Futures h&dustrv Association
2001 Penn. Vlv, viis Avc NW 202 466 6460
, &ulic 600 &
07 &'76 11H4 (ix
W i&bin ion, IX'. 7000(& 1821 iuiiii' iuullcsli&dilsuy llx
F/A
November i 7, 2010
Mr. David A. Stawick
Secretary
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21"Street, N. W.
Washington, D. C. 20581
Ms. Elizabeth M. Murphy
Secretary
Securities and Exchange Commission
100 F Street, N. E.
Washing1on, D. C. 29549-1090
Re: Proposed Limits on Ownership or Voting Power of Derivative Clearing
Organizations, Designated Contract Markets, and Swap Execution Facilities—
75 Fed. Reg. 63732 (October 18, 2010)
Ownership Limitations and Governance Requirements for Security-Based
Swap Clearing Agencies, Security-Based Swap Lxecution Facilities, and
National Securities Exchanges with Respect to Security-Based Swaps Under
Regulation MC —Exchange Act Release 63107
Dear Mr. Stawick and Ms. Murphy:
The Futures lnduslry Association ("F1A'*) is pleased to submit this letter in response to the
requests for comment with respect to the rule proposals by the Commodity Futures Trading
Commission ("CFTC") and the Securities and Exchange Commission ("SFC" and, together with
the CFTC, the "Commissions" ) regarding con11icts of interest with respect to derivalives clearing
organizations ("DCOs**), designated contract markets ("DCMs"), swap execution facilities
("SEFs"), clearing agencies that clear security-based swaps ("securities clearing agencies*'),
security-based SEFs and nalional securities exchanges that post or make available security-based
swaps for trading.
FIA is a principal spokesman for the commodity futures and options industry. FIA's regular membership is
comprised of approximately 30 of the largest futures commission merchants in the United States. Among 1&IA's
assoc&ate members are representatives fiom virtually all other segments of the futures mdustry, botit national and
international. Reflccting the scope and diversity of its membership, FIA estimates that its members effect morc than
etghty percent of all customer transactions executed on United States contract markets.
Mr. David A. Stawick
Ms. F lizabeth M. Murphy
November 17, 2010
Page 2
FIA acknowledges lhat clcaringhouses and SEFs may from time to time be confronted with
conflicts between the advancement of their own commercial interests and the goals thai are
intended io be advanced by the Dodd-Frank Wall Street Reform and Consumer Protection Act
("Dodd-Frank" ). We nonetheless respectfully submit that the adoption of restrictions on the
ownership of clearinghouses and SFFs is inappropriate, at least at this time. In particular, FIA
notes that Sections 726 and 765 of Dodd-Franl& expressly provide that the adoption of ownership
limits is permissive, rather than mandatory, and further provide for thc adoption of rules only if,
after review, the Commissions dc1ermine that such rules are necessary or appropriate to improve
governance, mitigate systemic risi&, promote competition or mitigate conflicts of interest.
Further, and as the Commissions noted in their respective rule proposals, the Commissions are
authorized and required by other provisions of Dodd-1 rank to take steps to ameliorate conflicts
of interest, including through their review of the tmlcs of DCOs and securities clearing agencies
(collectively, "clearinghouses") and the rules of SEFs and security-based SEFs (collectively,
"SEFs"). FIA accordingly believes it is inappropriate for the Commissions to adopt the proposed
ownership restrictions bel'ore they have the benefit of the experience they will gain from the
implementation of those other rules. Finally, FIA believes that the adoption of the ownership
restrictions in the form in which they were proposed is potentially counter-productive because
they are likely to inhibit the I'ormation of new clearinghouses and SFFs and will concentrate risk
in the existing clearinghouses.
FIA accordingly urges the Commissions io defer any further consideration of thc proposed
ownership restrictions until the Commissions have had 1he opportunity to gain experience with
the implementation of the new regulatory regime that is mandated by Dodd-Frank. If the
Commissions nonetheless conclude that they must adopt ownership restrictions at Ibis time, FIA
believes that the Commissions should include in their regulations a mechanism for
clearinghouses to request and obtain waivers of those requirements where appropriate.
FIA supports that aspect of the Commissions' proposals that would require tlaat at least 35% of
the Board of Directors of a clearinghouse or SEF be public directors. FIA further supports thc
Commissions' proposals 1o expressly provide that employees of a member of a clearinghouse or
SEF member or participant, as well as employees of the clearinghouse or SEF itself, will noi be
deemed to meet the independencc standards that are required for public directors.
