Thursday, May 18, 2023

Commission proposes to strengthen risk-management rules for covered clearing agencies

By Suzanne Cosgrove

SEC commissioners on Wednesday unanimously approved proposed changes to certain rules governing covered clearing agencies (CCAs), amending requirements applicable to CCA risk-based margin systems, and adding new requirements to CCA recovery and wind-down plans.

Greater consistency across CCA plans “will enhance the resiliency of this part of our market plumbing, which is fundamental for the capital markets to operate,” said SEC Chair Gary Gensler in a release.

The latest proposal gives specificity to rules adopted by the Commission in 2016 that required CCAs, registered clearing agencies that act as a central counterparty, to have plans for recovery and wind-down.

Recovery is the process by which a CCA maintains its ability to perform critical services if losses render it insolvent, and wind-down is the process by which its services would move to another entity. “We expect that this [new rule] would reduce the risk of an unsuccessful disruption,” said Jessica Wachter, SEC Chief Economist.

Risk-based margining. The proposal also amends existing rules regarding intraday margins and the use of substantive inputs to a CCA’s risk-based margin system. “The Division believes that it is essential that a covered clearing agency monitors its intraday exposure because it faces a risk that its exposure to its participants can change rapidly as a result of intraday changes in prices, positions, or both,” said Haoxiang Zhu, director of the SEC’s Division of Trading and Markets.

“Intraday margin calls played an important role in clearinghouses’ ability to respond to volatility during the January 2021 ‘meme-stock’ events and during recent periods of heightened Treasury volatility,” said Gensler. “I think enhancing these intraday tools would help make our markets more resilient.”

The latest proposal builds on an existing requirement that a covered clearing agency have policies and procedures reasonably designed to cover its credit exposures to its participants by establishing a risk-based margin system that, among other things, includes the authority and operational capacity to make intraday margin calls in defined circumstances.

Specifically, the proposed rule amendments would require that a covered clearing agency’s risk-based margin system monitor intraday exposure on an ongoing basis and make intraday margin calls as frequently as circumstances warrant, including when risk thresholds specified by the covered clearing agency are breached or when the products cleared or markets served experience elevated volatility.

The proposal also requires a CCA to establish a risk-based margin system that addresses the use of substantive inputs to its risk-based margin system, specifically, when such inputs are not readily available or reliable. Substantive inputs could include, for example, portfolio size, volatility, and sensitivity to various risk factors that are likely to influence security prices.

“Margin calls are sometimes pointed to as a source of procyclicality,” that is, as potentially worsening market crises because they are positively correlated with the overall state of the market, commented Commissioner Caroline Crenshaw. “The covered clearing agencies are cognizant of this in setting margin requirements and calibrating their models so that they do not fluctuate too drastically in response to changing market conditions,” she said. “However, this change ensures that covered clearing agencies are aware of intraday exposures that may arise,” enabling them to react without delay, she said.

Wind-down rule. The proposed rule also identifies nine elements that a CCA would need to include in its recovery and wind-down plan (RWP). Specifically, the new rule would require that a covered clearing agency:
  • Describe the covered clearing agency’s critical payment, clearing and settlement services and address how the CCA would continue to provide such services in the event of recovery and wind-down;
  • Identify any service providers upon which the CCA relies;
  • Describe scenarios that may potentially prevent the CCA from being able to provide services;
  • Describe criteria that could trigger the RWP’s implementation and the process that the CCA uses to monitor and determine whether the criteria have been met;
  • Identify the rules, policies, procedures and other tools the CCA would use in a recovery or orderly wind-down;
  • Address how the identified rules, policies, procedures, and any other tools or resources would ensure timely implementation of the RWPs;
  • Set procedures for informing the Commission as soon as practicable when the CCA is considering initiating a recovery or orderly wind-down;
  • Include procedures for testing the CCA’s ability to implement the RWPs every 12 months;
  • Arrange for review of the plans by the board of directors at least every 12 months or following material changes that would significantly affect the RWPs’ viability or execution.
A note of caution. While Commissioner Hester Peirce voted to approve the proposal, she expressed concern that testing the CCAs’ plans every 12 months could impose undue burdens on clearing agencies, participants and other stakeholders. In addition, Peirce said while the proposed amendments are largely principles-based, the release indicates existing recovery and wind-down plans “have, to a great degree, converged in terms of the types of elements that are included in each plan.” Although it may be reasonable to require clearing agencies to ensure that their plans address a common set of issues, “I hope that the amendments do not foreshadow a desire to harmonize recovery and wind-down plans through the Commission’s rule filing process,” Peirce said.

This is Release No. 34-97516.