-6.
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    e. Should certain payment systems that transfer relatively low 
aggregate values be considered by the Council for designation as 
systemically important given that the system's failure or

[[Page 17051]]

disruption could still cause widespread disruption, especially if there 
is no ready alternative means of making payments? For example, the 
failure or disruption of a system used extensively to make payments 
could leave a significant portion of the general public with unexpected 
overdrafts and/or lack of liquid funds. If so, what factors should the 
Council consider in making a determination of systemic importance for 
such systems?
    Many commenters urged the Council to consider only the largest 
interbank payment systems for designation, arguing that smaller retail 
systems do not fit the definition of ``systemically important.'' \18\ 
There was significant consensus among commenters in the reasons 
provided for this argument, namely that: (i) Retail systems operate 
relatively low-aggregate monetary value systems that do not settle 
transactions for important financial markets or other payment systems; 
(ii) there are reliable and timely substitutes for retail payments; 
(iii) retail systems do not operate real-time final settlement systems, 
meaning that the liquidity would not be guaranteed to be available 
immediately for pending outgoing payments; and (iv) retail systems are 
already under strong regulatory oversight and designations would result 
in unnecessary costs and regulatory burdens.\19\ Also of note, one 
commenter mentioned that the ability of depository institutions to 
permit overdrafts to cover retail payments strongly mitigates the 
potential for a disruption to a low-value system to have a systemic 
impact that could threaten the stability of the U.S. financial 
system.\20\
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    \18\ See, e.g., comment letter from The Clearing House (Jan. 20, 
2011) (hereinafter ``Clearing House letter''), pp. 1-2 and comment 
letter from NACHA--The Electronic Payments Association (Jan. 18, 
2011) (hereinafter the ``NACHA letter''), pp. 3-4.
    \19\ See, e.g., comment letter from the American Bankers 
Association (Jan. 20, 2010) (hereinafter ``ABA letter''), pp. 3-5, 
comment letter VISA (Jan. 20, 2011) (hereinafter the ``VISA 
letter''), pp. 3-6, and the Financial Services Roundtable Letter, p. 
4.
    \20\ See the NACHA letter, p. 4.
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    While largely mentioning similar reasoning for why low-value 
systems would likely not qualify for designation, two commenters argued 
that such systems should first be evaluated to determine if a 
disruption to them would have a significant impact on a substantial 
market or a large number of households, or if there were no readily-
available substitutes.\21\
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    \21\ See the TIAA-CREF letter, p. 9 and the Pew letter, p. 10.
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    5. How should the Council measure and assess the aggregate exposure 
of financial market utilities engaged in payment, clearing, or 
settlement activities to its counterparties?
    a. How should the Council identify the extent to which financial 
market utilities bear and create risk exposures for themselves and 
their participants?
    b. What measures of exposure should be considered (e.g., liquidity 
exposures, current and potential future counterparty credit exposures, 
operational risk, and the degree of concentration of exposures across 
participants)?
    There was significant consensus among commenters on the types of 
factors that should be used by the Council. These include: (i) The 
liquidity, complexity and volatility of the asset classes/market served 
by the FMU; (ii) whether the FMU has the potential to create 
significant liquidity disruptions or dislocations in the event of a 
failure; (iii) whether the FMU has the potential to create large credit 
or liquidity exposures relative to participants' financial capacity; 
(iv) whether the FMU covers a high proportion of large-value 
transactions; (v) if, and, if so, how many, large financial 
institutions and/or other FMUs rely on the FMU for its own operations; 
(vi) whether there are reliable and timely substitutes with other FMUs; 
\22\ (vii) whether the FMU offers finality in settlement, arguing that 
participants rely on real-time finality to settle positions elsewhere 
such that a disruption in such a system is more likely to have an 
effect on a participant's counterparties than in a system without 
immediate settlement finality; \23\ (viii) how the ownership and 
governance arrangements affect the incentives and risk-tolerance of an 
FMU; \24\ and (ix) whether the FMU is already subject to an existing 
regulatory regime, arguing that an FMU already under supervision would 
be less likely to require further designation and that therefore a 
systemically important designation under Title VIII would result in 
unnecessary costs and regulatory burdens, as well as the establishment 
of duplicate regimes of oversight.\25\ While some commenters did not 
specify which types of existing oversight were adequate to avoid 
designation, several commenters specifically indicated that 
institutions that are already subject to comprehensive Federal Reserve 
oversight, have access to central bank liquidity, and/or are already 
subject to designation under Title I of the DFA, should not be 
designated.\26\
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    \22\ See, e.g. the VISA letter, pp. 8-9.
    \23\ See, e.g. the VISA letter, p. 8.
    \24\ See, e.g., the ISDA letter, p. 3.
    \25\ See, e.g. the ABA letter, p. 2, 5.
    \26\ See, e.g., the comment letter from Debevoise & Plimpton 
(Jan. 20, 2011) (hereinafter ``the Debevoise letter''), pp. 2-5.
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    A majority of commenters also suggested that if standards and 
policy in risk management, governance, capital, margin, and liquidity 
were strong and well-managed, this would reduce the need for 
designation. Several commenters emphasized the importance of 
considering the governance and ownership arrangements of FMUs, noting 
the importance of aligning the interests of an FMU so that it engages 
in prudent behavior. For those FMUs that have achieved this balance 
such that a significant portion of equity capital is at risk, they 
argue that the FMU would pose a lesser degree of systemic risk. These 
commenters suggest that the inherent risk alone that an FMU may 
concentrate or be exposed to should not be considered in isolation. 
Rather, they argue that the adoption of strong risk mitigating 
practices could greatly reduce systemic risk, and therefore the need 
for designation.
    c. For each type of financial market utility (e.g., central 
counterparty, funds transfer system), what is the best approach for 
measuring current credit exposure or, where relevant, potential future 
exposures? For liquidity (funding), how might the Council assess the 
potential liquidity risks that a financial market utility may bear or 
liquidity risks it may impose on the broader financial system should it 
fail to settle as expected?
    When assessing credit risk, most commenters emphasized the 
importance of looking at both the quality of the counterparties and the 
products served by the FMU. When assessing liquidity risk, many 
commenters emphasized the importance of considering the concentration 
of the FMU in the market and the capacity/substitutability available 
among other FMUs. Several commenters also suggested that the Council 
make use of existing risk assessment tools such as approaches outlined 
under Basel and in the CPSS/IOSCO Recommendations for CCPs as a 
foundation to build on.\27\ In addition, many emphasized the importance 
of using stress tests as a useful way to measure liquidity risk, as 
well as reverse stress tests to help identify issues of macro 
prudential concern.
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    \27\ See, e.g., ISDA letter, p. 5; CPSS-IOSCO, ``Recommendations 
for Central Counterparties'' (November 2004); ``Guidance on the 
Application of the 2004 CPSS-IOSCO Recommendations for Central 
Counterparties to OTC Derivatives CCPs--Consultative Report'' (May 
2010).

