June 28, 2012
The Dodd-Frank Wall Street Reform and Consumer Protection Act established a comprehensive framework for regulating the over-the-counter swaps markets. Title VII of the Dodd-Frank Act mandates that security-based swap transactions must be cleared through a clearing agency if they are of a type that the SEC determines must be cleared - unless an exception applies.
Essentially, the clearing agency generally acts as a middleman between the parties to a transaction, and assumes the risk should there be a default. When structured and operated appropriately, such clearing agencies can provide benefits such as improving the management of counterparty risk and reducing outstanding exposures through multilateral netting of trades. In other words, by acting as a central counterparty for security-based swap transactions, a clearing agency helps to reduce the risk of cascading harm throughout the financial system in the event a party to a transaction fails to meet its obligations.
Through clearing agencies, regulators also are more easily able to monitor transactions, including prices and positions taken by traders.
Currently, self-regulatory organizations (SRO), including clearing agencies, are required to file with the SEC copies of any proposed rule or any proposed change in, addition to, or deletion from the rules of the SRO. Unless a clearing agency has rules that permit it to clear a security-based swap, it would need to obtain SEC approval of a proposed rule change in accordance with Section 19(b) of the Exchange Act in order to commence clearing an applicable security-based swap.
The Dodd-Frank Act also requires the SEC to adopt rules for setting out the way in which clearing agencies must submit information to the SEC so that the SEC could determine whether such security-based swap is subject to mandatory clearing.
Title VIII of the Dodd-Frank Act provides regulators with enhanced authority over financial market utilities, including clearing agencies that are designated as systemically important by the Financial Stability Oversight Council. In particular, Title VIII requires any such designated financial market utility to provide 60 days advance notice to its Supervisory Agency, such as the SEC, before making any change to its rules, procedures, or operations that could materially affect the nature or level of risk that the entity presents. In connection with this notice requirement, the SEC is required to adopt rules that define and describe when such clearing agencies are required to file notices with the SEC.
Final Rule Regarding Security-Based Swap Submissions
Under the final rule, a clearing agency will be required to file information with the SEC regarding any security-based swap - or any group, category, type, or class of security-based swaps - that a clearing agency plans to accept for clearing. These "security-based swap submissions" will be filed electronically with the SEC using the existing Electronic Form 19b-4 Filing System and Form 19b-4.
The final rule, which amends Rules 19b-4 and Form 19b-4 under the Exchange Act, also describes the information that must accompany each submission so that the SEC will be able to determine whether the security-based swap should be subject to mandatory clearing. This information includes quantitative and qualitative information to assist the SEC in the assessment of the factors set forth under Dodd-Frank Act which the SEC is required to take into account in its review of the security-based swap submission.
The final rule also specifies how the clearing agency must notify its members about the submissions it makes, and requires clearing agencies to post their security-based swap submissions on their public websites within two business days.
Final Rule Regarding Advance Notice by "Systemically Important" Clearing Agencies
The SEC also adopted rules that define and describe when a designated "systemically important" clearing agency must provide advance notice to the SEC before it makes certain changes to its rules, procedures, or operations. As with the final rules regarding security-based swap submissions, such "advance notices" will need to be filed electronically with the SEC using the existing Electronic Form 19b-4 Filing System and Form 19b-4 and must be posted on the clearing agency's public website within two business days.
The final rule will generally require an advance notice when:
The proposed change would affect the risk management functions performed by the clearing agency that are related to systemic risk
- The proposed change could affect the clearing agency's ability to continue to perform its core clearance and settlement functions
Changes that could require advance notice may include, but are not limited to, changes that materially affect participant and product eligibility, risk management, daily or intraday settlement procedures, default procedures, system safeguards, governance, or financial resources of the designated clearing agency.
Changes that may not require advance notice include, but are not limited to, changes concerned solely with the administration of the designated clearing agency.
Clearing agencies can file one form to meet the various SEC filing requirements contemplated by Form 19b-4 as long as the clearing agency meets the individual requirements of each applicable regulatory scheme.
Additional Final Rules
In addition to the matters described above, the final rules also:
Establish the procedure by which the SEC may stay the mandatory clearing requirement at the request of a counterparty to the security-based swap or on the SEC's own initiative
Seek to prevent evasion of the clearing requirement by clarifying that clearing needs to occur through a central counterparty
- Make form and rule changes to reflect new deadlines under the Dodd-Frank Act for proposed rule changes by self-regulatory organizations
Most of these new rules become effective 30 days after the date of publication in the Federal Register. However, the amendments to Form 19b-4 and the requirement to submit security-based swap submissions and advance notices electronically using the Electronic Form 19b-4 Filing System and Form 19b-4 will not become effective until December 10, 2012. Until such date, clearing agencies will be required to make these filings by sending them to a dedicated electronic mailbox established by the SEC.
In addition, Title VII of the Dodd-Frank Act provided that security-based swaps listed for clearing by a clearing agency as of July 21, 2010, were deemed to have been submitted to the SEC for review as to whether such security-based swaps should be subject to mandatory clearing. Sixty days after the date the SEC issues its first written determination with respect to these security-based swaps, a clearing agency will be required to make submissions with respect to all security-based swaps that were listed for clearing after July 21, 2010, and, going forward, whenever a clearing agency plans to accept a new security-based swap for clearing.
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