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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Statement at SEC Open Meeting Regarding Conflicts of Interest Rules for Clearing Agencies


Commissioner Kathleen L. Casey

U.S. Securities and Exchange Commission

Washington, D.C.
October 13, 2010

Thank you, Chairman Schapiro. First, I want to also take the opportunity to thank the staff, and particularly Robert Cook and his team in the Division of Trading and Markets, for their tireless efforts on this release. You have been given a difficult task, to craft a statutorily mandated and critically important proposed rule on an extremely tight timeframe, and to consider complex issues, many of them of first impression, and to weigh often conflicting interests in doing so. I appreciate the time, effort, and careful thought you have given to this release, and while I have reservations about the specific ownership and governance models we suggest to mitigate conflicts of interest, I believe that the release ultimately asks the right questions that will help the Commission get to a result that will further the development of a strong and robust central clearing and trading capacity for security-based swaps.

Indeed, this is the first significant rulemaking under Title VII of Dodd-Frank, and is emblematic of the challenges that we will face more generally as the Commission strives to give effect to the new regulatory objectives and its burgeoning oversight of the OTC derivatives market. Congress has imposed tight timelines, and often, as in this instance, with timetables that expect the Commission to adopt rules that necessarily rely on definitions and structures that have yet to be implemented or established. Moreover, all this rulemaking must be done in consultation with both the CFTC and prudential regulators to the greatest extent possible for the purposes of ensuring regulatory consistency and comparability.

The massive amount of rulemaking that the Congress has mandated the SEC accomplish in a short timeframe has necessarily required that we approach the project piecemeal, but as we consider each rule separately, it is critical that we always keep in mind what is animating the rulemaking under Title VII of Dodd-Frank. Our efforts to transform a highly concentrated and opaque market to a more transparent and resilient one through greater standardization, clearing, trading, and trade reporting is intended to achieve an overarching objective of reducing systemic risk. Indeed, the Title VII obligation to consult with the Federal Reserve reinforces the notion that systemic risk should remain the paramount consideration animating the rules we adopt. For that reason, we need to view each of the rules in Title VII in the context of how they further the objective of mitigating systemic risk. This is vital, because our actions, if not well considered as a whole, could actually result in both greater risk and a greater concentration of risk under the law's requirements.

Today's rulemaking follows the CFTC proposal last week and is broadly similar in key respects. But the release today, as did that of the CFTC and comments of several of their Commissioners during the open meeting recently, recognizes several key points that I believe are vitally important as we consider how best to address concerns about conflicts of interest.

First, as the release notes, unlike the cash equity and listed options markets, the markets for the central clearing and trading of security based swaps are still in their infancy and will change over time. While we may be attempting to solve for identified conflict concerns arising from issues of access, product eligibility and risk management by providing prescriptive rules on ownership and voting interests which borrow from these models, I am deeply concerned that imposing such restrictions risks negatively affecting the development of the market structure for clearing as well as trading of security-based swaps, and will potentially drive in the direction of a sub-optimal market structure. As the release further notes, particularly with respect to clearing, under variations of its alternative ownership limit proposals, it is likely to "reduce the potential number of investors that would be willing to devote resources to form a security-based swap clearing agency and that "this potentially diminishes the likelihood for a long-term market structure with multiple clearing agencies." Such likely potential effects further underscore our need to be very considered, perhaps even incremental, in our approach. We must be vigilant that, in pursuing the goal of mitigating conflicts, we allow for the creation of viable capital structures which will be essential to the development of robust clearing agencies.

Second, the release appropriately highlights the fundamental tension between access and risk management. And it is absolutely essential that we get the balance right. Ultimately, while these interests need to be balanced, I am concerned that the alternatives suggested in the release may tilt the scale in favor of access over risk management. And in this regard it is important to remember that, while undoubtedly access is vitally important, it is not principally an end to itself, but rather a means to an end. Access is important to facilitate clearing and trading objectives which--again, I would note--are designed to achieve broader systemic risk goals. But if we tilt the scale too far in the direction of access, at the expense of sound risk management, we actually run the risk of concentrating and enhancing risk, which would undercut the very objective of Title VII. So this balance is critical.

Third, we need to avoid looking at these issues in isolation, which, given the language of Section 765, might tend to focus our efforts exclusively on ownership or governance structure restrictions, and unduly undervalue a more a holistic approach which may more effectively achieve the objectives. I fear that the piecework approach in this instance naturally tends to overvalue the effectiveness of independent directors and very particular ownership and governance rules to mitigate conflicts. A more comprehensive approach, however, should include utilization of our ongoing oversight authority of clearing agencies under 17A, as well as consideration of the effect of additional rules we will consider dealing with trade reporting and capital requirements for non-cleared swaps. Such a comprehensive review may help produce a more tailored yet more robust regulatory regime that addresses the real conflicts we actually observe as the markets develop and that may impact sound risk management, access and product eligibility.

As we consider the approach that we should take, I tend to think that we should avoid making definitive judgments about the structure of nascent and developing markets when we are unclear what the effects these rules will have on the development of these markets, and instead use the tools we already possess in our toolkit that can help us monitor, manage, and address conflicts. We may find, as these markets develop, that the ownership and governance rules in place for other market participants may not be perfect fits in the swaps clearing and trading space. Or they may be, but we will allow our experience as an active regulator serve as our guide.

Notwithstanding some of the real reservations I've noted, I generally believe that the release is very thoughtful in considering these issues and queries on these fundamental questions I've noted as much as it makes definitive judgments at this stage. Moreover, I believe that the release tees up the full range of questions so that we can arrive at an outcome that meets the particular objectives of Section 765 while remaining faithful to the broader Title VII goal of minimizing systemic risk.

Again, I'd like to thank the staff for their hard work in putting together a release that addresses all the fundamental questions we need to focus on as we decide on the best approach to mitigate conflicts of interest. I have no questions.


Modified: 10/13/2010