Dissenting from Stakeholder Governance for Clearing Agencies
Aug. 8, 2022
Clearing agencies and other clearinghouses play a central role in our financial markets. That role continues to increase as market participants and regulators look to these entities to mitigate and manage risk. Accordingly, as the proposing release recognizes, how clearinghouses are governed and managed matters. The proposal takes an overly prescriptive, regulator-knows-best approach to these matters that risks diluting the duties of directors to the clearing agency and depriving clearing agencies of the flexibility and expertise needed for effective governance.
The Commission’s approach manifests a common regulatory tendency: market participants set up an effective market infrastructure on their own initiative because it will improve the market; the government, noticing the efficacy and importance of this private infrastructure, pulls it into the regulatory fold and forces all market participants to use it; regulatory mandates displace the market incentives that used to drive risk management and may sow the seeds for a shift away from member ownership; and the regulatory mandates get more prescriptive over time, or, as the proposing release puts it, an “incremental evolution of the . . . regulatory framework” happens.
That evolution continues today with a proposed set of governance requirements. The proposal would require in most cases that a majority of a registered clearing agency’s directors be independent. A director generally would be independent under the proposed rules if she has no material relationship with the registered clearing agency, or any affiliate thereof. The proposal would require each registered clearing agency to have a nominating committee composed of a majority of independent directors and to have in place a written process for evaluating nominees against written fitness standards. The proposal also would require each registered clearing agency to have a risk management committee that may need to meet the independence requirements, also has owner- and participant-affiliated members, is regularly reconstituted, and is “able to provide a risk-based, independent, and informed opinion on all matters presented to it for consideration in a manner that supports the safety and efficiency of the registered clearing agency.”
In addition to board composition requirements, the proposal would impose requirements intended to address other governance concerns. The proposal would require each registered clearing agency to have written policies to identify conflicts of interest so that the clearing agency can reduce or eliminate them. Directors would have a corresponding obligation to report potential conflicts without a materiality threshold. The proposal also would require each registered clearing agency to establish, implement, maintain, and enforce policies regarding critical service provider risk management. Each registered clearing agency would also have to implement, maintain, and enforce written policies and procedures reasonably designed to solicit, consider, and document its consideration of the views of participants and other relevant stakeholders of the registered clearing agency regarding material developments in its governance and operations on a recurring basis.
The proposal is puzzling for a number of reasons. First, in 2016, when the Commission finalized rules establishing standards for a subset of clearing agencies, it expressly rejected the suggestion from several commenters that it impose a director independence requirement. It acknowledged that including public or independent directors on the board “could be one way” or “one possible approach” to achieve the fair representation requirement set forth in Section 17A of the Exchange Act but concluded that it was unnecessary to further specify requirements for the composition of clearing agency boards, noting that “these topics . . . are already addressed” in that paragraph (b)(3)(C) of that section. Today’s proposing release, attempting to explain the change, notes that:
given the growing concentration of clearing and settlement participants among a small number of firms and the concentration of differing perspectives into distinct groups of clearing agency stakeholders, the Commission believes it is appropriate to propose requirements on independent representation to facilitate the consideration and management of diverse stakeholder interests in the decision-making of the clearing agency.
It is unclear what this observation means or how it relates to the proposed requirements. Moreover, the reference to facilitating the board’s “consideration and management of diverse stakeholder interests” is ominous. An independent director mandate sounds good because it resembles what we require in many other contexts, but clearing agencies operate best when a visceral awareness of the consequences of failed risk management drives the board’s decision-making. Focusing on stakeholder interests sounds expansive and inclusive, but an embrace of diffuse interests might distract the board from the dry but extremely important task of risk management. The Commission asserts that “The appearance of conflicts of interest can reduce confidence among direct and indirect participants, other stakeholders, and the public in the functioning of the clearing agency, particularly during periods of market stress when general confidence in market resilience may be low,” but it seems more likely that a board distracted by a cacophony of stakeholders and hobbled by a lack of expertise will reduce market confidence during periods of market stress.
Second, Exchange Act Section 17A(b)(3)(C) suggests that the Commission’s role with respect to the composition of the board extends to ensuring “fair representation of its shareholders (or members) and participants.” The proposed rule would impose requirements that go well beyond those contemplated by the statute while not even ensuring that clearing agencies satisfy the fair representation standard set out in Exchange Act Section 17A(b)(3)(C). Although an employee of a participant could serve as an independent director, the rule does not guarantee that any owners or participants have affiliates on the board. The proposal turns what seems to be the statutory focus—ensuring that owners and participants are both key players in overseeing management—on its head by making it possible that directors drawn from owners and participants will represent only a minority of directors.