' FIA has
serious reservations, however, about that aspect of thc Commissions' proposals that would
require a clearinghouse to set aside a substantial portion of its Risl& Management Committee or
Risk. Committees (hereafter, "Risk Management Comnflttee") for public directors (and, in the
case of the CFTC proposal, customer representatives). FIA is conccmed that public directors
2
The CETC and SEC proposals respectively refer to "public" and "independent'* directors. Unless othcrvrise
indicated, references in this letter to "public directors'* are intended to refer to both "public directors" and
"independent directors" as those terms are used in the Commissions' respective proposals
Mr. David A. Stawick
Ms. Flizabeth M. Murphy
November 17, 2010
Page 3
and customer representatives, who can provide meaningful knowledge and insight when serving
on the Board of a DCO or SEF, will typically lack ihc specialized knowledge and hands-on
experience with margin and other risk systems (and, potentially, with the management of a
clearing member default) that should be prerequisiies to service on a Rislc Management
Committee.
FIA's concerns are ameliorated of the CFTC's proposal that would exempt
in pari, by that portion
the Risk Management Committee fiom these rcquiremcnts if a Subcommittee of the Risk
Management Committee is given the initial authority to establish membership eligibility criteria,
approve (or deny) applications for membership and determine which products should be eligible
for clearing, and we recommend that the SEC malce a similar alternative available to the
securities clearing agencies. As discussed in greater detail below, however, FIA believes
strongly that the criteria for service on the Risk Management Committee (including a
Subcommittee thereof) need to be qualitative rather than quantitative, and that it would be a
mistalce to impose rigid quotas that are unrelated to the management of risk. FIA accordingly
urges the Commissions to omit fiom their final rules the rcquircmcnts, currently contained in one
or both of the Commissions' proposals, that 35% or morc of the Risk Management Committee
and any Subcommittee thereof be composed of public directors, thai an additional 10% of the
Committee or Subcommittee be representatives of customers, and that the Chair of the
Committee or Subcommittee be a public director.
"I'he Cominisslonsi Proposals.
The Commissions' proposals would impose limits on the ownership of DCOs, securities clearing
agencies, SEFs, securities-based SEFs, DCMs and national securities exchanges. Specifically,
the Commissions' respective proposals would place strict caps on the amouni of voting equity
interests that can be held by one or more specified categories ol'marlcet participants:
e SEFs would be required to take steps to prohibit any of their members or participants
(together with any such member*s or participant's "related persons*') from owning more
than 20% of the voting equity in the SEF.
e Clearinghouses would be required to elect one of two alternative sets of restrictions. The
first would impose a 20% limitation on the voting equity that any single member or
participant in the clearinghouse may own, coupled with an aggregate 40% limitation on
the voting equity that may be held by clearinghouse members or participants. (The
CFTC — but not the SFC — would additionally apply thc 40% cap to "enumerated
"
entities, without regard to whether the enumerated entities are members of the DCO. i)
3
The CFTC and SEC proposals respectively use tbe terms "enumerated entity" and "speciiicd cniity" to
mean' . (i) a bank holding company with total consoiidatcd assets of SSO billion or morc; (ii) a nonbank financial
company that is supervised by the Board of Governors of the Federal tteservc System; (iii) an affiliate of such bank
holding company or nonbanic financial company; (iv) as applicable, a swap dealer or security-based sv, ap dealer;
and (v) as applicable, a major swap participant or major security-based sv. ap participant. The CFTC definition
(cont. )
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 4
In the alternative, a clearinghouse could adopt a 5% cap on the voting equity that could
be held by any of its members or participants or, under the CFTC proposal, by any
enunierated entity.
The Commissions have additionally proposed rules that would establish minimum requirements
for the participation of public directors on the governing boards and the key operating
commi1tees of clearinghouses and SEI's. This requirement would be augmented in its
application to thc Risk Management Committee of a DCO, which would additionally be required
1o reserve its Chair for a public director and allocate 10% of its seats to customer representatives,
The Commissions have explained that their proposals are intended 1o lacilitate the
implementation of the new regulatory framework that is created by Dodd-Frank by seeking to
mitigate the conflicts of interest that a clearinghouse may confront when de1ermining (i) tv hether
a swap or security-based swap is capable of being cleared, (ii) the minimum criteria that an
applicant must satisfy in order to become a swap or security-based swap clearing member, and
(iii) whether a particular applicant satisfies such criteria. Thc Commissions have further
explained that their proposals are intended 1o address the potential conflicts of interest that may
arise as a SEF balances its commercial interests and its self-regulatory responsibilities.
The Commlssloiis Should Vttithdraw or Defer ihe Proposed Ownership Restrictions.
FIA believes that the adoption ol' ovvncrship restrictions —and, in particular, the 40'!c aggregate
ownership restrictions that have been proposed for clearinghouses — are likely to have
miintended and undesirable consequences. FIA accordingly recommends that the Commissions
withdraw or, at a minimum, defer any consideration of Ihe ownership restrictions that are
authorized by Sections 726 and 765 until such time as they have had experience with the
implemen1ation of the new Commodi1y Exchange Act ("CEA*') core principles for DCOs and
SFFs and thc comparable provisions of the Securi1ies Exchange Act of 1934 ("Exchange Act**)
that are applicable to securities clearing agencies and security-based SEFs.