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[[Page 17052]]

    One commenter argued that the sources of liquidity for an FMU, 
which are highly related to the underlying credit of members, should be 
ignored or severely discounted in any analysis. The commenter argued 
that during a time of stress, sources of liquidity are unreliable 
because members will be unlikely to respond to an FMU's call for 
additional support during a severe market event and major default of 
another member. Similarly, the commenter argued that lines of credit 
and liquidity will not likely be available in a major default 
scenario.\28\
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    \28\ See the Better Markets letter, pp. 7-8.
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    6. How should the Council identify, measure, and assess the effects 
of relationships, interdependencies, and other interactions of 
financial market utilities listed as considerations in section 
804(a)(2)?
    a. What role should models of interdependencies (e.g., 
correlations; stress tests) play in the Council's determinations?
    Many commenters discussed the importance of using stress tests and 
correlations in any model to measure levels of interdependence, 
although there was some variation in the appropriate assumptions and 
time horizons that should be used. One commenter, for example, 
emphasized the need for the stress scenarios to use both historical 
worst-case scenarios as well as future potential events in order to 
apply more extreme cases of market illiquidity.\29\ In addition, some 
argued that correlations both between counterparties and industry 
sectors and between financial markets and instruments should be 
incorporated and appropriately stress-tested.\30\
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    \29\ See the Better Markets letter, p. 8.
    \30\ See, e.g., the LCH.Clearnet letter, p. 7.
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    b. What role should the nature of participants or counterparties 
play in the Council's determinations (e.g. common participants across 
utilities, systemic importance of participants)?
    The majority of commenters emphasized the importance of examining 
the nature of participants and counterparties to an FMU, particularly 
as a means of measuring interdependence and concentration. This should 
include considerations such as the type and number of counterparties, 
particularly if they are significant financial firms or FMUs, as well 
as the nature of relationships these counterparties have to each other 
and other FMUs.
    c. Should the Council consider the legal, corporate, or contractual 
relationships of financial market utilities in assessing relationships, 
interdependencies, and other interactions (e.g., common holding 
company, joint ventures, cross-margining agreements, and service 
provider relationships)?
    One commenter emphasized the importance for FMUs to operate under a 
well-established and enforceable legal framework. In particular, the 
commenter emphasized the importance of assessing the legal risks 
arising from cross-border relationships, governance and corporate 
structures and any affiliates or holding companies that are under the 
same control as the FMU and thus depend on the same creditors. 
Furthermore, the commenter noted that the Council should consider any 
cross-margining and/or outsourcing and servicing relationships that an 
FMU may have.\31\ Please see the discussion of public responses 
provided to question (7) of the ANPR for more detailed information.
---------------------------------------------------------------------------

