Swap Entities - Conflict Mitigation

Tuesday,
October 26, 2010
Part IV
Securities and
Exchange
Commission
17 CFR Part 242
Ownership Limitations and Governance
Requirements for Security-Based Swap
Clearing Agencies, Security-Based Swap
Execution Facilities, and
NationalSecurities Exchanges With
Respect to Security-Based Swaps Under
Regulation MC; Proposed Rule
srobinson on DSK8KYBLC1PROD with PROPOSALS2
VerDate Mar<15>2010 17:22 Oct 25, 2010 Jkt 223001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\26OCP2.SGM 26OCP2
65882 Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules
SECURITIES AND EXCHANGE All submissions should refer to File the Commission and the Commodity
COMMISSION Number S7–27–10. This file number Futures Trading Commission (‘‘CFTC’’)
should be included on the subject line with the authority to regulate over-the-
17 CFR Part 242 if e-mail is used. To help us process and counter (‘‘OTC’’) derivatives in light of
[Release No. 34–63107; File No. S7–27–10] review your comments more efficiently, the recent financial crisis, which
please use only one method. The demonstrated the need for enhanced
RIN 3235–AK74 Commission will post all comments on regulation in the OTC derivatives
the Commission’s Internet Web site market. The Dodd-Frank Act is intended
Ownership Limitations and (http://www.sec.gov/rules/ to close loopholes in the existing
Governance Requirements for proposed.shtml). Comments are also regulatory structure and to provide the
Security-Based Swap Clearing available for Web site viewing and Commission and the CFTC with
Agencies, Security-Based Swap printing in the Commission’s Public effective regulatory tools to oversee the
Execution Facilities, and National Reference Room, 100 F St., NE., OTC swaps market, which has grown
Securities Exchanges With Respect to Washington, DC 20549 on official exponentially in recent years and is
Security-Based Swaps Under business days between the hours of capable of affecting significant sectors of
Regulation MC 10 a.m. and 3 p.m. All comments the U.S. economy.
AGENCY: Securities and Exchange received will be posted without change; The Dodd-Frank Act provides that the
Commission. the Commission does not edit personal CFTC will regulate ‘‘swaps,’’ the
ACTION: Proposed rule. identifying information from Commission will regulate ‘‘security-
submissions. You should submit only based swaps,’’ and the CFTC and the
SUMMARY: In accordance with Section information that you wish to make Commission will jointly regulate ‘‘mixed
765 (‘‘Section 765’’) of Title VII (‘‘Title available publicly. swaps.’’ 3 The Dodd-Frank Act amends
VII’’) of the Dodd-Frank Wall Street FOR FURTHER INFORMATION CONTACT: the Exchange Act to require, among
Reform and Consumer Protection Act of Proposals relating to security-based other things, the following:
2010 (‘‘Dodd-Frank Act’’), the Securities swap clearing agencies: Catherine (1) Transactions in security-based swaps
and Exchange Commission (‘‘SEC’’ or Moore, Senior Special Counsel, at (202) must be cleared through a clearing
‘‘Commission’’) is proposing Regulation 551–5710; and Joseph P. Kamnik, agency if they are of a type that the
MC under the Securities Exchange Act Special Counsel, at (202) 551–5710; Commission determines must be
of 1934 (‘‘Exchange Act’’) for clearing Office of Clearance and Settlement, cleared, unless an exemption from
agencies that clear security-based swaps Division of Trading and Markets, mandatory clearing applies; (2)
(‘‘security-based swap clearing Securities and Exchange Commission, transactions in security-based swaps
agencies’’) and for security-based swap 100 F Street, NE., Washington, DC must be reported to a registered
execution facilities (‘‘SB SEFs’’) and 20549–7010; proposals relating to security-based swap data repository or
national securities exchanges that post security-based swap execution facilities
or make available for trading security- and national securities exchanges that 3 Section 712(d) of the Dodd-Frank Act provides
based swaps (‘‘SBS exchanges’’). that the Commission and the CFTC, in consultation
post or make available for trading with the Board of Governors of the Federal Reserve
Regulation MC is designed to mitigate security-based swaps: Nancy Burke- System (‘‘Federal Reserve’’), shall jointly further
potential conflicts of interest that could Sanow, Assistant Director, at (202) 551– define the terms ‘‘swap,’’ ‘‘security-based swap,’’
exist at these entities. Specifically, the 5621; Molly Kim, Special Counsel, at ‘‘swap dealer,’’ ‘‘security-based swap dealer,’’ ‘‘major
Commission seeks to mitigate the (202) 551–5644; Steven Varholik, swap participant,’’ ‘‘major security-based swap
potential conflicts of interest through participant,’’ ‘‘eligible contract participant,’’ and
Special Counsel, at (202) 551–5615; ‘‘security-based swap agreement.’’ These terms are
conditions and structures relating to Sarah Schandler, Attorney, at (202) 551– defined in Sections 721 and 761 of the Dodd-Frank
ownership, voting, and governance of 7145; and Iliana Lundblad, Attorney, at Act and, with respect to the term ‘‘eligible contract
security-based swap clearing agencies, (202) 551–5871; Office of Market participant,’’ in Section 1a(18) of the Commodity
SB SEFs, and SBS exchanges. Exchange Act (‘‘CEA’’), 7 U.S.C. 1a(18), as re-
Supervision, Division of Trading and designated and amended by Section 721 of the
DATES: Comments should be submitted Markets, Securities and Exchange Dodd-Frank Act. Further, Section 721(c) of the
on or before November 26, 2010. Commission, 100 F Street, NE., Dodd-Frank Act requires the CFTC to adopt a rule
to further define the terms ‘‘swap,’’ ‘‘swap dealer,’’
ADDRESSES: Comments may be Washington, DC 20549–7010. ‘‘major swap participant,’’ and ‘‘eligible contract
submitted by any of the following SUPPLEMENTARY INFORMATION: The participant,’’ and Section 761(b) of the Dodd-Frank
methods: Commission is proposing new Act permits the Commission to adopt a rule to
further define the terms ‘‘security-based swap,’’
Electronic Comments Regulation MC under the Exchange Act ‘‘security-based swap dealer,’’ ‘‘major security-based
relating to conflicts of interest with swap participant,’’ and ‘‘eligible contract
• Use the Commission’s Internet respect to security-based swap clearing participant,’’ with regard to security-based swaps,
comment form (http://www.sec.gov/ agencies, SB SEFs, and SBS exchanges. for the purpose of including transactions and
rules/proposed.shtml); or entities that have been structured to evade Title VII
• Send an e-mail to rule- I. Introduction of the Dodd-Frank Act. Finally, Section 712(a) of
comments@sec.gov. Please include File the Dodd-Frank Act provides that the Commission
On July 21, 2010, the President signed and CFTC, after consultation with the Federal
Number S7–27–10 on the subject line; the Dodd-Frank Act into law.1 The Reserve, shall jointly prescribe regulations
or Dodd-Frank Act was enacted to, among regarding ‘‘mixed swaps’’ as may be necessary to
• Use the Federal eRulemaking Portal other purposes, promote the financial carry out the purposes of Title VII. To assist the
(http://www.regulations.gov). Follow the Commission and CFTC in further defining the terms
stability of the United States by specified above, and to prescribe regulations
instructions for submitting comments. improving accountability and regarding ‘‘mixed swaps’’ as may be necessary to
Paper Comments transparency in the financial system.2 carry out the purposes of Title VII, the Commission
and the CFTC have requested comment from
• Send paper comments in triplicate Title VII of the Dodd-Frank Act provides interested parties. See Securities Exchange Act
to Elizabeth M. Murphy, Secretary, Release No. 62717 (August 13, 2010), 75 FR 51429
1 The Dodd-Frank Wall Street Reform and
(August 20, 2010) (File No. S7–16–10) (advance
Securities and Exchange Commission, Consumer Protection Act (Pub. L. 111–203, H.R. joint notice of proposed rulemaking regarding
100 F St., NE., Washington, DC 20549– 4173). definitions contained in Title VII of the Dodd-Frank
1090. 2 See Public Law 111–203, Preamble. Act) (‘‘Definitions Release’’).