Dodd-PkanhDoes ittat Mandat~ the yidoption of OwnershipLiinits.
Sections 726 and 765 of Dodd-Frank do not require the Commissions to restrict the ability oi
market participants to hold significant ownership interests in clearinghouses or SEFs. The
so-called "Lynch Amendment, '* which would have imposed an aggregate limit of 20% oli swap
dealers' ownership of clearinghouses or SEFs, was included in earlier versions of the House bill.
Those limits were not included in thc final version of Dodd-Frank that was enacted by Congress
and signed into law by the President, however, and the floor colloquy between Congressmen
additionally includes an associated person of a swap di:alar or major swap participant. References in this letter to
"enumerated entities" are, therefore, intended to apply equally to "specified entities. "
4
The Commission's proposals would apply comparable restrictions on thc voting rights that can be held by
those market participants. In the interest of simplicity, this letter focuses primarily on the ownership restrictions, but
our comments should be read to apply equally to ihe proposed restrictions on voting rights.
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
Xiovember 17, 2010
Pttge 5
Frank and Lynch 8 and subsequent correspondence from Members of Congress to Chairman
Gensler and Chairman Shapiro do not change the fact that any ownership restrictions thai may
ultimately be adopted by the Commissions are permissive and noi mandatory.
The statutory language is clear: the Commissions are authorized to adopt rules imposing limits
on ownership only if they first determine, after review, that such rules are necessary or
appropriate to improve the governance of clearinghouses or SEFs, or to mitigate systemic risk,
promote competition, or mitigate conflicts of interest. ' The CFTC is separately charged with the
responsibility io adopt rules that give efl'ect to the core principles for DCOs and SEFs (Dodd-
Frank Sections 725(c) and 733); the SEC has comparable requirements in respect of securities
clearing agencies and security-based SEFs (Dodd-Franl& sections 763(b) and 763(c)). We do not
view the existence of these independent requirements as a justification for the adoption of the
proposed ownership restrictions. To the contrary, we believe ii is clear that Congress envisioned
that these requirements would be implemented independently, without regard io whatever action
might ultimately be taken by the Commissions after the review that is required by Sections
726(b) and 765(b) of Dodd-Frank. '
The Commissions note in their respective proposals that they are required to adopt rules to give
effect to Sections 726 and 765 by January 17, 2011 (180 days after the enactment of Dodd-
Frank). 8 While the Commissions clearly are required to adopt rules pursuant to Sections 726 and
765 by January 17, it is equally clear that nothing in Sections 726 and 765 (or, for that matter,
anywhere cise in Dodd-Frank) requires the Commissions to adopt ownership restrictions at any
time, much less before that date, and that the Commissions remain free to return to that subject in
the future after implcmcnting, and gaining experience with, the conflict mitigation and otlncr
rules that they will adopt pursuant to Dodd-Frank Sections 725(c) (DCOs), 733 (SEFs), 763(b)
(securities clearing agencies) and 763(c) (security-based SEFs).
See 75 Fed. Reg. 63732, 63732 n. 5 (October 18, 2010).
Dodd-Frank Sections 726(b), 765(b).
7
In this regard, wc note that thc European Conunission's Proposal fr&r rz Rcgzziariozz of the European
Pvriizimear and of zhe Cvuzzcii vn OTC Der ii&olives, Cemrai Couzzrerporries, nnd Trade Depositories concluded that
ownership limitations were unnecessary, but that structural governance requncmcnts, such as those that would be
adopted under Sections 725(c), 733, 763(b) and 763(c) of Dodd-Frank, "are considered more effective in addressing
any potential conllicts of interest that may limit the capacity of (central counterparties ("CCPs*')j to clear, than any
other form of regulation which may have undesirablc consequence on market structures (e.g. , limitation of'
ownership, which would need to extend also to so-called vertical structures in which exchanges own a CCP). See "
75 Fed. Rcg. 63732, 63743 n. 78 (October 18, 2010).
75 Fed. Reg. 63732, 63733 (October 18, 2010) (CFTC); 75 Fed. Rcg. 65882, 65884 (October 26, 2010)
(SEC).
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 6
'
Tlze Commissions Proposals Overlook lnzportant Coulztervailing Considerations.