    \31\ See the TIAA-CREF letter, p. 11.
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    Another commenter emphasized this point as well, noting the 
importance for the Council to consider legal, corporate, or contractual 
relationships of FMUs. This commenter emphasized the importance of 
paying attention to cases where the same legal entity is acting in 
multiple capacities, for example if a legal entity acts both as a 
market operator and a CCP, and also as a participant in a money or tri-
party market. Furthermore, this commenter argued that the Council 
should carefully consider cases in which the holding company of an FMU 
has significant exposure to foreign markets.\32\
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    \32\ See the LCH.Clearnet letter, p. 7.
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    d. Should the Council consider whether there are readily available 
substitutes for the payment, clearing, and settlement services of 
financial market utilities?
    The importance of readily available substitutes for an FMU was a 
theme common among all commenters, who argued that the availability of 
a readily-available alternative would significantly reduce the systemic 
threat an FMU posed to the financial system, thereby reducing the need 
for designation by the Council.
    7. How should the Council assess whether failures or disruptions to 
a financial market utility could potentially threaten the financial 
system of the United States?
    a. What measures, information and thresholds should be used in 
assessing the effect of a financial market utility failure or 
disruption on critical markets and financial institutions? For example, 
how might the Council assess potential credit and liquidity effects and 
spillovers from a financial market utility disruption?
    The vast majority of commenters emphasized the importance of 
considering the level of interconnectedness of participants--both 
directly and indirectly--of an FMU as well as between FMUs. These 
relationships would help inform the Council on the potential effect on 
all relevant market participants in the event that an FMU is unable to 
function. While some explicitly believed that this should be limited to 
a more permanent long-term loss of function, noting that temporary 
disruptions such as operational failures should not be considered, one 
commenter believed that any potential disruption should be examined to 
understand the dependencies of participants on the FMU and the 
resulting impact on the economy as a whole.
    Furthermore, nearly all commenters noted the importance of 
considering the type of counterparties to an FMU, and whether they 
themselves are systemically important, as well as the concentration of 
the market and the availability of substitutes. Other factors mentioned 
widely by commenters, as elaborated on in question (5b) were the 
capital and liquidity cushions of an FMU, its governance structure, 
whether or not it offered finality of settlement, and the nature, in 
terms of size, depth and volatility, of the market that it serves.
    As mentioned in question (6a) as well, many suggested the 
importance of using stress tests and a variety of extreme but plausible 
assumptions in order to assess the effects from any disruption.
    b. What factors should the Council consider when determining 
whether markets served by financial market utilities are critical? What 
qualitative or quantitative characteristics might lead the Council to 
scope in or out particular markets?
    Many commenters emphasized the importance of considering the size, 
depth and volatility of a particular market in order to determine its 
systemic importance. Furthermore, many argue that the Council should 
also consider the type and number of participants to the market--for 
example, if they themselves are systemically important, this will 
increase the likelihood that the market itself is critical--as well as 
what percentage of a market may be used by a large percentage of U.S. 
households.
    One commenter argued that all types of disruptions--both temporary 
and permanent--must be examined by the Council. In addition, the 
commenter suggested considering whether the