Federal Register / Vol. 75, No. 206 / Tuesday, October 26, 2010 / Proposed Rules 65883
the Commission; and (3) if a security- swap participant (collectively, under Section 765, the Commission
based swap is subject to a clearing ‘‘Specified Entities’’).9 shall consider any conflicts of interest
requirement, it must be traded on a Section 765(b)—captioned arising from the amount of equity
registered trading platform, i.e., a SB ‘‘Purposes’’—provides that the ownership and voting by a single
SEF or SBS exchange, unless no facility Commission shall adopt such rules if it investor; the ability of owners to vote,
makes such security-based swap determines they are necessary or cause the vote of, or withhold votes
available for trading.4 appropriate to improve the governance entitled to be cast on any matters by the
of, or to mitigate systemic risk, promote holders of the ownership interest; and
II. Mandated Rulemaking on Mitigating
competition or mitigate conflicts of the governance arrangements of any
Conflicts of Interest
interest in connection with a security- derivatives clearing organization that
Section 765 of the Dodd-Frank Act based swap dealer’s or major security- clears swaps, or swap execution facility
requires the Commission to adopt rules based swap participant’s conduct of or board of trade designated as a
to mitigate specified conflicts of business with, a security-based swap contract market that posts swaps or
interest.5 Section 765(a) requires the clearing agency, SB SEF, or SBS makes swaps available for trading.11
Commission to adopt rules, which rules exchange and in which such security-
may include numerical limits on the The Commission is cognizant that the
based swap dealer or major security-
control of, or the voting rights with proposed rules discussed herein, as well
based swap participant has a material
respect to, any security-based swap debt or equity investment.10 Section as other proposals that the Commission
clearing agency, or on the control of any 765(b) sets forth a number of underlying may consider in the coming months to
SB SEF or SBS exchange, by specified policy objectives for the Commission’s implement the Dodd-Frank Act, if
entities, such as a bank holding rulemaking—improving governance, adopted, could significantly affect—and
company with total consolidated assets mitigating systemic risk, promoting be significantly affected by—the nature
of $50 billion or more,6 a nonbank competition, and mitigating conflicts of and scope of the security-based swaps
financial company,7 an affiliate of such interest with respect to security-based market in a number of ways. For
bank holding company or nonbank swap clearing agencies, SB SEFs, and example, the Commission recognizes
financial company, a security-based SBS exchanges. In considering proposed that if the measures proposed in this
swap dealer,8 or a major security-based rules to mitigate conflicts of interest, the release are adopted and are too onerous
Commission is mindful that, in some for new entrants, they could hinder the
4 See Section 761 of the Dodd-Frank Act, added
instances, certain of these diverse policy further development of a market for
as Section 3(a)(77) of the Exchange Act, 15 U.S.C. security-based swaps by unduly
78(c)(a), which defines the term ‘‘security-based objectives may be in tension with
swap execution facility’’ to mean ‘‘a trading system others. For example, as described in discouraging competition and the
or platform in which multiple participants have the Section III.A.2.a below, with respect to formation of new security-based swap
ability to execute or trade security-based swaps by security-based swap clearing agencies, clearing agencies and of new SB SEFs or
accepting bids and offers made by multiple SBS exchanges. On the other hand, if
participants in the facility or system, through any the statutory objective of promoting
means of interstate commerce, including any competition, which may be furthered the Commission adopts rules that are
trading facility that (A) facilitates the execution of through enhanced access to cleared too permissive, conflicts of interest may
security-based swaps between persons; and (B) is products and clearing venues, may to be inadequately mitigated and such
not a national securities exchange.’’ See Public Law conflicts may incentivize restricting
111–203, Section 761. The Dodd-Frank Act amends some extent be in tension with the
the CEA to provide for a similar regulatory objective of minimizing systemic risk access to centralized clearing and lack
framework with respect to transactions in swaps through effective risk management of of transparency in the trading of
regulated by the CFTC. the clearing agency. security-based swaps as described in
5 See Public Law 111–203, Section 765.
Section 765(c) of the Dodd-Frank Act detail in Section III below. The
6 The term ‘‘bank holding company’’ has the
also provides that in adopting rules Commission is also mindful that the
meaning set forth in Section 2 of the Bank Holding
Company Act of 1956 (12 U.S.C. 1841) (‘‘Bank further development of the security-
Holding Company Act’’), and generally means any a dealer or market maker in security-based swaps. based swaps market may alter the
company that has control over any bank or over any See Public Law 111–203, Section 761 for the calculus for future regulation of
company that is or becomes a bank holding complete definition. See also Definitions Release, conflicts of interest. As commenters
company by virtue of the Bank Holding Company 75 FR 51429, supra note 3.
Act. 9 Pursuant to Section 761 of the Dodd-Frank Act, review the instant proposals, they are
7 Under Section 765(a) of the Dodd-Frank Act, the the term ‘‘major security-based swap participant’’ is urged to consider generally the role that
term ‘‘nonbank financial company’’ has the meaning added as Section 3(a)(67) of the Exchange Act, 15 regulation may play in fostering or
set forth in Section 102 of the Dodd-Frank Act, and U.S.C 78c(a), and generally means any person limiting the development of the market
generally means a company, other than a bank (A) who is not a security-based swap dealer; and
holding company, national securities exchange, (B)(I) who maintains a substantial position in
for security-based swaps (or, vice versa,
clearing agency, SB SEF, registered security-based security-based swaps for any of the major security- the role that market developments may
swap data repository, board of trade designated as based swap categories, as such categories are play in changing the nature and
a contract market (‘‘DCM’’), derivatives clearing determined by the Commission, excluding positions implications of regulation) and
organization, swap execution facility (‘‘SEF’’) or held for hedging or mitigating commercial risk; (II)
registered swap data repository, that is whose outstanding security-based swaps create
specifically to focus on this issue with
predominantly engaged in financial activities substantial counterparty exposure that could have respect to the proposals to mitigate
(including through a branch in the U.S., if such serious adverse effects on the financial stability of conflicts of interest for security-based
company is incorporated or organized in a country the U.S. banking system or financial markets; or (III) swap clearing agencies, SB SEFs, and
other than the U.S.). See Public Law 111–203, that is a financial entity that (a) is highly leveraged
SBS exchanges.
Section 102 for the complete definition. relative to the amount of capital such entity holds
8 Pursuant to Section 761 of the Dodd-Frank Act, and that is not subject to capital requirements
the term ‘‘security-based swap dealer’’ is added as established by an appropriate Federal banking 11 See Public Law 111–203, Section 765(c).
Section 3(a)(71) of the Exchange Act, 15 U.S.C regulator; and (b) maintains a substantial position Although this provision refers to swaps and to
78c(a), and generally means any person who (A) in outstanding security-based swaps in any major entities regulated by the CFTC, the Commission
holds themselves out as a dealer in security-based security-based swap category, as such categories are believes that the Congress intended it to refer to
swaps; (B) makes a market in security-based swaps; determined by the Commission. See Public Law security-based swaps and to security-based swap
(C) regularly enters into security-based swaps with 111–203, Section 761 for the complete definition. clearing agencies, SB SEFs, and SBS exchanges,
counterparties as an ordinary course of business for See also Definitions Release, 75 FR 51429, supra because Section 765 pertains to transactions in
its own account; or (D) engages in any activity note 3. security-based swaps and persons and entities
causing it to be commonly known in the trade as 10 See Public Law 111–203, Section 765(b). related thereto.
The Commission must adopt the rules risks. In November 2008, under the the activities of these clearing
required by Section 765 of the Dodd- auspices of the President’s Working agencies.18
Frank Act by January 17, 2011, which is Group on Financial Markets, the The Exchange Act does not impose
180 days after enactment of the Dodd- Secretary of the Department of the specific requirements regarding the
Frank Act.12 The Commission therefore Treasury, the Chairs of the Board of ownership structure of a clearing
is proposing Regulation MC under the Governors of the Federal Reserve, the agency. As a result, clearing agencies
Exchange Act to mitigate conflicts of Office of the Comptroller of the may operate under a variety of
interest with respect to security-based Currency, the CFTC, and the appropriate organizational structures
swap clearing agencies, SB SEFs, and Commission established as a policy provided that they have the capacity to
SBS exchanges. objective for the OTC derivatives market meet the standards in Section 17A of the
This proposed rulemaking is among that regulators and prudential Exchange Act.19 Certain clearing
the first that the Commission has supervisors require participants in a agencies registered with the
considered in connection with its central counterparty (‘‘CCP’’) Commission are owned either by
mandates under the Dodd-Frank Act, arrangement to clear all eligible participants or by securities
and the Commission is mindful of the contracts through that CCP.15 In exchanges.20 Other clearing agencies,
considerations raised by this timing. In furtherance of this policy objective, the such as the security-based swap clearing
particular, under the prescribed Commission, the Federal Reserve, and agencies that, once registered, would be
timeframes of the Dodd-Frank Act, the the CFTC signed a Memorandum of required to comply with proposed
Commission must propose rules Understanding that established a Regulation MC, are subsidiaries of or
required by Section 765 before it has the framework for consultation and partly-owned by publicly traded
opportunity to consider proposed rules information sharing on issues related to companies.21 These entities are not
that also are likely to affect the central counterparties for the OTC wholly-owned by participants or
development of security-based swap derivatives market.16 exchanges and may have different
clearing agencies, SB SEFs, and SBS The Commission has taken steps to governance related issues than the
exchanges, as well as the security-based help foster the prompt development of securities clearing agencies currently
swaps market overall. The Commission CCPs. In particular, the Commission registered with the Commission.