The Commissions' proposals reflect the assumption that clearing members and the enumerated
entities have an overriding economic incentive to limit the products that a DCO or securities
clearing agency will clear and, by extension, the products that are subject to mandatory trading
on a SEF or DCM (in the case of swaps) or on a security-based SEF or national securities
exchange (in the case of security-based swaps). In particular, the Federal Register notices that
accompany the Commissions' respective rule proposals note that over-the-counter ("OTC")
markets tend to provide informational advantages to swap dealers relative to their end-user
customers and go on to conclude that swap dealers, therefore, have an economic incentive to
restrict the products that 01ay be accepted for clearing by a DCO or securities clearing agency. s
This overlooks the fact that swap dealers and enumerated entitics have substantial incentives
under thc applicable capital rules to submit their hades to a clearinghouse. Specifically, under
Basel 11, derivative transactions that are traded on exchanges that require daily payment and
receipt of cash-variation margin may be excluded altogether (rom the risk-based capital
lo
requirements. Furthermore, a banking organization may attribute an "exposure at default" of
zero (effectively, a zero risk weight) to outstanding derivative transactions and any associated
clearing fund deposits and collateral with a "qualifying central counterparty" (i. e. , a
11
clearinghouse). Swap dealers and other enumerated entities, thcreforc, will have a significant
incentive to submit their trades to a clearinghouse that outweighs any potential pricing advantage
they might gain by trading in the OTC marftets.
It further appears that the Commissions may not have adequately considered to the very real
prospect for competition between and among the existing clearinghouses. I'or example, and as
default swaps ("CDS"). "
noted by the SEC in its proposal, five clearinghouscs were authorized by the SEC to clear credit
It is true that only two of those clearinghouses, each of which is
owned in substantial part by swap dealers, have been successful in doing so. It would be a
mistake to generalize from that experience, however, because there is reason to believe that the
success of those clearinghouses was attributable primarily to their development of a robust and
specialized inliastructure that was uniquely related to CDS clearing. In any event, I'IA believes
that the vigorous competition that will be fostered by Dodd-Frank (which includes a requirement
that DCOs and securities clearing agencies provide comparable treatment to economically
equivalent instruments) will facilitate robust competition between and among the DCOs and
securities clearing agencies that are seel&lug to clear over-the-counter products, without regard to
their ownership.
75 Fed. Reg. 63732, 63734 (October 18, 2010); 75 Fed. Reg. 65882, 65885 (October 26, 2010).
10
12 C.F.R. Parts 208 and 225, Appendix A, section llLE. t. e.
li
See 12 C.F.R. Part 208, Appendix F; 12 CFR Part 225, Appendix G. The Bascl Committee on Banking
Supervision has indicated it v ill bc revisiting this treatment.
12
75 Fed. Reg. 65882, 65884 n. l7 (October 26, 2010).
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 7
As discussed more fully below, we further believe that the adoption of ownership restrictions
could have the unintended effect of inhibiting, rather than enhancing, competition. If the
Commissions nonetheless believe that ownership restrictions are necessary, FIA would urge the
Commissions to evaluate all types of ownership anangements and consider whether any
restrictions that may be adopted should apply noi only to enumerated entities and members of the
clearinghouses, but also to other potential forms of concentrated ownership, such as sovereign
wealth and private equity funds and clearinghouses that are owned by one or more exchanges.
The Ownership Restrictfotzs Would Create Barriers to Llztry and, ThereJore, Would Be Contrary
to the Public Interest and tize Purposes of Dodd-Frank.
The vast preponderance of the resources backing a clearinghouse typically arc supplied by
clearing members. ' This required commitmcnt of funds is over and above ihe operating capital,
13
intellectual property and human resources that are required to form and operate a clearinghouse.
A new entrant in these markets, therefore, needs to raise sufficient capital from its founders and
initial clearing members to be a credible alternative to thc established clearinghouses.
Given these business realities, it is impractical to think that market participants will make thc
substantial contributions of capital and other properly that are required to form a new
clearinghouse if they cannot be assured a substantial and meaningful role in its governance and
operations. For its part, the CFTC has acknowledged that ihe enumerated entities are the most
likely source of funding for new DCMis ancl SEFs and indicated that. "the benefits ol slisttdnecl
competition between new DCMs and SEFs outweigh the incremental benefit of better
governance through limitations on the aggregate influence of the enumerated entities. »14 FIA "
believes that same rationale applies with evml greater force to the clearinghouses. Given that
there are likely io be only a small number of new clearinghouses, 13 it is especially important that
~
the Commissions not create additional barriers to entry in this vitally important segment of the
marketplace.
For all of the foregoing reasons, FIA believes that the Commissions should not adopt the
proposed ownership restrictions, at least not until the Commissions have had an opportunity to
13
As an example, ihe combined security deposits (i. e. , guaranty fund contributions) anil guaranty fund
assessmcnt liabilities of Chicago Mercantile Exchange ("CME") clearing members totals more than $8 billion; CME
guaranty
gsi 8 Thi h,
stockholders, by comparison, have only $100 million at risk if a futures clearing member were to default. See
funds and assessmcnt liabilities arc typically far greater than the stockholders'
I „
I dgh
equity ui those
clcaringhouses.
