The Securities and Exchange Commission recently adopted a new, stricter rule governing risk management and operation standards for registered clearing activities. This new Rule, 17 Ad-22, will become effective 60 days after its publication in the Federal Register.
The Rule requires registered clearing agencies that perform central counterparty services to establish, maintain and enforce written policies and procedures reasonably designed to limit their exposure. At minimum, they must measure their credit exposure at least once per day and maintain margin requirements to limit their credit exposure to participants, using risk-based models and parameters. The procedures must be reviewed monthly, and the models must be validated annually.
The Rule is an attempt “to ensure that clearing agencies will be able to fulfill their responsibilities in the multi-trillion dollar derivatives market and more traditional securities market.” It is part of an effort to promote financial stability by improving accountability and transparency in the financial system. It was adopted in accordance with the Dodd-Frank Act, which gave the SEC greater authority to establish standards for clearinghouses.
In general, clearing agencies act as middlemen to the parties in a securities transaction. They play a crucial role in the securities markets by ensuring the successful completion of operations and avoiding the risk of a defaulting operator. In addition, they ensure transactions are settled on time and on the agreed-upon terms.
The rule is similar to the Supervisory Capital Assessment Program, publicly described as the bank “stress tests.” This examination, conducted by the Federal Reserve System, measured the financial strength of the nation’s 19 largest financial institutions. The stress tests measured whether banks had enough capital to weather a downturn with enough funds to continue lending. Like the new Rule, the stress tests were intended to reduce uncertainty surrounding the financial system, while building up transparency and investor confidence.
Under the new Rule, clearing agencies will have to maintain sufficient financial resources to withstand, at a minimum, a default by the participant group to which it has the largest exposure in extreme (but plausible) market conditions. In addition, the clearing agencies will now be required to calculate and maintain a record of the financial resources that would be needed in the event of a participant default. Clearing agencies must perform the calculation quarterly, or at any time upon the SEC’s request, and must post on their websites annual audited financial statements within 60 days of fiscal year-end.
The Rule also requires clearing agencies to implement membership standards for central counterparties reasonably designed to: 1) provide membership opportunities to persons who are not dealers or security-based swap dealers, 2) not require minimum portfolio size or transaction volume. Those who have a $50 million portfolio should also be able to obtain membership, provided they comply with other reasonable membership standards.