also notes that the market for security- Upon the effective date of Title VII of
acted to authorize the clearing of OTC
based swaps is in a nascent stage of the Dodd-Frank Act, clearing agencies
security-based swaps by permitting
development compared to the markets that clear and settle security-based swap
certain clearing agencies to clear credit
for equity securities and listed options transactions will be subject to a number
default swaps (‘‘CDS’’) on a temporary
and that the market for security-based of regulatory obligations that are
conditional basis.17 Today, a significant
swaps could develop further as the intended to promote the policy
volume of CDS transactions is cleared objectives of the Dodd-Frank Act,
Dodd-Frank Act is fully implemented
centrally and the Commission monitors including increased clearing of security-
and these transactions continue to move
to central clearing and trading on based swaps and effective risk
15 See supra note 13. See also Policy Statement
organized markets. management. Accordingly, security-
on Financial Market Developments, The President’s
Working Group on Financial Markets (March 13, based swap clearing agencies will be
III. Discussion of Potential Conflicts of required to be registered with, and
2008) (available at http://www.treas.gov/press/
Interest releases/reports/ regulated by, the Commission under
A. Security-Based Swap Clearing pwgpolicystatemktturmoil_03122008.pdf) and Section 17A.22 In addition, all registered
Progress Update on March Policy Statement on
Agencies Financial Market Developments, The President’s
18 To date most cleared CDS transactions have
Working Group on Financial Markets (October
1. Current Regulatory Structure 2008) (available at http://www.treas.gov/press/ cleared at ICE Trust US LLC (‘‘ICE Trust’’) or ICE
Credit market events from the last few releases/reports/q4progress%20update.pdf). Clear Europe Limited (‘‘ICE Clear Europe’’). As of
16 See Memorandum of Understanding Between October 8, 2010, ICE Trust had cleared
years have demonstrated that a security- approximately $7.1 trillion notional amount of CDS
the Board of Governors of the Federal Reserve
based swaps market operating without System, the U.S. Commodity Futures Trading contracts based on indices of securities and
meaningful regulation 13 and central Commission, and the U.S. Securities and Exchange approximately $490 billion notional amount of CDS
counterparties 14 can pose systemic Commission Regarding Central Counterparties for contracts based on individual reference entities or
Credit Default Swaps (November 14, 2008) securities. As of October 8, 2010, ICE Clear Europe
(available at http://www.treas.gov/press/releases/ had cleared approximately Ö3.09 trillion notional
12 Section 726 of the Dodd-Frank Act similarly
reports/finalmou.pdf). amount of CDS contracts based on indices of
requires the CFTC to adopt rules designed to securities and approximately Ö560 billion notional
17 The Commission authorized five entities to
mitigate conflicts of interest with respect to entities amount of CDS contracts based on individual
under its jurisdiction that clear or trade swaps. See clear credit default swaps. See Securities Exchange
reference entities or securities. See https://
Public Law 111–203, Section 726. The Commission Act Release Nos. 60372 (July 23, 2009), 74 FR 37748
www.theice.com/marketdata/reports/
preliminarily believes that an entity that registers (July 29, 2009) and 61973 (April 23, 2010), 75 FR
ReportCenter.shtml.
with the Commission as either a security-based 22656 (April 29, 2010) (CDS clearing by ICE Clear 19 See 78q–1(b)(3)(A).
swap clearing agency or a SB SEF is likely to Europe Limited); 60373 (July 23, 2009), 74 FR
20 The Depository Trust and Clearing Corporation
register also with the CFTC as a derivatives clearing 37740 (July 29, 2009) and 61975 (April 23, 2010),
organization or swap execution facility, 75 FR 22641 (April 29, 2010) (CDS clearing by (‘‘DTCC’’) is participant-owned and has three
respectively. As a result, the Commission staff and Eurex Clearing AG); 59578 (March 13, 2009), 74 FR separate subsidiaries that are registered clearing
the CFTC staff have consulted and coordinated with 11781 (March 19, 2009), 61164 (December 14, agencies which function as quasi-utilities. The
one another regarding their respective agencies’ 2009), 74 FR 67258 (December 18, 2009) and 61803 Options Clearing Corporation is owned by five
proposed rules to mitigate conflicts of interest. (March 30, 2010), 75 FR 17181 (April 5, 2010) (CDS unaffiliated options exchanges.
21 These clearing agencies include ICE Trust US

13 See, generally, Policy Objectives for the OTC clearing by Chicago Mercantile Exchange Inc.);
Derivatives Market, The President’s Working Group 59527 (March 6, 2009), 74 FR 10791 (March 12, LLC, ICE Clear Europe Limited, Eurex Clearing AG,
on Financial Markets (November 14, 2008) 2009), 61119 (December 4, 2009), 74 FR 65554 and Chicago Mercantile Exchange Inc.
(available at http://www.ustreas.gov/press/releases/ (December 10, 2009) and 61662 (March 5, 2010), 75 22 Section 763(b) of the Dodd-Frank Act adds new
reports/policyobjectives.pdf). FR 11589 (March 11, 2010) (CDS clearing by ICE Section 17A(k) to the Exchange Act, which
14 See The Role of Credit Derivatives in the U.S. Trust US LLC); 59164 (December 24, 2008), 74 FR authorizes the Commission to exempt,
Economy before the H. Agric. Comm., 110th Cong. 139 (January 2, 2009) (temporary CDS clearing by conditionally or unconditionally, a security-based
(2008) (Statement of Erik Sirri, Director of the LIFFE A&M and LCH.Clearnet Ltd.) (collectively, swap clearing agency from registration if the
Division of Trading and Markets, Commission) ‘‘CDS Clearing Exemption Orders’’). LIFFE A&M and Commission determines it is subject to comparable,
(available at http://agriculture.house.gov/testimony/ LCH.Clearnet Ltd. allowed their order to lapse comprehensive supervision and regulation by the
110/110-49.pdf). without seeking renewal. CFTC or appropriate government authorities in the
clearing agencies must comply with the SBS exchanges, as well as methods for the OTC market for security-based
standards in Section 17A, which mitigating conflicts of interest swaps. Third, participants could use
include, but are not limited to, (‘‘Conflicts Roundtable’’).25 Panelists their influence to lower the risk
maintaining rules for promoting the from this roundtable included industry management controls of a security-based
prompt and accurate clearance and and non-industry participants.26 swap clearing agency in order to reduce
settlement of securities transactions, Drawing on these experiences, the the amount of collateral they would be
assuring the safeguarding of securities Commission has reviewed the potential required to contribute and liquidity
and funds which are in the custody or for conflicts of interest at security-based resources they would have to expend as
control of the clearing agency or for swap clearing agencies in accordance margin or guaranty fund to the security-
which it is responsible, fostering with Section 765 of the Dodd-Frank Act based swap clearing agency.
cooperation and coordination with and has identified those conflicts that Each of these potential conflicts of
persons engaged in the clearance and could affect access to clearing agency interest could limit the benefits of a
settlement of securities transactions, services, products eligible for clearing, security-based swap clearing agency in
removing impediments to and and risk management practices of the the security-based swaps market, and
perfecting the mechanism of a national clearing agencies. Preliminarily, the even potentially cause substantial harm
system for the prompt and accurate Commission believes that the most to that market and the broader financial
clearance and settlement of securities significant conflicts of interest that may markets, as described below. Conflicts
transactions, and, in general, protecting have an adverse effect on statutory goals of interest in these areas could also
investors and the public interest.23 A in Section 765 of the Dodd-Frank Act potentially undermine the mandatory
registered clearing agency is also are those that arise when a small clearing requirement in Section 763 of
required to provide fair access to number of participants,27 including the Dodd-Frank Act, thereby affecting
clearing and to have the capacity to participants that are Specified Entities transparency, investor protection, risk
facilitate the prompt and accurate and including related persons of the management, efficiency, and
clearance and settlement of securities participants,28 exercise undue control or competition in the security-based swaps
transactions and derivative agreements, influence over a security-based swap market.30
contracts, and transactions for which it clearing agency.
is responsible, as well as to safeguard The Commission has identified three a. Limitations on Open Access to
securities and funds in its custody or key areas where it believes a conflict of Security-Based Swap Clearing Agencies
control or for which it is responsible.24 interest of participants who exercise The Commission believes that the
Pursuant to Section 765 of the Dodd- undue control or influence over a increased use of central clearing for
Frank Act, the Commission must security-based swap clearing agency security-based swaps should help to
identify the nature and sources of any could adversely affect the central promote robust risk management, foster
conflicts of interest relating to the voting clearing of security-based swaps. First, greater efficiencies, improve investor
interests in and governance of a participants could limit access to the protection, and promote transparency in
security-based swap clearing agency security-based swap clearing agency, the market for security-based swaps. For
that may interfere with achieving the either by restricting direct participation these reasons, the Commission has
policy objectives described above or in the security-based swap clearing encouraged the use of central clearing
with the clearing agency complying agency or restricting indirect access by for security-based swaps.31 A
with the regulatory mandates of Section controlling the ability of non- consequence of increased use of central
17A of the Exchange Act described participants to enter into correspondent clearing services, however, is that
above, including the obligation to adopt clearing arrangements.29 Second, participants that control or influence a
rules consistent with the protection of participants could limit the scope of security-based swap clearing agency
investors and the public interest. products eligible for clearing at the may gain a competitive advantage in the
security-based swap clearing agency, security-based swaps market by
2. Sources of Conflicts of Interest particularly if there is a strong economic restricting access to the clearing agency.