75 Fed. Reg. 63732, 63745 (October 18, 2010).
13
The SEC has indicated that it does not expect there to be a large number of securities clearing a encies that
clear security-based swaps, based on tire significant level of capital and other tniancial resources necessary for the
formation of a clearing agency. 75 Fed. Reg. 65882, 65915 n. 192 (October 26, 2010).
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 8
implement and monitor the workings of the new regulatory framework that has been created by
Dodd-Franlq including the review that is required by Sections 726(b) and 765(b) of Dodd-Frank.
ytzzy Ownership Restrictions That May Be ztdopted Should Be Moderated.
If the Commissions nonetheless decide to adopt ownership restrictions at this time, FIA would
urge the Commissions to increase the permitted ownership ceilings to levels that will encourage
market patxicipants to invest substantial amounts of capital in new clearinghouses. In this regard,
we would ask that the Commissions recognize that the domestic DCOs generally are owned (i)
directly by their members and paixicipants or (ii) directly or indirectly by, or in common with,
the exchanges for which they provide clearing services and which were, in turn, formed and
owned by their respective members. 16 In other words, the clearinghouscs all have their origins in
membership organizations that simply would have not passed muster under the Commissions'
proposals.
FIA, therefore, would urge the Commissions not to act upon this aspect of their proposals until
they have conducted an empirical evaluation of whether it is possible, much less likely, that a
new DCO or securities clearing agency will ever be formed by a consortium of 20 (or more)
owners, each of whom would own 5% or less of thc business, or that clearing members and
enumerated entities will be willing to make the commitments of capital and intellectual property
that are necessary to form a new clearinghouse if they can own no more than 40% of the voting
equity in the aggregate. If the Commissio11s notletzhelcss believe that they must adopt ownersh''p
restrictions at this time without first evaluating the likely adverse effects upon the formation of
ncw clearinghouses, FIA would recommend that the aggregate ownership limits be eliminated
altogether and that the alternative test be recalibrated to permit any single member or participant
to own as much as 10%, rather than 5%, ol the clearinghouse.
The Conzrnissions Should Give Themselves Neede&l Flexitzility.
As noted, FIA believes it would be ill-advised to adopt the proposed ownership restrictions at
this time. FIA nonetheless commends the CFTC for its willingness to consider thc granting ol'
waivers to DCOs for a reasonable period of time, and we urge the SEC to adopt a similarly
flexible approach for securities clearing agencies. The CFTC proposal, however, would
condition any such waiver on a finding by that agency that the ownership restrictions are not
necessary or appropriate to: (i) improve the governance of the DCO; (ii) mitigate systemic risk;
(iii) promote competition; (iv) mitigate conflicts of interest in connection with a swap dealer's or
major swap participant's conduct of business with the DCO with respect to fair and open access
and participation and product eligibility; and (v) otherwise accomplish the puiposes of the
Commodity Exchange Act. We believe that requiring that each of these requirements be
satisfied as a condition of granting the waiver is unnecessarily restrictive, and believe that thc
16
The one exception to this rule is OCC, which provides clearing services to exchanges and markets in
addition to the five securities option marketplaces that own OCC.
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
'november )7, 20 I 0
Page 9
Commissions would be better served by an arrangement that permits them to grant a waiver,
where appropriate, if one or more (but not necessarily all) of those criteria are satisfied.
The Commiissiions Should Approach With Caution Rules That Would Dictate the
Composition of a Clearinghouse's Risk Management Committee.
The Commissions' proposals would require that at least 35% of the governing Board of a
'
clearinghouse or SEI7 be public directors. FIA has previously supported such a standard with
respect lo DCMs and supports the extension of this requirement to clearinghouses and SEFs.
The Commissions' proposals also would make clear that employment by a clearinghouse or SEF„
or by a member or participant in one of the foregoing, is sufficient to exclude an individual from
characterization as a public director. FIA supports those clarifications and believes that they are
18
important safeguards if the independence requirements are to be meaningfully applied. We
nonetheless believe that 1he one-year and three-year "look back" periods that are included in the
CFTC's and SEC's respective proposals are unnecessaiy and will make it more difficult than
necessary for clcaringhouses and SEFs to aiirac1 candidates with the necessary qualifications and
skills to serve in these importani positions.
ln this regard, FIA has serious reservations about that aspect of the Commissions' proposals tha1
would extend the public director requirements to a clearinghouse*s Risk Management
Committee'" and, in the case of DCOs, additionally require (i) that the Chair of the Risk
I'vianagement Coinriiittee be a public director and (ii) that an additional I0% of thc Committee br.
set aside for customer representatives. Further, and as discussed in greater detail below, the
duties and responsibilities of a Risk Management Commi(1ee are functionally different than those
of a Board of Directors (or, for that matter, the other Commit1ees of a clearinghouse, SEF, DCM
or national securities exchange), and FIA accordingly believes that it would be unwise to adopt a
mandate that the Risk Management Committee include public directors.
i7
The SEC proposal would further require that a niajority of the Board of a sccunties clearing agency be
independent directors if the securities clearing agency elects the alternate 5% ownership test.