[[Page 17053]]

failure or suspension of a market for a significant period of time 
interrupts the supply of vital foodstuffs or energy, halts commercial 
activity, or prevents financial institutions from managing their own 
risks.\33\
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    \33\ See the LCH.Clearnet letter, p. 8.
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    8. Title VIII of the DFA contains distinct provisions with respect 
to financial market utilities and financial institutions engaged in 
payment, clearing and settlement activities. What factors should the 
Council consider in distinguishing between a systemically important 
financial market utility and a financial institution that is very 
substantially engaged in a systemically important payment, clearing, or 
settlement activity?
    Most commenters urged the Council to ensure that any designations 
did not lead to duplicative oversight regimes.\34\ Furthermore, it was 
noted that if an institution were designated under Title I, it should 
not also be subject to designation under Title VIII. One commenter 
believes that the same qualitative and quantitative criteria and 
metrics should be applied in all cases, including if the potential 
designee is a financial institution.\35\
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    \34\ See, e.g. the Debevoise letter, p. 2.
    \35\ See the LCH.Clearnet letter, p. 8.
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    A different commenter stated that the distinction is a critical 
issue for market participants but that it requires clarification by the 
Council in order to allow stakeholders the ability to provide a 
substantive answer.\36\
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    \36\ See the Financial Services Roundtable letter, p. 5.
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    9. What other types of information would be effective in helping 
the Council determine systemic importance? What additional factors does 
your organization consider when assessing exposure to, or the 
interconnectedness of, financial market utilities?
    In addition to the set of common factors elaborated on in question 
(5b), one commenter also suggested that the Council consider an FMU's 
opacity/complexity/disclosure, leverage, rate of change of activity, 
role in monetary and/or fiscal policy, segregation of client margin, 
business conduct rules, execution requirements, and methodology of 
margin calculation.\37\
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    \37\ See the ISDA letter, pp. 5-7.
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    One commenter developed a framework for consideration by the 
Council. This framework attempts to measure three broad components in 
order to value systemic significance: fragility of the FMU, exposure of 
its financial firm members to its failure, and fragility of the 
members. The framework involves seven steps: (1) Developing a set of 
``heightened reporting firms;'' (2) identifying factors--such as 
leverage, liquidity, concentration, risk management, complexity, and 
credit exposure--that can affect systemic significance, defining 
measures for each factor and dividing them into factors that affect 
fragility of the FMU and factors that affect exposure of firms to FMUs; 
(3) estimating the fragility of each heightened reporting firm that is 
a member of each FMU; (4) estimating the exposure of members to each 
FMU and for each FMU candidate; (5) creating a single measure of the 
system's vulnerability by adding up the measures of exposures of all 
heightened reporting member firms to the candidate FMU, weighted by 
their fragility estimates; (6) estimating systemic importance of an FMU 
using several statistical factors; and (7) applying a universal 
threshold to each FMU to ultimately determine designation.\38\
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    \38\ See the Pew letter, pp. 3-7.
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    Lastly, one commenter noted that a supervisory gap existed in the 
oversight of internet-based payment systems, including P2P payment 
systems, and asked for the Council to consider the appropriate actions 
to take to close this loophole.\39\
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    \39\ See the Clearing House letter, p. 10.
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    10. What role should international considerations play in 
designating financial market utilities?
    In response to this question, many commenters emphasized the 
importance of adopting international standards and best practices, such 
as the CPSS Core Principles \40\ and the work of the Financial 
Stability Board \41\ to promote common standards and cross-border 
cooperation. Particularly in light of the interconnectedness of global 
markets, commenters emphasized that adherence to internationally agreed 
upon standards would help ensure consistency in practice across FMUs 
globally.\42\
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    \40\ See CPSS ``Core Principles for Systemically Important 
Payment Systems'' (Jan. 2001).
    \41\ See, e.g. https://www.financialstabilityboard.org.
    \42\ See, e.g., the ISDA letter, pp. 6-7.
---------------------------------------------------------------------------