The Commission’s experience in incentive to keep a product traded in If that occurred, financial institutions
monitoring the activities of the clearing and marketplaces that do not have
agencies engaged in clearing CDS has 25 See Securities Exchange Act Release No. 62725,
access to central clearing would have
provided it with insight into the 75 FR 51305 (August 19, 2010). The Commission
solicited comments on the Conflicts Roundtable limited ability to trade in or list
potential sources of conflicts of interest (comments received by the Commission are security-based swaps. This problem
that may exist at security-based swap available at http://sec.gov/cgi-bin/ruling- would continue to exist after the
clearing agencies. Since shortly after the comments?ruling=4-609&rule_path=/comments/4-
609&file_num=4- mandatory clearing requirement under
enactment of the Dodd-Frank Act, the
609&action=Show_Form&title=SEC%2DCFTC Section 763 of the Dodd-Frank Act
Commission staff and staff from the Roundtable on Swaps and Security%2DBased becomes effective, because financial
CFTC have met with interested persons Swaps%3A Notice of roundtable discussion and
institutions may be required either to
to learn more about potential conflicts. request for comment).
26 The transcript of the Conflicts Roundtable is submit security-based swaps for central
Moreover, on August 20, 2010, the staff
available on the CFTC’s Web site at http://cftc.gov/
of the Commission and CFTC held a ucm/groups/public/@newsroom/documents/file/ 30 See Public Law 111–203, Section 763(a).
joint public roundtable in part to gain derivative9sub082010.pdf. Section 763(a) of the Dodd-Frank Act adds new
further insight into the sources of 27 The term ‘‘participant’’ when used with respect Section 3C to the Exchange Act, which requires
conflicts of interest at security-based to a clearing agency has the meaning set forth in clearing for certain security-based swaps.
Section 3(a)(24) of the Exchange Act, 15 U.S.C Specifically, Section 3C(a)(1) provides that ‘‘It shall
swap clearing agencies, SB SEFs, and 78c(a), and shall include Specified Entities. See be unlawful for any person to engage in a security-
proposed Rule 700(o) under Regulation MC. based swap unless that person submits such
home country of the security-based swap clearing 28 See infra Section IV.A.3. for a discussion of security-based swap for clearing to a clearing
agency. See Public Law 111–203, Section 763(b). ‘‘related person’’ in the context of a security-based agency that is registered under the Exchange Act or
23 See 15 U.S.C. 78q–1(b)(3)(F). Section 17A of swap clearing agency. a clearing agency that is exempt from registration
the Exchange Act also includes standards that help 29 See, generally, Matthew Leising and Shannon under the Exchange Act if the security-based swap
to mitigate conflicts of interest. See infra Section D. Harrington, ‘‘Wall Street Dominance of Swaps is required to be cleared.’’
IV.C. for a discussion of these standards. Must End, Brokers Say (Update 1),’’ Bloomberg 31 See CDS Clearing Exemption Orders, supra
24 15 U.S.C. 78q–1(b)(3)(A), (B), and (F). (March 16, 2010). note 17.
clearing or face heightened capital or While appropriate participation In situations where direct access is
margin requirements associated with standards are necessary for the sound limited by reasonable participation
bilateral agreements. operation of the security-based swap standards, non-participant firms may be
Market participants generally obtain clearing agency, unduly high standards able to access the security-based swap
access to a clearing agency in one of two may needlessly exclude persons who clearing agency through correspondent
ways: (1) Directly, by becoming a are otherwise qualified to clear security- clearing arrangements with direct
participant in a clearing agency or (2) based swaps. On the other hand, some participants. Correspondent clearing is
indirectly, by entering into a panelists at the Conflicts Roundtable common in securities markets as well as
correspondent clearing arrangement also suggested that increasing access can in futures markets. However, the non-
with a participant in a clearing come at the expense of sound risk participant firms ultimately would be
agency.32 There are several ways that management practices.35 required to enter into a correspondent
both direct and indirect access to a Access could also be restricted by the clearing arrangement with a participant
security-based swap clearing agency way that clearing members determine in order to have the transactions
could be restricted if persons who make executable end-of-day settlement prices. submitted to the security-based swap
decisions for or act on behalf of the Since there is currently no exchange or clearing agency. Thus, the success of
clearing agency have a conflict of other venue that publishes security- correspondent clearing arrangements
interest because of their incentives to based swap prices, the Commission has depends on the willingness of security-
further their own business interests required security-based swap clearing based swap participants to enter into
outside of the security-based swap agencies to publish end-of-day such arrangements with non-participant
clearing agency. Participants may seek settlement prices and any other prices firms that may act as direct competitors
to limit the number of other direct with respect to cleared security-based to the participants. Given that current
participants in a security-based swap swaps that the security-based swap participants may have an incentive to
clearing agency in order to limit clearing agency may use to calculate restrict access to potential competitors,
competition and increase their ability to mark-to-market requirements.36 To correspondent clearing arrangements
maintain higher profit margins. A ensure that end-of-day settlement prices may not be readily established while
security-based swap clearing agency are reliable and consistent, a security- only the large dealer firms are direct
that is controlled by a limited number based swap clearing agency may require participants in the security-based swap
of participants might also adopt policies that the price submission be clearing agency.
and procedures that are designed to executable.37 The security-based swap In addition, procedural barriers may
unduly restrict access, or have the effect clearing agency, however, might not prohibit a firm from having indirect
of unduly restricting access, to the permit an entity to rely on a third party access to a security-based swap clearing
clearing agency by other participants in to provide an executable end-of-day agency. For example, although there are
ways that are unrelated to sound risk settlement price. This could potentially no overt restrictions on indirect access
management practices.33 At the same prevent all but the largest dealer firms at the currently exempted security-
time, affording greater access to the from having direct access to the clearing based swap clearing agencies, many of
clearing agency at some point may come agency as they may be the only firms the processing platforms by which
at the expense of sound risk that have the processes to determine participants submit transactions to the
management practices. executable end-of-day settlement security-based swap clearing agency do
The Commission recognizes that prices.38 not have the functionality to allow a
security-based swap clearing agencies non-participant firm to submit a trade
must establish reasonable participation (available at http://media.ft.com/cms/fe51a538- with a customer to the security-based
standards in order to ensure the 78d7-11df-a312-00144feabdc0.pdf) (‘‘SDMA swap clearing agency through a
participants in the clearing agency do Letter’’). See also Public Roundtable on Governance correspondent arrangement with a
and Conflicts of Interest in the Clearing and Listing
not expose it to unacceptable risk or of Swaps, comments of Darrell Duffie (‘‘[W]e want direct member.
otherwise adversely affect the to be very careful that the members of a central Prohibitively burdensome or
performance of the clearing agency, clearing counterparty that determine what gets restrictive direct participation standards
particularly during periods of market cleared * * * are the members that have * * * the and lack of availability of correspondent
right social incentives to create competition.’’)
stress. However, participant standards (available at http://cftc.gov/ucm/groups/public/
clearing arrangements effectively deny
may have the effect of restricting access @newsroom/documents/file/derivative9 non-participant firms access to the
to the clearing agency. On the one hand, sub082010.pdf at 62). security-based swap clearing agency’s
panelists at the Conflicts Roundtable 35 See supra note 25.
services and, accordingly, create a
36 See, e.g., CDS Clearing Exemption Orders,
and others have raised the concern that substantial competitive advantage for
supra note 17.
participation requirements could be 37 As part of their internal processes, security-
those firms that are direct participants
unnecessarily restrictive and primarily based swap clearing agencies generally calculate in the security-based swap clearing
designed to limit the number of entities end-of-day settlement prices for each product in agency. As previously noted, this
that are permitted to become direct which they hold a cleared interest each business competitive advantage would become
day. See, e.g., Letter from Kevin McClear, ICE Trust, even more significant after the
participants in the clearing agency.34 to Elizabeth Murphy, Secretary, Commission,
December 4, 2009, and letter from Ann K. Shuman, mandatory clearing requirement for
32 Correspondent clearing is an arrangement
Managing Director and Deputy General Counsel, security-based swaps in the Dodd-Frank
between a current participant of a clearing agency CME, to Elizabeth Murphy, Secretary, Commission, Act becomes effective.