18
FIA has noted in the past that it is "vitally important that DCMs include a significant. number of Board
Members that are recognized to be independent of the DCM' and its members. ** See February 20, 2009 letter from
.John M. Danigard, FIA, to David A. Stawick, CFTC, rc Regulatory Governmice; Conflicts of Interest in Self-
Regulation and Self-Regulatory Organizations (74 Fed. Reg. 3475 (Jan. 21, 2009)). FIA accordingly supports those
aspects of thc Commissions' proposals that would codify and extend this requirement to clearinghouses mid SEFs.
19
The SEC proposal would apply these requirements to the Risk Management Committee only if the
Committee is authorized to act on behalf of the Board. The SEC proposal would in such circumstances require that
the Risk Management Conunitiee have the same composition as the Board (35% public directors, if no clearing
agency participant owns more than 20% of the securities clearing agency or a majority of public directors, if the
clearing agency elects the alternative test, which does not permit a clearing agency participant to own morc than 5%
of thc securities clearing agency).
Mr. David A. Stawiclc
Ms. Flizabeth M. Murphy
i iovcmber 17, 2010
Page 10
Very Few Public Dii ectors W'ill Have Meat&i ngfizl Risk Management Expertise.
Proposed CFTC Regulation 40.9(b)(3) would expressly require lhat the public directors of a
DCO possess "sufficient experlise . . . in financial services, risk management and clearing. "
While we agree that this is a laudable goal, we think that the Commissions may be substantially
overestimating the extent to which lhere are qualified individuals with the inclination and with
the necessary experience skill relating to lhe relevant products to serve as members of a Risk
Management Committee.
As the SBC noted in its proposal, "[c]!earing and settlement is a highly specialized area and i1
may bc difficult to find independent directors with relevant experience.
»20 "
We agree. We
further note that otherwise-qualified individuals will in some cases no1 be permitted by their
employers to serve on the Board or committees of another company and that it is highly unlikely
that a clearinghouse would permit an individual to serve as a public director if that individual is
a!ready serving on the Board of another clearinghouse. There may be antitrust considerations
that may prevent the appointment of the same individua! to serve on the Boards of competing
2i
clearinghouses. If despite these reasons, the same individual is appointed to the Boards of
different clcaringhouses, thai individual may be compelled by fiduciary duties to recuse himself
or herself from so many key decisions so as to be ineffective as a Board member for either
clearinghouse.
The Risk rvfanagettrent Conirnittee. Veeds to Consist ctf gaalified Persoiinel.
Risk management is at the very core of a clearinghouse's business. Risk management suffuses
every determination that is made by a clearinghouse, beginning with its thresholds for
membership and the minimum capital rind guaranty fund requirements for its clearing members;
its selection of clearing and settlemenl. banks; its determination of the levels of margin thai it
charges on a daily basis and that it monitors and modifies in response to changing risks; its
determination of settlement prices; its development and continuous refinement and testing of its
risk systems; its decision to clear (or not to clear) particular products and to permit a!1 or 1'ewer
than all of its clearing members to participate in 1!iat process; and, finally, its managenient of
emergencies, including (but not limited to) clearing member defaults.
It is for ibis reason that Risk Management Committees have historically been comprised of
seasoned representatives of the firms whose capital backs the clearinghouse. Unlike public
directors, whose fiduciary duties may require them to focus on the maximization of profits for
the benefit of the stockholders of the clearinghouse, members of the Risk Management
Committee who arc employed by clearinghouse parlicipants "have a unique financial incentive to
75 Fed. Reg. 65882, 65921 (Ocioher 26, 2010).
2l
See Section 8 of the Clayton Act; 15 U. S.C. 1; 19.
Mr. David A. S1awicl&
Ms. Elizabeth M. Murphy
November 17, 2010
Page II
ensure that lhc [clearinghouse] has sufficient collateral from each participant to withstand a
participant default in almost all marke1 conditions.
"
We therefore have the utmost concern about the unintended effcc1s of a rule that would have
clearinghouse risk management practices and the management of defaults being overseen by a
Committee whose members are not all seasoned professionals who understand lhe special
attributes of complicated flnancial products. Unlike, for example, the disciplinary processes of a
DCM, where the views of non-members can provide a useful perspective even if they have no
substantive expertise in the underlying subject. ma11er, there is no room for inexperience on the
73
Committee that is charged with oversight of the risl& management of a clearinghouse.
