Statement on Clearing Agency Governance and Conflicts of Interest
Aug. 8, 2022
Clearing agencies form critical components of the U.S. financial market infrastructure by facilitating the securities transaction lifecycle. The 2017 U.S. Department of the Treasury Report on Capital Markets emphasized that clearing agencies, and financial market utilities generally, serve a core function in financial market infrastructure:
[b]ecause of the level and concentration of financial transactions handled by [financial market utilities] and their interconnectedness to the rest of the financial system, [financial market utilities] represent a significant systemic risk to the U.S. financial system. Much of this systemic risk is the result of inherent interdependencies, either directly through operational, contractual, or affiliation linkages or indirectly through payment, clearing, and settlement processes.
The Commission’s challenge is achieving the appropriate regulatory framework for clearing agencies. The potential systemic implications flowing from these marketplace functions and financial interdependencies of participants means that a reactive regulatory approach is insufficient. The Commission must proactively identify current and future marketplace risks and work to build a regulatory framework designed to mitigate such risks.
An effective regulatory framework is particularly important given that clearing agencies impact, directly or indirectly, each element of the Commission’s tripartite mission. Earlier this year, the Commission proposed to shorten the standard settlement cycle for equity transactions in the United States to one business day, down from two business days, to further mitigate risks in the clearance and settlement process.
Any clearing agency governance rules, however, should foster competition, promote entry of new firms, reduce concentration of risk, accommodate any differentiating factors between types of clearing agencies, and provide appropriate flexibility for each clearing agency to tailor aspects of its governance provisions to its specific business model. I have concerns that the proposal does not achieve these goals.
First, the rules may limit competition. The release’s economic analysis acknowledges that “registered clearing agency activities exhibit high barriers to entry and economies of scale. These features of the existing market, and the resulting concentration of clearing and settlement services within a handful of entities, informs the Commission’s examination of the effects of the proposed rules on competition, efficiency, and capital formation.” However, the rules proposed today may have the effect of fostering an environment that further limits the number of firms providing clearing and settlement services. The proposed rules may disincentivize new firms from entering this market due to their cumulative effects. For example, the proposed rules include prescriptive provisions related to board composition, risk management functions, and how boards of clearing agencies oversee relationships with service providers for critical services.
Second, the proposal may further increase market concentration risks. The release notes that “registered clearing agencies currently feature specialization and limited competition” and that “there is only one registered clearing agency serving as a central counterparty for each of the following asset classes: exchange-traded equity options (OCC), government securities (FICC), mortgage-backed securities (FICC), and equity securities (NSCC).” To the extent that the proposed rules, if implemented, deter new entrants, then the sole clearing agency handling a particular asset class will be required to take on additional risk as trading volumes grow and become enshrined as a “too big to fail” institution.
Third, the proposal appears overbroad. The proposed rules would generally set governance requirements for all registered clearing agencies, irrespective of status as a covered clearing agency. The proposal supports this approach by stating “[b]ecause all clearing agencies would face these [governance] tensions, the Commission believes it is appropriate to have this governance proposal apply to all registered clearing agencies.” The Commission could have proposed a bifurcated approach with more stringent requirements on the dominant incumbents, while providing more scaling and flexibility for new entrants. This approach, however, was not considered in the release.
Fourth, the prescriptive nature of the proposal does not adequately reflect differences in a clearing agency’s organizational structure or services provided. I am concerned that a “one size fits all” approach to corporate governance, by mandating specific governance structures for all registered clearing agencies, may not take into account current or future differences in the underlying business models of these firms. I am concerned that the proposal rules will result in a “check the box” approach to clearing agency governance that does not effectively address the underlying concerns.
While I am unable to support the proposal, I look forward to the public’s comments, including responses regarding the economic analysis, and whether we can reduce potential systemic risks associated with clearing agencies through governance structural requirements. I thank the staff in the Division of Trading and Markets, Division of Economic and Risk Analysis, Division of Examinations, Division of Corporation Finance, Division of Investment Management, and the Office of the General Counsel for their efforts on the proposal.
 U.S. Department of the Treasury, A Financial System that Creates Economic Opportunity: Capital Markets (Oct. 2017), at 152, available at https://home.treasury.gov/system/files/136/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf. The Treasury Report provides a historical perspective into the development of clearing houses: “[t]he existence of clearinghouses dates back to the late 19th century when they were used to net payments in commodities futures markets. In the United States, the New York Stock Exchange (NYSE) established a clearinghouse in 1892; outside the United States, securities exchanges established clearinghouses later in the 20th century. Central securities depositories, which facilitate the safekeeping of securities, have existed in the United States since at least the 1970s.” Id.
 Certain of these challenges were identified in a recently published article tackling the challenges associated with clearinghouse governance, noting that clearing members are the ultimate risk bearers of the business, but could be a different group than the clearinghouse shareholders for large publicly-listed for-profit financial infrastructure groups. See Paolo Saguato, Financial Regulation, Corporate Governance, and the Hidden Costs of Clearinghouses, 82 Ohio State L.J. 1071 (2022), available at https://moritzlaw.osu.edu/sites/default/files/2022-03/18.%20Saguato_v82-6_1071-1140.pdf.
 Shortening the Securities Transaction Settlement Cycle, Release No. 34-94196, 87 FR 10436 (Feb. 24, 2022), available at https://www.govinfo.gov/content/pkg/FR-2022-02-24/pdf/2022-03143.pdf.
 Clearing Agency Governance and Conflicts of Interest, Release No. 34-95431 (Aug. 08, 2022), at 109 (Clearing Agency Governance Proposal).
 Id. at 4.
 Id. at 109.
 Covered clearing agencies are a subset of registered clearing agencies that provide the services of a central counterparty or central securities depository. See 17 CFR 240.17Ad-22(a)(5).
 Clearing Agency Governance Proposal, at 11.