and a non-participant that desires to use the
December 14, 2009. One method for calculating an

clearing agency for clearance and settlement end-of-day settlement price for open positions is b. Limitations on the Scope of Products
services. based on prices submitted by participants. As part Eligible for Clearing
33 An example of such restrictive policies and of this mark-to-market process, the security-based
procedures would be a clearing agency establishing swap clearing agency may periodically require As discussed above, Congress found
prohibitively high participation standards so that participants to execute certain security-based swap and the Commission believes that
only the largest financial institutions qualify as trades at the applicable end-of-day settlement price. increased use of central clearing would
participants. This is designed to ensure that participants’
34 See, generally, Swaps and Derivatives Market submitted prices reflect their best assessment of the provide significant benefits to the
Association, ‘‘Lessening Systemic Risk: Removing value of their open positions on a daily basis. Id. security-based swaps market and
Final Hurdles to Clearing OTC Derivatives’’ 38 See SDMA Letter, supra note 34. mitigate systemic risk, particularly
during times of financial crisis. Central Publicly available pricing data may Commission believes, however, that
clearing of security-based swaps likely result in reducing the spreads and decisions regarding the products that
would result in lower spreads and lower reduce the profit per trade for firms that are eligible for clearing by a security-
transaction costs for end-users. A have dominated the OTC market. based swap clearing agency should not
participant in a security-based swap While certain security-based swaps be subject to undue influence by parties
clearing agency might, however, derive may be suitable for central clearing, the that have a financial interest in keeping
greater revenues from its activities in Commission recognizes the possibility such products from being centrally
the OTC market for security-based that some security-based swaps may not cleared, while also noting that non-
swaps than it would from sharing in the be suitable for clearing if their risks participants may have an interest in
profits of a security-based swap clearing cannot be adequately managed by the increasing access, which potentially
agency in which it holds a financial security-based swap clearing agency. could serve to compromise effective risk
interest. As a result, the increased use Clearing products whose risks cannot be management.
of central clearing may be contrary to adequately managed may increase the
the economic interests of some c. Reduced Risk Management Controls
potential of a default of a participant or
participants to a security-based swap even the failure of the security-based Security-based swap clearing agencies
clearing agency. Such participants or swap clearing agency.42 This in turn will perform a critical function in
their related persons could therefore could adversely affect systemic risk, as mitigating financial risk for market
seek to have the security-based swap participants and their customers would participants. The Commission believes
clearing agency limit the types of likely have significant funds and that through uniform margining and
security-based swaps that are eligible for securities tied to the clearing agency other risk controls, including controls
clearing at a security-based swap and would be dependent on the over market-wide concentrations that
clearing agency over which they continued operations of a security-based cannot be implemented effectively
exercise influence or control.39 swap clearing agency in order to enter when counterparty risk management is
A further incentive for a clearing into new transactions in security-based decentralized, security-based swap
agency controlled by participants to swaps. This again highlights the clearing agencies would help to prevent
restrict the products that are eligible for potential tensions between sound risk a single market participant’s failure
clearing at the security-based swap management and the increased use of from destabilizing other market
clearing agency may be to control a central clearing services. Expanding the participants and, ultimately, the broader
security-based swap’s price number and scope of products cleared financial system.
transparency. Trading in the OTC would in some cases be in the best Although participants may seek to
derivatives market is currently interests of the security-based swap raise risk management controls in order
dominated by a small number of firms.40 clearing agency and the security-based to restrict access to the clearing agency
Prior to the use of clearing agencies to swaps market generally, because it or protect their financial stake in the
clear security-based swaps, end-users provides processing efficiencies and clearing agency, they might also seek to
had to transact directly with a small replaces bilateral counterparty risk. lower certain risk management controls
number of firms to trade in security- However, allowing a greater number and such as margin requirements in order to
based swaps without the benefit of scope of products to be centrally cleared release collateral that they may wish to
publicly available pricing data. would in some cases be harmful to the use for other purposes. Furthermore, as
Security-based swap clearing agencies security-based swap clearing agency and security-based swap clearing agencies
provide greater price transparency by become more established and the
the security-based swaps market, if
making certain price data available to mandatory clearing requirement under
sound risk management standards are
the public and thereby helping to Section 763 is implemented, more
compromised in order to clear those
reduce the information asymmetry that security-based swaps will likely be
products.
benefits firms in the OTC market.41 centrally cleared and clearing
The Commission is mindful of the
39 Representative Barney Frank, who chaired the need to balance goals associated with participants will be required to provide
conference committee that reconciled the House promoting the central clearing of a substantially larger amount of liquid
Bill and the Senate Bill, referred to this specific security-based swaps and assuring that collateral to security-based swap
concern when discussing the amendment adding proposed rules are designed to increase clearing agencies in the form of margin.
Section 765 to the Dodd-Frank Act. Chairman Frank
stated, ‘‘The purpose of this in part is to get many the number of products eligible for As a result, participants may be willing
more derivatives cleared. But the clearing houses central clearing with the goals to accept greater risk than is prudent for
have the right to refuse them if they say the associated with effective risk the security-based swap clearing agency
transactions aren’t suitable for clearing. We believe in order to reduce the amount of their
that some banks have an interest in not having them
management. The Commission is also
cleared. So we don’t want entities that have an aware that any rules that it may margin contributions. A reduction in
interest and [sic] there being no clearing, owning ultimately adopt relating to conflicts of risk management controls ultimately
the clearing houses. That’s why this is an important interest may affect this balance. The could function to increase systemic risk
amendment to us, and it was passed after
considerable debate on the House floor.’’ House-
by increasing the potential for a
Senate Conf. Comm. Holds Markup on HR 4173, Infrastructure,’’ Federal Reserve Bank of New York financial loss that must be borne by the
Financial Regulatory Overhaul Bill, June 24, 2010, Staff Report No. 424, dated January 2010, as revised participants of the security-based swap
reprinted in CQ Congressional Transcripts, 111th March 2010 (‘‘Even after an OTC derivatives
product has achieved relatively active trading
clearing agency.43
Cong. 182 (2010) (statement of Barney Frank,
The Commission recognizes that
Chairman, House Comm. on Fin. Serv.). * * * dealers have an incentive to maintain the
40 See Office of the Comptroller of the Currency, wide bid-ask spreads that they can obtain in the participants generally have a financial
Quarterly Report on Bank Trading and Derivatives OTC market * * *. Thus, from the viewpoint of incentive to ensure that the security-
Activities, First Quarter 2010. (‘‘Derivatives activity profits, dealers may prefer to reduce the migration
of derivatives trading from the OTC market to
based swap clearing agency collects
in the U.S. banking system continues to be
dominated by a small group of large financial central exchanges.’’). sufficient margin from each participant.
institutions. Five large commercial banks represent 42 Section 763(a) adds new Section 3C(d)(3)(A) to
97% of the total banking industry notional amounts the Exchange Act, which prohibits the Commission 43 Such a scenario would arise, for example,
* * *.’’) from requiring any clearing agency to accept a where a defaulting participant has contributed
41 See Darrell Duffie, Ada Li, and Theo Lubke, security-based swap for central clearing. See Public insufficient margin to meet its obligations to the
‘‘Policy Perspectives on OTC Derivatives Market Law 111–203, Section 763(a). security-based swap clearing agency.
A clearing agency’s rules and dominate much of the trading in restricting access to the clearing agency,
procedures typically provide that in the security-based swaps and could use which as discussed above would serve
event of a participant default, losses their controlling position to maintain or to preserve profits that participants earn
exceeding a participant’s individual extend their dominant market position. through trading security-based swaps in
margin contribution may be satisfied In addition, it is important to consider the OTC markets.
from a guaranty fund composed of the likely incentives of individual In contrast, non-participant-related
contributions from all participants. As a directors, once they are on the Board, directors may, on balance, be more
result, participants have a unique when they are governing the security- likely to seek to maximize the value of
financial incentive to ensure that the based swap clearing agency.45 Directors the enterprise, which, in addition to
security-based swap clearing agency has of a security-based swap clearing agency sound risk management, may involve
sufficient collateral from each owe a fiduciary duty to the security- increasing the revenues of the security-
participant to withstand a participant based swap clearing agency and all of its based swap clearing agency, such as by
default in almost all market conditions. shareholders. In addition, among other expanding the number and scope of
However, participant defaults occur obligations, the Board as a whole is products being cleared. Moreover, at a
infrequently and the incentive for ultimately responsible for overseeing minimum it would seem less likely that
participants to protect their guaranty the clearing agency’s compliance with non-participant-related directors would
fund contributions may have less weight the regulatory obligations of security- favor unduly restricting access to the
than the incentive to reduce margin based swap clearing agencies under the clearing agency and its services. Thus,
requirements in order to release margin Dodd-Frank Act and the Exchange Act, non-participant-related directors may be
collateral for immediate use. including the open and fair access inclined to favor expanded access to
A non-participant does not contribute requirements. At the same time, products and services, which may
to a guaranty fund and may not have the however, directors may be subject to increase the amount of risk that the
same incentives as a participant with different perspectives when fulfilling clearing agency must successfully
respect to establishing and maintaining these duties and roles. Although the manage. The interest in expanded
sufficiently robust participant margin Commission recognizes that incentives access to products and services may be
requirements. Non-participants’ and motivations may vary among especially relevant in the early stages of
incentives may be to focus less on risk directors and over time for a range of a clearing agency’s development, when
management and focus more on reasons—and therefore it is not possible establishing a new entity as a viable
allowing more participants to be to predict precisely how any individual clearing agency is especially important.
admitted to the clearing agency and director will address a particular The Commission recognizes that other
more products to be made eligible for matter—directors who are appointed by factors may also affect director
central clearing. or related to participants (‘‘participant- incentives and behavior. For example, it
related directors’’) may on balance be may be argued that participant-related
d. Implications for Ownership and directors may in general have greater
Governance more likely to reflect the views of
participants than would directors who risk management expertise and
As described above, conflicts of are not appointed by or related to experience than non-participant-related
interest may arise if participants participants (‘‘non-participant-related directors, and that non-participant-
exercise undue control or influence over directors’’).46 related directors may tend to defer to
a security-based swap clearing agency. In light of these dynamics, as between the views or judgment of participants or
This influence, typically acquired the two categories of directors, participant-related directors on risk
through an ownership stake in the participant-related directors, like matters, with the effect that open access
clearing agency, generally may be participants themselves, may on balance may be unduly compromised in favor of
exercised by participants through either be more likely to favor reducing or risk management. On the other hand, it
(i) voting interests in the security-based minimizing the risk exposure of the may be argued that qualified non-
swap clearing agency or (ii) clearing agency, potentially at the participant-related directors with
participation in the governance of the expense of more open access. In sufficient risk management expertise
security-based swap clearing agency, addition, participant-related directors can be readily found, and in any event
such as by selecting (or influencing the these directors’ independence of
may also be more likely to favor
selection of) the directors of the participants would justify their
security-based swap clearing agency.44 45 The Commission’s discussion in this Release of heightened involvement on the Board.