It is, therefore, of tremendous concern to FIA that the very individuals who have the expertise,
skill and experience that is required to oversee the rislc management of a clearinghouse could be
marginalized by the mandatory inclusion of a minimum number of inexperienced personnel on
the Risl& Management Committee. This would be problematic in normal marke1 conditions, but
could be disastrous in an emergency, particularly if one or more of thc experienced members of
the Committee is unavailable for any reason. In such a case, decisions could end up being made
by a quotum of the Committee that is disproportionately comprised of public directors who are
neither experienced in the resolution of' a default nor employed by or accountable to clearing
*'
members with "skin in the game.
There are no "do-overs" in clearing and scttlcnicnt. The inability to manage and respond
promptly and appropriately in a crisis can have catastrophic consequences. We, therefore, urge
the Commissions to withdraw their respective proposals that at least 35 "/c of the members of the
Risk Management Committee be public direc1ors and allow the clearinghouses to bring their own
expert judgment to bear in the selection and staffing of their Risk Management Committees.
The Risk Mattagemettt Coiiimittee is Subject to Oversigltt by a Board with PuMic Directors.
FIA nonetheless recognizes that there is a perception, which we believe to be ill-founded, that
the!e are certain inherent conflicts in thc administration and management of the clearinghouses
that need to be ameliorated through the diversification of membership on clearinghouse Boards
and Committees. As no1ed above, I'IA docs not object to the overarching requirement that at
least 35'/c of the Board of a clearinghouse or SEF be public directors. It bears emphasis that it is
the Board of Directors that has ultimate authority and control over all of the policies and
decisions that are made by a clearinghouse, including its Risk Management Committee. We
75 Fcd. Rcg. 65882, 65888 (October 26, 2010I.
23
No one would scnously suggest that the members of the Audit Committee of a clearinghouse (or, for that
matter, a public company) should not be required to have experience in accounting and financial matters. We
believe that the same logic apphes with equal 1'orcc to the Risk Management Committee, which should not bc
compelled to appoint members who lack expertise in risk management and urge the Commissions to recognize that
the criteria for appointment to a Risk Management Committee need to be qualitative, and not quantitative.
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 12
therefore respectfully submit that ii is unnecessary, and inappropriately prescriptive, to establish
detailed requirements for the composition of the Risk Management Committee given that the
Committee's decisions are in all cases subject to oversight (including, where appropriate,
disapproval) by the clearinghouse's Board of Directors.
The CFTC's Subcommittee Proposal Should Be Modified and Adopted by Both Cotntnissions.
If ihe Commissions nonetheless conclude that the Risk Management Committee must include a
public director to give effect to the purposes underlying Dodd-Frank, we would support the
altcmative approach that has been proposed by the CFTC that allow the Risk Management
Committee of a DCO to establish one or more Subcommittees that meet the composition
requirements of the proposed rule. More particularly, the CFTC proposal would permit the
formation of a Risk Management Subcommittee that would be given the authority, in the first
instance, to establish membership eligibility criteria, approve (or deny) applications for
membership, and determine which products should be eligib]e for c]earing. FIA believes thai
this is a reasoned and pragmaiic approach that lairly balances the Commissions' stated concerns
with the need to ensure that the most sensitive rislr management decisions, including the
adoption of margin systems and ihe nianagement of a clearing member default, are overseen by
clearing member representatives with substantia], real-world risk management experience. F I A
accordingly recommends that ihe SEC make a simi]ar alternative availab]e to the securities
clearing agencies.
FIA believes it would be a mistake, however, to transpose onto the Risk Managenient
Subcommittee the same structural difficulties that are discussed above in the context of ihe Risk
Managcmcnt Committee. FIA, therefore, recommends that the Commissions allow the
clearinghouses to create Risk Management Subcommittees that would be given the initial
responsibility to make the determinations set forth in the CFTC proposal if the Subcommittee has
at least one public representative.
' FIA further recommends as an additional safeguard that any
such public representative be required to have skill and experience in clearing and settlemeni
commensurate with that of other members of the Risk Management Subommittee (but that any
such public representative not additionally be required to be the Chair of the Risk Management
Subcommittee).
24
See 75 Fed. Rcg. 63732, 63740-41 (October 18, 2010).
25
As noted above, the CFTC proposal envisions that the Risk Management Committee could delegate to the
Subcommittee the responsibility in thc first instance to: (i) determine the standards and requircmcnts for initial and
continuing clearing membership ehgibility; (ii) approve or deny (or review approvals or denials of) clearing
niembership applications; and (iii) determine producis eligible for clearing. 75 Fed. Rcg. 63732, 63740-41 (October
18, 2010). If it did so, the I&isk Managcmcnt Committee v, ould no longer be subject to the public director and othor
composition requirements set forth in the CFTC proposal. Id. FIA envisions that such an approach, modified as
suggested above, would appropriately allow the Risk Management Committee to retain responsibility, subject to
review by the clearinghouse's Board, of the adoption and modification of the clearinghouse's risk models; the
oversight of the clearinghouse's margin system and requirements; periodic reviews of the Chief Compliance
Oflicer's and Chief Risk Officer*s performance; and the resolution of a clearing member default.
