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Statement on the Proposal of Rules Related to Registered Clearing Agencies

Commissioner Kara M. Stein

March 12, 2014

Today, the Commission considers changes to the regulation of registered clearing agencies. I want to echo my colleagues’ thanks to the staff who have worked on this proposal, in particular Katherine Martin and Narahari Phatak.

After the “back office” crisis of the late 1960s and early 1970s, Congress directed the Commission to establish a safe, sound, and efficient clearance and settlement system.[1] Nearly forty years later, we have seen the need for sound clearance and settlement processes in a new area: derivatives.

Derivatives contracts transfer various types of risk from one party to another. But, for these contracts and the market to work properly, the parties need to know that their counterparties will make good on their end of the bargain.

During the financial crisis, that essential premise of the market dissolved. Solvency and liquidity concerns for some of the largest financial firms in the world translated into a counterparty credit risk panic that spread throughout financial markets and destabilized firms and businesses around the globe. No one knew what their counterparties’ risks were, or whether they could pay off their obligations. The financial markets seized up as firms sought to minimize their counterparty credit risks.[2] And lending came to a standstill. This was systemic risk.

The Dodd-Frank Act sought to mitigate counterparty credit risks by establishing a regime where most security-based swaps would be cleared, and the clearing agencies would be supervised by the Commission.

For decades, centralized clearing has been a part of the securities markets, bolstering market integrity. As these common-sense practices are brought to the derivatives markets, we must be careful.

We must ensure that clearing agencies have the tools and the will to assess appropriate margin requirements. We must ensure that clearing agencies involved in securities-based swaps appropriately address the risks inherent in the products that they clear. Under the proposed rules, clearing agencies that meet the definition of “covered clearing agencies” or those that are designated as systemically important or have a more complex risk profile, would be subjected to heightened standards to ensure that they do not become nodes of systemic risk transmission.

And we must ensure that clearing agencies don’t distort the markets. Fair competition among brokers and dealers, and between and among exchange markets and other markets has long been a guiding principle for the Commission. [3] Clearing agencies should implement standards to ensure fair and open access.

All of these demands require the clearing agency to have strong governance. Risk management and modeling can only be effective when built on a foundation of sound governance using appropriate incentives. Risk limits and stress tests are of limited use if management will simply disregard them.[4] Effective risk management needs to be strong enough to withstand pressures from both within the clearing agency and from outside the clearing agency.

In the end, the “buck” should stop at the clearing agency. The clearing agency needs to employ a comprehensive framework to manage all of its risks: financial, legal, and operational. Without appropriate incentives and controls, all market participants and ultimately the American taxpayers could get caught up in a tidal wave of risk that cascades through the financial system.

These issues are complex. And I’m sure that there are several elements of the proposed rule that we should refine and improve over time. But we should not let the perfect be the enemy of the good. The proposal before us is a strong step forward, and I think the Commission will benefit from comment on it.

I look forward to everyone’s views on the proposal.

[1] 15 U.S.C § 78q–1

[2] Kate Kelly, Fear, Rumors Touched Off Fatal Run on Bear Stearns, 2008 Wall Street J., May 28, 2008;

Brian Burrough, Bringing Down Bear Stearns, Vanity Fair, August 2008.

[3] 15 U.S.C. § 78k-1(a) (2006)

[4] For example, the Lehman Brothers examiner found that the role of risk limits and stress tests were of limited utility when Lehman management “chose to disregard or overrule the firm’s risk controls on a regular basis.” Report of Examiner Anton R. Valukas, In re Lehman Brothers Holdings, Inc, etal, Volume I - United States Bankruptcy Court Southern District of New York - March 11 2010, at 49.

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