In either case, undue control or the motivations or incentives of directors of a In addition, directors may face other
influence may be particularly acute if (i) clearing agency, SB SEF, or SBS exchange comes in conflicts of interest. For example, there
the participants are part of the process the context of requiring modes of governance that may be conflicts between the competing
permit consideration of a variety of perspectives. As
for nominating the directors, even if noted throughout this Release, a company’s
interests of different shareholders—
such participants are not themselves directors have a duty to all the company’s whether or not participants—which
directors, or (ii) the election of directors shareholders, and the Commission does not regard could have implications for director
is subject to concentrated voting power any directors as simply surrogates for a particular behavior, as discussed more fully below.
group of shareholders. The Commission’s
in a small number of participants, discussion is intended to forestall possible conflicts
There also may be a tension between the
especially if such participants also and does not reflect findings that particular directors’ incentives to maximize profits
conflicts are present. and their duties to oversee the security-
44 Section 765 of the Dodd-Frank Act authorizes 46 This distinction between participant-related
based swap clearing agency’s
the Commission to adopt rules regarding conflicts and non-participant-related directors may be most compliance with applicable legal
of interest of Specified Entities at security-based significant where the clearing agency is (i) a
swap clearing agencies in general. However, the publicly owned corporation, or part of a publicly restrictions which, although not
Commission preliminarily believes that those owned corporation, or (ii) otherwise owned by necessarily unique to clearing agencies,
entities that are participants in a security-based persons other than participants. The Commission may nevertheless affect how they decide
swap clearing agency will have a conflict of interest recognizes that ownership structures for clearing any particular matter.
that could be acted upon to adversely affect the agencies may take other forms, including ownership
development of the market for security-based swaps solely by participants, in which case the incentives
As described more fully below, the
consistent with the policy objectives of Section 765 and perspectives of the directors may be somewhat proposed rules are intended to strike a
of the Dodd-Frank Act. different. balance among these various
considerations by allowing participants conflicts of interest likely to change as clearing agency, to act in conformity
to maintain a significant voice within a the central clearing of security-based with the Exchange Act, or to act to meet
security-based swap clearing agency swaps, and security-based swap clearing the policy objectives in Section 765 of
while also imposing ownership agencies, become more established? the Dodd-Frank Act? Would directors be
limitations and independent director What potential new conflicts of interest less likely to act to meet the policy
requirements to mitigate the potential could arise that the Commission should objectives in Section 765 of the Dodd-
influences of participant owners and consider? How will potential changes in Frank Act if they are selected by
participant-related directors. the trading of security-based swaps shareholders seeking to maximize the
affect conflicts of interest at security- profits of the security-based swap
e. Request for Comments Regarding based swap clearing agencies? In
Identified Conflicts of Interest clearing agency? What effect would they
addition, competitive forces within the likely have on security-based swap
The Commission requests comment security-based swaps market may help clearing agencies? How do participants’
on the conflicts of interest it has to mitigate conflicts of interest, for
conflicts of interest that affect risk
identified with respect to security-based example, by increasing the number of
management and open access issues
swap clearing agencies, including the institutions that trade in security-based
conflicts related to participant swaps and creating a broader market in compare with non-participants’ interests
standards, product eligibility, and risk security-based swaps. How might regarding these issues? How do
management. Do commenters agree with competition issues affect or change participants’ incentives with respect to
the potential conflict concerns that the current conflicts of interest? Will risk management compare with the
Commission has identified? Some competition potentially create different incentives of non-participant
parties have questioned the benefits of or additional conflicts of interest that shareholders or directors? How do the
central clearing generally in terms of the Commission should consider? Will incentives of independent directors
reducing systemic risk,47 potentially competition potentially mitigate differ from the non-independent
suggesting a different analysis with conflicts of interest? directors in terms of considering the
respect to the identified conflicts of What other parties may have conflicts potential for conflicts of interest?
interest. What are commenters views on of interest that would affect whether The Commission also requests
the potential benefits and costs of they should control or participate in the comment on the interplay of the
central clearing and the resulting effect governance of a security-based swap identified conflicts of interest, and any
on the conflicts of interest analysis? clearing agency? In what circumstances additional conflicts of interest identified
What effect would the identified do these conflicts of interest arise?
by commenters, and how that may affect
conflicts of interest likely have? Should Under certain circumstances, there is
a security-based swap clearing agency.
the Commission focus on any of these the potential that incentives of
shareholders to maximize profits could For example, there may at times be a
conflicts more than others? Are there trade-off between risk management
other existing conflicts concerns that compromise prudent risk management
by a security-based swap clearing standards and open access to the
commenters believe warrant scrutiny? If
agency. For example, shareholders clearing agency. What is the best way to
so, what are they and how are they
could seek to increase revenue from balance these and other potential
likely to affect security-based swap
clearing fees by increasing the number conflicts of interest in order to assure
clearing agencies?
The conflicts of interest discussed in of products cleared by the clearing that the clearing agency has both robust
part stem from the current concentrated agency beyond those that can be risk management and fair and open
market structure for security-based appropriately risk managed or by having access to clearing services? Are there
swaps. How is the current market the clearing agency expand its services any other conflicts of interest that pose
structure likely to evolve over time? or engage in new lines of business that similar trade-offs? What conflicts are
What effect will that evolution have on would expose the security-based swap these and how should the Commission
the consideration of conflicts of clearing agency to increased risk. balance the related concerns?
interest? Are there any other conflicts of Shareholders that are not users of a The Commission recognizes that other
interest that may result due to expected security-based swap clearing agency conflicts of interest may arise in the
changes in the security-based swaps may also not have the same incentives governance of security-based swap
market or the clearing of security-based to keep the costs of clearing low. The clearing agencies—for example, there
swaps that the Commission should Commission requests comment on the may be a conflict between the interests
consider? If so, what are they and how conflicts of interest that non-participant of certain shareholders. The rules the
are they likely to affect security-based shareholders may have and the effect Commission is proposing today focus on
swap clearing agencies? such conflicts could have on a security-
the conflicts of interest presented by the
The central clearing of security-based based swap clearing agency. What are
potential influence of participants in the
swaps is still developing and may the differences in conflicts of interest
security-based swaps market because, as
change significantly as the market for between participants and non-
participants? What are the different described above, the Commission
security-based swaps develops. In believes those conflicts may be most
particular, the new provisions in the effects these conflicts could have on a
security-based swap clearing agency? relevant to the development of security-
Dodd-Frank Act relating to the central based swap clearing agencies. The
clearing of security-based swaps are not Which conflicts of interest could
Commission recognizes that conflicts of
yet effective. Once they become potentially cause the greatest harm to
the security-based swap clearing interest may also arise with respect to
effective, security-based swap clearing independent directors and has
agencies will be subject to substantially agency?
Do persons who are selected to be attempted to achieve a balance between
more regulation, which may have an the different incentives of participant-
effect on conflicts of interest. How are directors of a security-based swap
clearing agency by participants have a related and non-participant-related
47 See, e.g., Craig Pirrong, ‘‘The Inefficiency of conflict of interest based on their status directors and the potential benefits each
Clearing Mandates,’’ Cato Institute Policy Analysis as directors that would affect their might bring to the Board of a security-
No. 665, July 21, 2010. ability to act in the best interest of the based swap clearing agency.
