The Securities and Exchange Commission has proposed new rules to enhance its oversight of clearing agencies deemed to be systemically important—meaning that their insolvency could drag down the entire financial system—by the Financial Stability Oversight Council. Included in the proposal are capital requirements, liquidity standards, and ongoing stress tests similar to those conducted at the nation's largest banks.

The Dodd-Frank Act required an enhanced regulatory framework for certain clearing agencies. Building upon previous rules issued in 2012, the new proposal, approved by SEC commissioners on March 12, imposes new requirements for financial risk management, operations, governance, and disclosures to market participants and the public. Also covered by the rule are clearing agencies involved in complex transactions, such as security-based swaps.

“In the end, the buck should stop at the clearing agency,” SEC Commissioner Kara Stein said in a post-vote statement. “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.”

A securities clearing agency acts as a middleman between the parties to a securities transaction. Their services include ensuring that funds and securities are correctly transferred between parties and, in some cases, assuming the risks of a party defaulting on a transaction by acting as a central counterparty. The SEC has overseen clearing agencies since 1975. In 2012, FSOC designated six registered clearing agencies as systemically important. The SEC serves as the supervisory agency for four of them; the CFTC supervises the remaining two.

Under the SEC's plan, a covered clearing agency must establish, implement, maintain, and enforce policies to address risk management. This includes: financial risk management (including credit risk, collateral, margin, and liquidity risk); settlement (including money settlements and physical deliveries); business and operational risk management (including general business risk, custody, and investment/operational risk); access; efficiency (including communication procedures and standards); and transparency.

Procedures to verify the qualifications of directors and senior management are also required, as is ensuring that risk management and internal audit personnel have sufficient authority, resources, independence from management, and access to the board to fulfill their functions effectively. Firms would need to have an independent audit committee.

Similar to the stress tests demanded of banks that are designated systematically important, the proposed rule requires clearing agencies to hold “qualifying liquid resources” sufficient to withstand the default of the participant family that would generate the largest aggregate payment obligation in extreme market conditions. Liquidity holdings can consist of cash or readily available and convertible assets.

Clearing agencies would need to hold a liquid asset buffer, funded by equity and equal to at least six months of current operating expenses, so they can continue operations during a recovery or wind-down. They must also maintain a viable plan – approved by the board of directors and updated at least annually – for raising additional equity should levels fall close to or below the amount required. Daily stress testing, monthly review, and annual validation of credit risk models is required.

While applauding the effort, SEC Commissioner Michael Piwowar said he was not yet “convinced the proposal sufficiently justifies the imposition of the entire package of new requirements.” 

“Many of these requirements would strengthen the regulatory regime governing clearing agencies that fall within the scope of the proposal,” he said. “However, we cannot ignore the significant costs and other economic effects that would result from these new proposed rules.”

The public will have 60 days to comment on the proposed rules, and a set of accompanying questions, after they are published in the Federal Register.