SEC Proposed Amendment to Improving Central Clearing Risk Management and Resilience

The Securities and Exchange Commission (SEC) recently proposed new rules to improve the risk management and resilience of Covered Clearing Agencies (CCAs). The proposed regulations would require CCAs to implement a number of new risk management measures, including:

• Establish risk-based margin systems that monitor intraday exposures and make margin calls as frequently as circumstances warrant.
• Use substantive inputs, in addition to price data, in their risk-based margin systems.
• Have recovery and orderly wind-down plans that are fit for purpose and provide sufficient detail on how the CCA would operate in a recovery or wind-down.
• Have robust governance structures that ensure the CCA is managed safely and soundly.

What is the role of a CCA?

CCAs act as the central counterparty to all transactions cleared through them, meaning that they act as the buyer to every seller and the seller to every buyer in a securities transaction, or as a central securities depository, meaning that they act as a custodian of securities in connection with a central system. This means that if one party to a transaction defaults, the CCA will be responsible for fulfilling that party’s obligations.

CCAs also provide liquidity to the market by making it easier for market participants to buy and sell derivatives. This is because CCAs typically have a large pool of capital that they can use to make markets in derivatives.

Proposed Risk Management Measures

The proposed rules would require CCAs to implement a number of new risk management measures. These measures are designed to improve the resilience of CCAs and reduce the risk of systemic financial disruption.

Proposed Amendment to Rule 17Ad-22(e)(6)(ii)

One of the most important proposed measures is the requirement to establish a risk-based margin system. This system would monitor intraday exposures and allow intraday margin calls as circumstances warrant. Intraday margin calls are designed to ensure that CCAs have sufficient capital to cover losses that may occur during the trading day. This proposal would help to reduce the risk of a CCA defaulting on its obligations to its clearing members.

Proposed Amendment to Rule 17Ad-22(e)(6)(iv)

The proposed rules would also require CCAs to address the use of substantive inputs in the risk-based margin system, in addition to price data, specifically when such inputs are not readily available or reliable. Substantive inputs are information used to calculate the value of derivatives contracts. Price data is the most common type of substantive input. However, CCAs may also use other types of substantive inputs from alternate sources or, if it does not use an alternate source, the use of an alternate risk-based margin system that does not similarly rely on the unavailable or unreliable substantive inputs, such as credit ratings or volatility estimates. This proposal would help to ensure that CCAs have a more complete picture of the risks associated with the transactions they clear.

Proposed New Rule 17ad-26

The rules would require CCAs to develop and implement recovery and orderly wind-down plans. Recovery plans describe how a CCA would continue to operate in the event of a financial crisis. Orderly wind-down plans describe how a CCA would wind down its operations in an orderly manner if it cannot recover from a financial crisis. This proposal would help ensure that CCAs can continue to provide critical financial services even during a disruption.