    One commenter argued that the global nature of markets serviced by 
FMUs as well as the interconnectedness of the global financial system 
as a whole means that there should be no differences in criteria 
employed when considering the designation of FMUs that may have 
substantial foreign activities. As a result, the commenter argued that 
U.S. supervisors have a justification and need for concomitant 
supervisory access to any foreign FMU deemed systemically 
important.\43\
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    \43\ See the LCH.Clearnet letter, p. 9.
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    One commenter urged the Council to be conservative when applying 
Title VIII to non-U.S. entities because Title VIII does not expressly 
provide for extra-territorial application. To the extent that the 
Council does apply Title VIII to non-U.S. entities, this commenter 
urged the Council to ensure that any determination maintains a level 
playing field for domestic and foreign FMUs with a comparable 
regulatory regime. Furthermore, the commenter noted that participation 
in government support programs should not be a factor in identifying 
whether an FMU is systemically important.\44\
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    \44\ See the Financial Services Roundtable letter, pp. 5-6.
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III. Overview of Proposed Rule

    Proposed part 1320 of Title 12 (``Rule 1320'') lays out the 
framework that the Council proposes to use to determine whether an FMU 
should be designated as systemically important. The proposed rule 
incorporates and augments the requirements set forth in the DFA with 
respect to the determination of whether to designate an FMU as 
systemically important. The Council requests comment on all aspects of 
the proposed rule, but in particular, comments in response to the 
specific questions raised below. The Council is providing a sixty (60) 
day comment period for this proposed rule.

A. Considerations for Determination

    Section 804 of the DFA provides the Council with the authority to 
designate those FMUs the Council determines are systemically 
important--that is, the failure of or a disruption to the functioning 
of which could create, or increase, the risk of significant liquidity 
or credit problems spreading among financial institutions or markets 
and thereby threaten the stability of the U.S. financial system. 
Section 803(6)(A) of the DFA generally defines an FMU as any person 
that manages or operates a multilateral system for the purposes of 
transferring, clearing, or settling payments, securities, or other 
financial transactions among financial institutions or between 
financial institutions and that person. Under section 804(a)(2) of the 
DFA, in making a determination on whether the FMU should be designated 
as systemically important, the Council must consider:
    A. The aggregate monetary value of transactions processed by the 
FMU;
    B. The aggregate exposure of the FMU to its counterparties;
    C. The relationship, interdependencies, or other interactions of 
the FMU with other FMUs or

[[Page 17054]]