B. Security-Based Swap Execution market. When a small group of those might justify the decision of participants
Facilities and National Securities same market participants also dominate in a SB SEF or members of a SBS
Exchanges much of the trading in security-based exchange not to make a particular
The Commission has also reviewed swaps, control of a SB SEF or SBS product available for trading on a SB
the potential for conflicts of interest at exchange by these participants raises a SEF or a SBS exchange. However,
SB SEFs and SBS exchanges in heightened concern. If a SB SEF or a decisions regarding the eligibility of
accordance with Section 765 of the SBS exchange is controlled by a small security-based swaps for trading on a SB
Dodd-Frank Act and has identified group of dealers who also dominate SEF or SBS exchange should not be
those conflicts that it believes may be trading in the market for security-based subject to undue influence by parties
mitigated by rules designed to improve swaps, the dealers may have that have a financial interest in keeping
the governance of a SB SEF or SBS competitive incentives to exert undue such products from being centrally
exchange, promote competition, or influence to control the level of access traded on a facility or exchange.
mitigate conflicts of interest in to the SB SEF or SBS exchange and thus Finally, the Commission also believes
connection with the operation of a SB impede competition by other market that a SB SEF or SBS exchange could
SEF or SBS exchange by a security- participants. In other words, have potential conflicts of interest
based swap execution facility participants or members in a SB SEF or between the commercial interests of the
participant (‘‘SB SEF participant’’) 48 or a SBS exchange, as applicable, might seek SB SEF or SBS exchange or the SB SEF’s
member of an SBS exchange (‘‘SBS to limit the number of direct or SBS exchange’s owners and the SB
exchange member’’) 49 that has an participants in the trading venue in SEF’s or SBS exchange’s market
ownership interest in the SB SEF or SBS order to limit competition and increase oversight responsibilities.54 With
exchange. As with security-based swap their ability to maintain higher profit respect to these kinds of conflicts of
clearing agencies, the Commission margins. Given such incentives, a SB interest, the Commission’s proposal is
preliminarily believes that conflicts of SEF or SBS exchange that is controlled informed, in part, by its experience
interest that may have an adverse affect by a limited number of participants or overseeing national securities
on the statutory goals of Section 765 are members might adopt policies and exchanges. The Commission notes,
those that arise when a small number of procedures that are designed to restrict however, that a SB SEF’s regulatory
market participants, including access. obligations under Section 763(c) of the
Participants or members also might be Dodd-Frank Act are not identical to
participants that are Specified Entities
motivated to restrict the scope of those of a national securities exchange’s
and including related persons of
security-based swaps that are eligible for obligations under Section 6 of the
participants,50 exercise control or undue
trading at SB SEFs or SBS exchanges if Exchange Act.
influence over a SB SEF or SBS
there is a strong economic incentive to National securities exchanges are self-
exchange. This influence may be
keep such swaps in the OTC market. On regulatory organizations (‘‘SROs’’) and
exercised either through ownership of
the other hand, this concern may be are statutorily required to comply, and
voting interests 51 or participation in the
mitigated by competitive forces if a enforce compliance by their members
governance of the SB SEF or SBS
greater number and variety of facilities and their associated persons, with the
exchange.
The Commission believes that where security-based swaps can be Federal securities laws, the rules and
through ownership of voting interests or traded are available. A small number of regulations thereunder, and their own
ability to influence governance, market firms currently dominate trading in the rules.55 Exchanges also generally
participants could exercise influence OTC derivatives market.52 Centralized operate for-profit markets and, as a
with respect to the services provided by trading of security-based swaps likely result, are concerned with preserving
SB SEFs or SBS exchanges, the rules would result in lower spreads and lower and enhancing their competitive
and policies applicable to participants transaction costs for end-users, positions vis-à-vis other exchanges.56
or members of such entities, and, more particularly as a result of increased pre- Consequently, exchanges have potential
generally, the security-based swaps trade and post-trade transparency of conflicts of interest between carrying
prices, assuming sufficient trading out their regulatory obligations to
48 The term ‘‘security-based swap execution volume and liquidity.53 As noted above, vigorously oversee their members and
facility participant’’ means a person permitted to increased price transparency might help marketplace and promoting their and
directly effect transactions on the security-based to eliminate much of the basis for their shareholders’ economic interests.
swap execution facility. See proposed Rule 700(z) asymmetrical information, reduce
under Regulation MC.
For example, an exchange could put its
49 A ‘‘member’’ when used with respect to a
spreads, and reduce the profit per trade interest and that of its members or
national securities exchange means (i) any natural for firms that dominated the OTC
person permitted to effect transactions on the floor security-based swaps market. As a 54 An entity that registers as a SB SEF will have
of the exchange without the services of another result, this might create an incentive for oversight responsibility over its market pursuant to
person acting as broker, (ii) any registered broker or the Exchange Act (as amended by the Dodd-Frank
dealer with which such a natural person is
participants or members in a SB SEF or Act) and rules adopted thereunder. See Section
associated, (iii) any registered broker or dealer SBS exchange, as applicable, to seek to 763(c) of the Dodd-Frank Act, Public Law 111–203,
permitted to designate as a representative such a limit the number of security-based Section 763(c). Similarly, all national securities
natural person, and (iv) any other registered broker swaps that are made available for exchanges, including those that may post or make
or dealer which agrees to be regulated by such available for trading security-based swaps, have
exchange and with respect to which the exchange
trading by such venues. The oversight responsibilities over their markets and
undertakes to enforce compliance with the Commission recognizes, however, that their members pursuant to the Exchange Act. See
provisions of the Exchange Act, the rules and there could in certain circumstances be Section 6 of the Exchange Act, 15 U.S.C. 78(f).
regulations thereunder, and its own rules. See legitimate concerns regarding liquidity 55 See Sections 6(b)(1) of the Exchange Act, 15
Section 3(a)(3)(A) of the Exchange Act, 15 U.S.C. U.S.C. 78f(b)(1).
78c(a)(3)(A).
or other trading characteristics of a
56 Historically, national securities exchanges were
50 See infra Section V.A. for a discussion of security-based swap that reasonably structured as not-for-profit or similar organizations
‘‘related person’’ in the context of a SB SEF and SBS owned by their members. Exchanges, however, have
exchange or facility thereof. 52 See supra note 40. more recently evolved to become shareholder-
51 See infra Section V.A. for a discussion of the 53 The Commission will address the issue of owned. See supra note 49 for the definition of
ownership and voting limits of proposed Rule 702 transparency of security-based swap pricing and ‘‘member’’ as applicable to national securities
under Regulation MC. transaction data in a separate rulemaking. exchanges.
shareholders ahead of its regulatory voting limits and addresses certain it provides fair procedures for
responsibilities by failing to take governance principles.62 Namely, the disciplining members, consistent with
regulatory or enforcement actions or to Commission looks to ensure that there the requirements in Sections 6(b)(6) and
adequately fund self-regulation. Further, are limits on the ability of persons to 6(b)(7) of the Exchange Act.67
the commercial interests of the own and control exchanges by, for The Commission’s recognition of
shareholders of an exchange may example, requiring at a minimum that potential conflicts of interest at
conflict with the regulatory obligations no person, alone or together with its exchanges and its approach to date in
of an exchange. A shareholder may be related persons,63 be permitted to own reviewing and approving measures
incentivized to maximize profits more than 40%, and no member, alone designed to mitigate those conflicts of
through the economic stake it has in the or together with its related persons, be interest are a useful point of reference
exchange or, if the shareholder is also a permitted to own more than 20%, of the as the Commission identifies, and
member of the exchange, to more ownership interests of the exchange or develops proposals to mitigate, the
directly further its own commercial be entitled to vote shares in excess of conflicts of interest potentially faced by
interests.57 For example, a shareholder 20%.64 Further, the Commission also SB SEFs and SBS exchanges as the
could promote the distribution of the looks to ensure that an exchange trading of security-based swaps moves
exchange’s revenues in a manner that provide fair representation of members to regulated markets. However, as noted
could result in inadequate funding of in the selection of directors and the above, the Commission recognizes that
the exchange’s regulatory operations or, administration of its affairs, consistent a SB SEF’s regulatory obligations are not
if also an exchange member, could use with the requirement in Section 6(b)(3) the same as a national securities
the exchange’s disciplinary process of the Exchange Act,65 that an exchange exchange’s regulatory obligations.
potentially to harass or penalize a is organized in a manner that allows it The Commission in 2004 proposed
competitor. to carry out the purposes of the rules to promote the fair administration
The Commission has considered the Exchange Act pursuant to Section and governance of, and to impose
conflicts between an exchange’s 6(b)(1) of the Exchange Act,66 and that ownership and voting limitations on,
regulatory responsibilities and its national securities exchanges and
commercial interests in operating a 62 See, e.g., Securities Exchange Act Release Nos. registered national securities
marketplace for the trading of securities. 62158 (May 24, 2010), 75 FR 30082 (May 28, 2010) associations.68 Among other things, the
(order approving the demutualization of the
To address these types of concerns, the Chicago Board Options Exchange, Incorporated proposal would have required an
Commission has developed, consistent (‘‘CBOE’’)) and 53382 (February 27, 2006), 71 FR exchange to: Have a Board composed of
with the requirements of Section 6 of 11251 (March 6, 2006) (order approving the merger a majority of independent directors;
the Exchange Act,58 an approach to of New York Stock Exchange, Inc. (‘‘NYSE’’) and maintain fully independent nominating,
Archipelago and NYSE’s demutualization).
mitigate conflicts of interest for national 63 Generally, a ‘‘related person’’ means, with compensation, and audit committees;
securities exchanges.59 Specifically, respect to any person, any other person, directly or separate its regulatory obligations and
through its review of proposals filed by indirectly, controlling, controlled by, or under business functions by establishing a
exchanges with respect to changes to common control with such person or any person fully independent regulatory oversight
their ownership and governance acting in concert with such person.