Third, the proposal would send boards running off in multiple directions, rather than keeping them singularly focused on the clearing agency’s well-being. The proposal seems to expect that directors will make decisions to further the interests of a constituency that they represent. That notion seems at odds with the fiduciary duty of a director to the entity on the board of which she sits. Just as with any company, a director of a clearing agency should not be “motivated by the needs of” any stakeholder other than the clearing agency. The proposal also explicitly would require clearing agencies “to obtain and consider the views of a diverse cross-section of their participants and stakeholders, who will likely bear any of the losses incurred as a result of the clearing agency’s decisions with respect to its governance and operations.” The release identifies participants’ customers and securities issuers as stakeholders that should be consulted. The Commission likewise requires that “the nominating committee consider the views of other stakeholders who may be impacted by the decisions of the registered clearing agency, including transfer agents, settlement banks, nostro agents, liquidity providers, technology or other service providers.” As already noted, Exchange Act Section 17A(b)(3)(C) appropriately focuses on governance by those who have a direct interest in effective operation of the clearing agency—its “shareholders (or members) and participants.” The Commission’s attempt to “complement” the statute with its solicitude toward “stakeholders” blurs this appropriately narrow focus established by Congress by insisting that the boards look to the interests of a diffuse group of stakeholders who may be only indirectly affected—if they are affected at all—by clearing agency operations.
Finally, compliance with the requirement that risk management committees be able to provide risk-based, independent, and informed opinions will be difficult to examine and enforce. A better way to facilitate the formation of competent risk management committees would be to avoid constraining unnecessarily boards’ ability to constitute their risk management committees. As one example, the proposed requirement to reconstitute the risk management committee periodically could be dropped.
Designing effecting clearinghouse governance is a difficult task. While I do not support the proposal, I welcome the thoughts of commenters on the proposal and the issues I have raised. I will take the comments into account as I continue to think about what effective clearinghouse governance looks like and what the role of the Commission should be in shaping it. These questions are not easy to resolve and have been a matter of debate for many years.
Thank you to staff throughout the Commission. In addition to their hard work on the proposal, the staff in the Office of Clearance and Settlement in the Division of Trading and Markets and the Division of Examinations work hard every day to ensure that registered clearing agencies are fulfilling their important function in the markets.
 Clearing Agency Governance and Conflicts of Interest, Exchange Act Rel. No. 95431 (Aug. 8, 2022) (“Release”), at 23.
 The proposed rules would establish a lower threshold for the number of independent directors for clearing agencies that are majority owned by participants. See Release at 56.
 The policy discussion in the release and the proposed rule text are not entirely clear on this point. Proposed Rule 17Ad-25(c) clearly requires a majority of the nominating committee to be independent directors, and the release discusses these requirements. See Release at 66-67. Paragraph (d) of the proposed rule addresses requirements applicable to the risk management committee, but the only requirement related to composition of the committee is that it must “include representatives from the owners and participants of the registered clearing agency.” Paragraph (e) imposes a minimum independent director threshold on any committee that “has the authority to act on behalf of the board of directors.” Request for Comment 24 asks whether the Commission should exclude the risk management committee from paragraph (e) “so that a registered clearing agency would not be required to include independent directors on the committee.” Release at 81.
 Release at 73.
 Standards for Covered Clearing Agencies, Exchange Act Rel. No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016) (“CCA Standards”).
 CCA Standards, 81 FR at 70804.
 Release at 36.
 Id. at 40.
 In 2016, the Commission concluded that a clearing agency could fulfill the requirements of this provision in part by including public or independent directors on its board, but as noted above it did not assert that the statute required their inclusion. See CCA Standards, 81 FR at 70804.
 The release is silent on this question, but the proposed rule does include a provision, as noted above, that would require owner and participant representation on the risk management committee. See proposed Rule 17Ad-25(d)(1).
 See, e.g., Release at 46 (“As long as a majority of directors are not solely motivated by the needs of one category of stakeholders, this structure can help ensure that the board addresses the full set of owners and participants, even smaller participants, in fulfilling these statutory objectives.”).
 Id. at 100.
 See id.
 Id. at 64.
 Id. at 69