payment, clearing or settlement activities;
    D. The effect that the failure of or a disruption to the FMU would 
have on critical markets, financial institutions, or the broader 
financial system; and
    E. Any other factors that the Council deems appropriate.
    As discussed in Part II, there were several themes in the ANPR 
commentary regarding how the Council should apply the statutory 
considerations to the designation process.
    One broad theme from the commenters is that the analytical 
framework for evaluating an FMU should be applied consistently across 
all FMUs and that the process used for designation be transparent to 
the public, or at least to the FMUs under consideration. The Council 
agrees with the broad theme raised by commenters that it is important 
to have a consistent framework and transparent process for all FMUs 
under consideration. However, not all criteria will be relevant to each 
FMU under consideration. The Council believes it would be appropriate 
to adopt a flexible approach to the analysis of metrics applicable to 
each FMU under consideration. Thus, the framework itself should 
accommodate the range of payment, clearing, and settlement activities 
that FMUs may engage in and allow the application of relevant criteria 
to each FMU under consideration, with the relative importance of the 
criteria applied to be informed by the specific circumstances of the 
FMU's role in the financial system and the Title VIII definition of 
``financial market utility.'' Several commenters also supported the 
need to weigh qualitative considerations in addition to quantitative 
factors.
    The Council shares the concerns of commenters and proposes to 
develop a systematic and robust process that is consistent with the 
intent of the DFA. Such an analytical framework would be based on the 
four specific considerations for systemic importance set forth in 
section 804(a)(2) of the DFA. This framework would apply consistent 
criteria to FMUs under consideration, recognizing differences across 
FMUs, including differences in risk management structures and in the 
potential impact of an FMU's disruption on markets, households, and the 
financial system. In addition, the Council shares the view of the 
commenters that both quantitative and qualitative judgments be applied 
to this process. The Council provides further information with regard 
to this analytical framework and related process in sections III.B and 
III.C below.
    The Council is equally interested in maintaining a transparent 
process, which is in keeping with one of the broader goals of the DFA. 
In particular, there is a provision in the proposed rule for 
notification of each FMU prior to a vote on a proposed designation, 
providing the FMU an opportunity to present the Council with arguments 
and information supporting or opposing its designation. In providing 
for an appropriately transparent process to the public, the Council 
will need to take into account that much of the information gathered 
and decisions made will be sensitive and likely require confidential 
handling so as not to reveal proprietary information or affect 
competition. Nonetheless, the Council will establish as transparent a 
process as is appropriate.
    With respect to the criteria for designation, there was broad 
consensus in the comments on the factors that the Council should 
incorporate into the analytical framework. The most common suggestions 
included: an examination of the type of market served by the FMU, the 
potential for large credit or liquidity dislocations in the event of a 
disruption, the proportion of large-value transactions that the FMU 
serves, the nature of counterparties to the FMU, the availability of 
substitutes for participants in the event of an FMU disruption, and 
whether the FMU offers finality in settlement.
    The Council agrees with commenters that many of these factors could 
offer considerable insight into the designation process and will 
consider incorporating them into the analytical framework that is 
developed. As noted, further insight into the types of factors that may 
be incorporated into the Council's analysis is further detailed in 
section III.B.
    Many commenters also urged the Council to only consider the largest 
interbank payment systems for designation, arguing that smaller retail 
systems do not fit the definition of systemically important. Many of 
the commenters argued that retail systems settle relatively low-
aggregate monetary value, that there are reliable and timely 
substitutes for retail payments, and that such systems do not operate 
with finality in settlement and are already under strong regulatory 
oversight.
    While the Council recognizes that the definition of an FMU covers a 
wide variety of systems, including low-value and large-value payment 
systems, it acknowledges that the factors raised by several commenters 
concerning retail payment systems are important considerations. In 
considering the systemic importance of various FMUs, the Council will 
take these factors into consideration as well as other relevant 
characteristics. The Council has decided not to include any categorical 
exclusion for retail payment or other systems in the proposed 
regulations because it believes that such exclusions would impair the 
Council's ability to effectively respond to changing market conditions 
and industry developments.
    Several commenters specifically indicated that institutions that 
are already subject to comprehensive Federal Reserve oversight, have 
access to central bank accounts and liquidity, or are already subject 
to designation under Title I should not be designated. Some also argued 
that FMUs that are already subject to prudential oversight, have strong 
risk management frameworks, governance standards, and sufficient 
financial resources in place have developed controls that would reduce 
the need for designation since the risk of a systemic disruption would 
be considerably lower.
    The Council recognizes the importance of oversight and of FMU's 
maintaining strong controls to mitigate the risk of failure. However, 
the purpose of Title VIII is to consider designating certain FMUs as 
systemically important because while FMUs that conduct or support 
multilateral payment, clearing, or settlement activities may reduce 
risks for their participants, such utilities may also concentrate and 
create new risks. Recognizing this, Title VIII instructs the Council to 
designate as systemically important any FMU whose failure or disruption 
could create, or increase, the risk of significant liquidity or credit 
problems spreading among financial institutions or markets and thereby 
threaten the stability of the financial system of the U.S. Thus, the 
Council is instructed to designate FMUs based on the effect that a 
disruption or failure of the FMU would have on the stability of the 
U.S. financial system. The likelihood of that precipitating event--that 
is to say, the likelihood, in light of any risk mitigating practices 
that may be in place, that an FMU would experience a disruption or 
failure is not one of the statutory considerations.
    There were several other suggestions raised in the comment letters 
in which there was no consensus. In particular, there were a number of 
different suggestions provided in response to ANPR question 4 on how 
the Council should measure and assess the aggregate monetary value of 
transactions processed by an FMU. Commenters suggested a variety of 
approaches for measuring value (notional values, margin flows, net 
versus gross values, etc.) and defining time horizons and

[[Page 17055]]

statistics (annual, peak, etc.). There was further divergence in 
thought with regard to ANPR question 6 on the type of model that should 
be used to measure interdependencies, (e.g., correlations, stress 
tests). The Council appreciates the range of suggestions provided by 
the commenters. The analytical framework and associated subcategories 
and metrics reflect the Council's efforts to incorporate commenters' 
suggestions, which are further outlined in section III.B.
    Lastly, in response to ANPR question 10, many commenters took the 
opportunity to stress the importance of applying consistent standards 
across borders, specifically advocating the use of international core 
principles and best practices to ensure consistency and a level playing 
field. One commenter cautioned the Council to be conservative in 
applying Title VIII to non-U.S. entities. The Council requests further 
comment on the role international considerations should play in this 
rule making, in particular on the application of the proposed 
analytical framework and the subcategories contained in the proposed 
section 1320.10 given cross-border payment, clearing and settlement 
flows, and cross-border participation in FMUs.

