Speech by SEC Chairman:
Statement at the SEC Open Meeting
Item 2 — Conflicts of Interest Rules for Clearing Agencies
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
SEC Open Meeting
October 13, 2010
We will now turn to the second item on our agenda — a proposal designed to mitigate conflicts of interests at security-based swap clearing agencies, security-based swap execution facilities (SEFs), and national securities exchanges that post or make available for trading security-based swaps.
Like the interim rule we just considered, this proposal also originates from Title VII of the Dodd-Frank Act, which authorizes the SEC to regulate security-based swaps.
Specifically, Section 765 directs the Commission to adopt rules to mitigate conflicts of interest. To achieve this, the law states that our rules can limit control or voting rights with respect to any security-based swap clearing agency, security-based swap execution facility, or exchange that posts or makes available for trading security-based swaps.
The concern about conflicts of interest stems from the fact that the over-the-counter derivatives markets have a relatively high concentration of market activity through a limited number of dealers — and those dealers earn significant revenues from their transactions in an opaque over the counter market.
For example, just five large commercial banks represent 97 percent of the total U.S. banking industry notional amount of derivatives outstanding. This concentrated market structure creates the potential for conflicts of interests if a similarly small number of firms are able to control the trading and clearing venues for the security-based swap markets, including access to those venues.
In today’s proposal, the Commission identifies several key areas where it believes a conflict of interest could affect the operations of a security-based swap clearing agency, security-based swap execution facility, and security-based swap exchange.
First, participants in a security-based swap clearing agency could seek to limit access to the clearing agency by other participants to maintain a competitive advantage. Similarly, participants in a security-based swap execution facility or members of a security-based swap exchange may seek to restrict the number of direct participants or members in the trading venue in order to limit competition and increase their ability to maintain higher profit margins.
Second, participants could seek to limit the scope of products eligible for clearing at a security-based swap clearing agency or available for trading on a security-based swap execution facility or a security-based swap exchange, particularly if there is an economic incentive to keep the product traded in the over-the-counter market; and
Third, participants in security-based swap clearing agencies could, in certain circumstances, seek to lower the risk management controls of a clearing agency in order to reduce their collateral requirements. And, security-based swap execution facility participants and security-based swap exchange members may have an incentive to promote their commercial interests over the regulatory oversight responsibilities of the facility or exchange.
To address these potential conflicts, the Commission is proposing limits on the ownership and voting of shares or other interests entitled to vote, by participants of these three entities — as well as requirements with respect to the governance of these entities.
In particular, with respect to security-based swap clearing agencies, the Commission is considering two alternative approaches - either of which would satisfy requirements designed to mitigate conflicts of interests. The staff will describe the proposals in detail.
The proposed restrictions on governance and limitation on voting interest are designed to mitigate conflicts of interest which may inappropriately limit access to, and the scope of, trading and clearing in the security-based swap markets.
By creating a structure that would promote more independent voices within clearing organizations and trading venues, this proposed rule is intended to make these entities less susceptible to promoting the interests of a few participants to the potential detriment of others.
Before I again turn to Robert Cook, I would like to thank Robert, Nathaniel Stankard, John Ramsay, Haime Workie, Catherine Moore, Joseph Kamnik, Heather Seidel, Nancy Burke-Sanow, Molly Kim and Sarah Schandler from the Division of Trading and Markets for the long hours and hard work they have devoted to preparing the recommendations before us.
Thank you, as well, to David Blass and Hope Jarkowski, from the Office of the General Counsel; Tom Kim and Larry Hamermesh from the Division of Corporation Finance, and Scott Bauguess and Eric Carr from the Division of Risk, Strategy, and Financial Innovation.
Now I will ask Robert to provide us with additional details about the Division’s recommendations.