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 13
In this regard, we believe the Commissions' concerns about the potential for conflicts in the
administra1ion and management of the clearinghouses would appropriately be addressed by a
requirement that the dissenting views, if any, of the members of the Risk Managenient
Subcommittee be forwarded to the Board for its consideration and by a requirement that a person
whose application for membership in the clearinghouse is denied by the Subcommittee be given
the right to appeal that decision to the Risk Management Commi1tee and the Board. We believe
that the Board, at least 35% of whose members would be public directors, would in each of these
cases be in a position to take ac1ion to address and, if appropriate, modify or countermand the
decisions of 1he Committee or Subcommittee.
We anticipate that the Commissions would review the actions that are taken (or not taken) by 1he
Board in response thereto as part of their respective reviews of the clearinghouses' compliance
wi1h the conflict of interest provisions of the CEA and the Exchange Act. The Commissions
would then be in a position to take futther steps as necessary if it appeared that the actions of
clearinghouse Boards in response to any such perceived conflicts were insufficient or
inappropriate, including by the adoption of further rules by the Commissions. FIA believes that
this measured approach, which would bc based upon and illuminated by real-world experience,
is vastly preferable to adopting prescriptive rules at this nascent stage of development ol the
market for cleared OTC products.
We further suggest that any requirement for the inclusion of a public representative on the Risk
Management Subcommittee be modified to make clear that ihe members of' the Subcommitlee
need not also be members of thc Board. Such a modiflcation would allow the clearinghouses to
more readily nominate individuals with appropriate risk management skills without additionally
requiring that those individuals agree to serve on the Board. More importantly, this modification
would allow the clearinghouses to identify individuals with highly specialized knowledge who
may not have the broad-gauged experience that is expected of Board members (or may not be
interested in holding a Board position) but who understand the risks associated with a particular
product class or derivative products generally.
Conclusion.
FIA recognizes that Dodd-Frank directs the Commissions to accomplish iwo important, but
potentially conflicting, goals: implementing a comprehensive regulatory fiamework that
promotes the competitive execution of swaps and the reduction of risk through clearing, while at
the same time managing the potential for any resulting conflicts of interest in the operation and
management of clearinghouses and SEFs that are formed and funded by industry participants.
FIA nonetheless believes that the Commissions' proposed ownership restrictions would, if
implemented as proposed, be counterproductive because they would likely have the effect of
making it far more difficult for new clearinghouses and SEFs to compete with existing
institutions. FIA accordingly recommends that the Commissions no1 adopt the ownership
restrictions, at least at this time. If the Commissions do decide to adopt ownership restrictions,
FIA would urge the Commissions to eliminate altogether the aggregate limits on ihe ownership
Mr. David A. Stawick
Ms. Elizabeth M. Murphy
November 17, 2010
Page 14
interests that may be held by the members of a clearinghouse and enumerated entities. Absent
such a step, we are concerned that market participants will not make the capital and other
commitments that will be necessar3 if they are going to innovate and compete with the existing
DCOs and securities clearing agencies.
Finally, while FIA supports a 35% public participation requirement at the clearinghouse and SEF
Board level, we believe that the application of a similar requirement to a clearinghouse's Risk
Management Committee could have the effect of increasing risk, without a commensurate public
benefit, if inexperienced individuals are given a voice in the establishment of margin
requirements and the management and resolution of a default. FIA believes, however, that
allowing a clearinghouse to constitute a Risk Management Subcommittee that has an
appropriately qualified public representative is a reasoned and appropriate compromise that, if
modified as discussed above —specifically, by providing for the review, by a Board of Directors
whose members include a substantial complement of public directors, of the dissenting views
that may be expressed by Subcommittee members and of appeals of adverse membership
determinations — would balance the Commissions' objectives with the need for sound and
experienced management of the risk functions of a clearinghouse.
FIA appreciates the opportunity to submit these comments regarding the proposed ownership
limitations and governance rcctuirernents for clearinghouscs and SEFs. 'f thc Commissior;!ias
any questions concerning the matters discussed in ihis letter, please contact Barbara Wierzynski,
FIA's Executive Vice President and General Counsel, at (202) 466-5460.
Since
hn . Dam
k
Pr ent
CC: Honorable Gary Gensler, Chairman
Flonorablc Michael Dunn, Commissioner
Honorable Jill E. Somnicrs, Commissioner
Honorable Bart Chilton, Commissioner
Honorable Scott O'Malia, Commissioner
Honorable Mary L. Schapiro, Chairman
Honorable Elisse B. Walter, Commissioner
Honorable Kathleen L. Casey, Commissioner
Honorable Luis A. Aguilar, Commissioner
Honorable Troy A, Paredes, Commissioner