B. Statutory and Analytical Framework for Designations

    The proposed rule incorporates each of the statutory factors that 
must be considered into the analytical framework to determine whether 
an FMU should be designated. In developing the proposed rule, the 
Council has also taken into consideration the comments received on the 
ANPR. If adopted into a final rule, this framework would be used by the 
Council to meet its statutory obligations of assessing the threat the 
failure or disruption of an FMU may pose to the stability of the U.S. 
financial system. In addition, the Council would consider any other 
risk-related factors that the Council deems appropriate, under section 
804(a)(2)(E).
    The Council would evaluate FMUs under each of the four statutory 
considerations as laid out in section 804(a)(2) of the DFA, in addition 
to any additional factors it deems appropriate, using quantitative 
metrics where possible. The Council expects to use its judgment, 
informed by data on the four considerations, to determine whether an 
FMU should be designated as systemically important and thus subject to 
heightened risk management standards prescribed by the Board of 
Governors, the SEC, or the CFTC, in consultation with the Council and 
relevant Supervisory Agencies. These standards will take into 
consideration relevant international standards and existing prudential 
requirements governing the operations related to the payment, clearing 
and settlement activities of designated FMUs.
    Any determinations of the Council made under the proposed rule 
using the analytical framework would be based on whether the failure or 
disruption of the FMU could pose a threat to the financial stability of 
the U.S. financial system as described in DFA section 803(9).
    Under the proposal, the Council expects to use the four statutory 
considerations as a base for the framework for assessing the systemic 
importance of FMUs, regardless of the type of payment, clearing and/or 
settlement activities that they are engaged in. However, the 
application of this framework would be adapted for the risks presented 
by a particular type of FMU and business model. For example, the 
metrics that are best suited to measure the four categories of systemic 
importance will likely vary across FMUs. The Council will review these 
metrics on a periodic basis and revise them as appropriate.
    In addition, the process that the Council will use to evaluate 
potential FMUs for designation under an analytical framework is 
outlined in more detail under section III.C. Briefly, the Council is 
considering using a two stage process for evaluating FMUs prior to a 
vote of proposed designation by the Council. The first stage will 
consist of a largely data-driven process for the Council, working with 
its committees \45\ to identify a preliminary set of FMUs, whose 
failure or disruption could potentially threaten the stability of the 
U.S. financial system. In the second stage, the FMUs identified through 
the initial review will be subject to a more in-depth review, with a 
greater focus on qualitative factors, in addition to FMU and market 
specific considerations.
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    \45\ See ``Financial Stability Oversight Council Committee 
Structure'' (Nov. 23, 2010 Council Meeting Document), available at 
https://www.treasury.gov/initiatives/Pages/FSOC-index.aspx.
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Proposed Analytical Framework
    To provide further transparency into the analytical framework that 
the Council is considering, set forth below is additional information 
regarding the types of metrics that may be considered by the Council.
Stage One
    As described above, the Council is proposing subcategories to 
further build out the four specific statutory considerations that are 
set forth in DFA section 804(a)(2). Some of these subcategories and 
associated metrics are described below to provide illustrative examples 
of how the factors will be considered in assessing systemic importance.
    Consideration (A): Aggregate monetary value of transactions 
processed by an FMU
     Number of transactions processed, cleared or settled by 
the FMU
    Within this subcategory, examples of the types of metrics that the 
Council may consider include the mean and median daily gross and net 
volumes processed, cleared or settled; the historical peak daily gross 
and net volumes processed; and the volumes processed, cleared or 
settled as a percentage of the total market volume; and for derivatives 
central counterparties, the median and peak daily changes in open 
interest.
     Value of transactions processed, cleared or settled, by 
the