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Statement on Adoption of Rule on Standards for Covered Clearing Agencies and Proposal on Amendments to Related Definitions

Commissioner Kara M. Stein

Sept. 28, 2016

I would like to thank the staff for their hard work in bringing these recommendations to the Commission, including Jeffrey Mooney, Stephanie Park, Matthew Lee, Elizabeth Fitzgerald, DeCarlo McLaren, Gena Lai, Carson McLean, Roy Cheruvelil, Hari Phatak, Parul Sharma, Robert Teply, Donna Chambers, and Paula Sherman.
Today, the Commission is considering two staff proposals related to systemically important clearing agencies.  The first is a final rule adopting standards for systemically important clearing agencies.  The second is a proposal to amend some of the definitions before us in the first proposal. 
In the late ‘60s and early ‘70s, Wall Street nearly ground to a halt because manual back office processes could not keep up with the increasing volume of securities transactions.  Clearance and settlement problems led to the failure of numerous broker dealers.[1]  To resolve what became known as the “paperwork crisis,” Congress directed the Commission to establish a safe, sound, and efficient clearance and settlement system.  Importantly, this system was to have “due regard for the public interest, the protection of investors, the safeguarding of securities and funds, and maintenance of fair competition.”[2]  
Clearing agencies became a central part of this new system.  They stood in-between market participants helping to ensure securities were efficiently transferred and paid for.  They also improved investor confidence by providing a financial backstop for cleared securities transactions. 
Then in 2008, our nation experienced another crisis which almost brought the financial system to its knees.  Concerns about the liquidity of some of the largest financial firms in the world caused market participants to question whether these firms could meet their financial obligations. This worry spread throughout the financial markets and destabilized firms and businesses around the globe. The financial markets seized up as firms sought to minimize their counterparty risk exposure.
In response to this crisis, Congress again passed legislation—in this case, the Dodd-Frank Wall Street Reform and Consumer Protection Act.  In particular, Title VII and VIII of the Act were designed to improve and enhance our markets’ clearance and settlement systems.  To address concerns about counterparty risk, these two sections of the Act sought to increase the use and effectiveness of clearing agencies that stand in the middle of financial transactions.  However, while clearing agencies can help mitigate concerns about the solvency of individual counterparties, they can also potentially concentrate risk.  As a result, Congress directed in Title VII that the Commission establish standards for security-based swap clearing agencies.  And Title VIII directed the Commission to adopt risk management standards governing systemically important clearing agencies.  Much like building codes, these standards are supposed to prevent or mitigate the spread of a fire.  Congress did not want clearing agencies to be nodes of risk that could cause a new financial conflagration. 
History has shown us how important well-run clearing agencies are to the healthy functioning of our markets.  This is not an area where we can afford to be lax.  We need to have clear, enforceable standards for clearing agencies to ensure they do not facilitate the transmission of risk and that the clearance and settlement of securities can continue unimpeded even in stressed markets. 
This is what worries me about the standards being adopted today.  While they are somewhat additive to the requirements that already exist, they simply fall short.  There is too much wiggle room.  “Standards” for systemically important clearing agencies should be clear and unambiguous. 
For instance, the rule before us requires that covered clearing agencies who are clearing the most complicated and riskiest financial products use models to figure out what will happen when the markets experience stress.  This sounds good.  However, the rule qualifies this requirement.  It says such analysis only needs to be done when “relevant” or “where practical.”  These terms are vague and left for the clearing agencies to interpret.  This is like requiring a construction company that is building a skyscraper to only comply with the building standards it wants to follow.  This does not necessarily take into account what is in the public interest or good for the community or surrounding buildings.   
Although I believe this rule should have been stronger, and I tried to make it so, this rule is long past due.  It has been 8 years since the financial crisis and 6 years since Congress enacted the Dodd-Frank Act.  Therefore, I will vote for this rule today, but only because it marginally decreases the risk posed by systemically important clearing agencies.
Which leads me to the second rulemaking—the proposal on definitions related to clearing agencies.  This release re-proposes certain definitions contained within the covered clearing rule I have been discussing.  However, it also could have provided a means to improve some of the weaknesses I just discussed.  This is a missed opportunity to strengthen our oversight of systemically important clearing agencies so that they can better withstand market disruptions and panics.  I invite commenters to use this proposal to comment on ways we can improve our clearing agency standards going forward.
Thank you.
[1] See, e.g., Commission, Study of Unsafe and Unsound Practices of Brokers and Dealers, H.R. Doc. No. 231, 92d Cong., 1st Sess. 13 (1971).
[2] 15 U.S.C. § 78q-1(a)(2)(A).
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