64 See, e.g., Exchange Act Release No. 61698, 75
committee (‘‘ROC’’) or equivalent
structures (generally from member- FR at 13156, supra note 59. The exchange’s Board structure; and limit ownership and
owned to shareholder-owned may waive the voting and ownership limits if it voting control by members.69 This
organizations) pursuant to Section 19 of makes certain findings, including a finding that proposal was intended to improve the
the Exchange Act 60 or of applications such a waiver would be consistent with the
exchange’s self-regulatory obligations. The board,
governance of certain SROs by
filed by entities to register as national however, may not waive these limits for any establishing independence standards for
securities exchanges pursuant to Section exchange members. Moreover, the exchange must the board of directors (‘‘Board’’) and key
6 of the Exchange Act,61 the file such waiver with the Commission as a proposed committees and by minimizing conflicts
Commission examines the way in which rule change for approval before it could be
implemented. of interest by instituting ownership and
an exchange applies ownership and voting limitations and the separation of
The ownership limits currently in place for
exchanges generally apply to any ownership the exchange’s regulatory obligations
57 See SRO Governance Proposing Release, 69 FR
interest. See, e.g., Exchange Act Release No. 61698, and commercial interests. Although the
71126, infra note 59. 75 FR 13151, supra note 59; Amended and Restated
58 See Section 6(b) of the Exchange Act, 15 U.S.C. Certificate of Incorporation of BATS Global
78f(b). Markets, Inc., Article FIFTH. In contrast, proposed dealer, is not associated with an entity that is
59 See, e.g., Securities Exchange Act Release Nos. Rule 702 would apply ownership limits only with affiliated with a broker or dealer, and has neither
61698 (March 12, 2010), 75 FR 13151 (March 18, respect to those shares or other interests entitled to a material ownership interest nor investment in a
2010) (In the Matter of the Applications of EDGX vote. See infra Section V.A. for a discussion of the broker or dealer. See, e.g., CBOE By-Laws, Article
Exchange, Inc., and EGDA Exchange, Inc. for differences between the ownership and voting III, Section 3.1. Some exchanges also have
Registration as National Securities Exchanges; limits in proposed Rule 702 and those limits ‘‘independent directors.’’ Typically, an independent
Findings, Opinion, and Order of the Commission) currently in place for exchanges. director has no material relationship with the
(‘‘Exchange Act Release No. 61698’’); 58375 (August 65 15 U.S.C. 78f(b)(3). Pursuant to Section 6(b)(3), exchange or an exchange member. See, e.g.,
18, 2008), 73 FR 49498 (August 21, 2008) (In the the Commission generally requires, at a minimum, Amended and Restated By-Laws of BATS Exchange,
Matter of the Application of BATS Exchange, Inc. that at least 20% of the directors on the board be Inc., Article I(m). For example, an officer or director
for Registration as a National Securities Exchange; selected by exchange members. The Commission of a listed issuer generally is considered a non-
Findings, Opinion, and Order of the Commission) also requires that exchange members be permitted industry director rather than an independent
(‘‘Exchange Act Release No. 58375’’). In 2004, the to participate in the nomination process of such director. The definitions of ‘‘non-industry’’ and
Commission proposed rules relating to: the fair representative directors and that they have the right ‘‘independent’’ do, however, differ across
exchanges.
administration and governance of SROs; disclosure to petition for alternative candidates. See, e.g.,
67 15 U.S.C. 78f(b)(6) and (7). To find an
and regulatory reporting by SROs; recordkeeping Securities Exchange Act Release No. 58375, 73 FR
requirements by SROs; ownership and voting at 49500, supra note 59. exchange’s disciplinary rules to be consistent with
limitations for SROs; and listing and trading of 66 15 U.S.C. 78f(b)(1). Pursuant to Section 6(b)(1), the Exchange Act, the Commission generally
affiliated securities by SROs. The Commission has the Commission generally requires, at a minimum, requires that disciplinary processes be balanced and
not taken action on these proposed rule changes. that the number of non-industry directors on the include industry member participation. See, e.g.,
See Securities Exchange Act Release No. 50699 exchange’s board equal or exceed the number of Exchange Act Release No. 61698, 75 FR at 13160,
(November 18, 2004), 69 FR 71126 (December 8, industry directors. Generally, a ‘‘non-industry n. 124, supra note 59.
2004) (‘‘SRO Governance Proposing Release’’). director’’ is someone who is not subject to 68 See SRO Governance Proposing Release, 69 FR
60 15 U.S.C. 78s. 71126, supra note 59.
regulation by the exchange, is not a broker or dealer
61 15 U.S.C. 78f. or an officer, director, or employee of a broker or 69 Id.
Commission has not acted further on unlike exchange-listed securities, listed options are generally liquid,
this proposal, a number of exchanges trading in the OTC derivatives market is trading is widely dispersed, and there
have adopted some of the governance currently dominated by a small group of are numerous trading venues and
concepts on their own initiative 70 and dealers.74 Although mechanisms in market participants. Unlike the well-
all of the exchanges registered under place to address conflicts of interest established cash equity and options
Section 6 of the Exchange Act have among members, shareholders, and markets, the security-based swaps
adopted ownership and/or voting exchanges would help mitigate some market is at an earlier stage of
limitations, with the Commission’s concerns about conflicts of interest that development and, as noted above, is
approval.71 could result from dealer control of the currently dominated by a small number
Each potential conflict of interest current security-based swaps market, of dealers. Further, the regulatory
identified in this Section III.B. could the Commission believes that additional structure governing the security-based
limit the benefits of centralized trading measures may be necessary to swaps market will not be completely
in the security-based swaps market and effectively mitigate conflict of interest realized until all provisions of the
potentially undermine the mandatory concerns. For example, applying Dodd-Frank Act and any rules
trading requirement in new Section standards approved for exchanges to SB promulgated thereunder are fully
3C(h) of the Exchange Act, thereby SEFs and SBS exchanges, as described implemented. However, like exchanges,
negatively affecting efficiency and above, may not alone adequately SB SEFs may have shareholder-owners
competition in the security-based swaps address the potential concern that a who also may be SB SEF participants
market.72 Further, while the small group of dealers could gain and may compete with any other SB
Commission believes that its past control over such entities and limit SEF to the extent that they trade the
application of statutory requirements security-based swaps from trading on, same security-based swaps. In addition,
has been appropriate to improve the and participant or member access to, a although SB SEFs would not be SROs
governance of, and mitigate the conflicts centralized market. Accordingly, the and therefore would not be subject to
of interest for, exchanges, given the Commission is proposing rules for SB the same obligations under the
difference in the structure of the OTC SEFs and SBS exchanges that are Exchange Act as SROs, they nonetheless
derivatives market and the markets for designed to mitigate the potential will be subject to regulatory
exchange-listed securities, it also conflicts of interest that it has identified responsibilities under Section 763(c) of
believes that potential conflicts of in the context of the security-based the Dodd-Frank Act and, as a result, will
interest in SBS exchanges can and swaps market, including ownership have to establish rules and enforce
should be further examined.73 Namely, limitations and governance compliance with those rules by their
requirements, as more fully described participants.76 Thus, the conflicts of
70 See, e.g., CBOE By-Laws, Article III, Board of below.75 interest that the Commission has
Directors (‘‘Board of Directors’’ must have a majority The Commission has considered the experienced with exchanges may be
of ‘‘Non-Industry Directors’’) and Article IV, mechanisms in place to mitigate similar, although not necessarily
Committees (‘‘Regulatory Oversight Committee’’ conflicts of interest at national securities
must consist of at least three directors, all of whom
identical, to the conflicts of interest that
shall be ‘‘Non-Industry Directors’’); By-Laws of the exchanges in developing its proposals to SB SEFs and SBS exchanges may face.
NASDAQ Stock Market LLC (‘‘Nasdaq’’), Article III, mitigate conflicts of interest for SB SEFs The Commission nevertheless is
Board of Directors, Section 2, Qualifications (‘‘Board and SBS exchanges. The Commission mindful of the need to mitigate conflicts
of Directors’’ must have a majority of ‘‘Non-Industry notes that there are similarities and of interest for SB SEFs and SBS
Directors’’) and Section 5, Committees Composed
Solely of Directors (Regulatory Oversight
differences between the exchange-listed exchanges without unduly restricting
Committee must consist of at least three members, markets and the market for security- the ability of trading facilities to be
each of whom shall be a ‘‘Public Director’’ and an based swaps that merit consideration in formed or the emergence of a
‘‘independent director’’ as defined in Nasdaq Rule crafting appropriate proposals to competitive market for the trading of
4200).
71 See, e.g., Amended and Restated Certificate of
mitigate conflicts of interest for SB SEFs security-based swaps.
Incorporation of BATS Global Markets, Inc., Article and SBS exchanges. National securities The Commission requests comment
FIFTH. exchanges list and trade cash equity on the types of conflicts of interest it has
72 See Public Law 111–203, Section 763(a). securities and options pursuant to a identified with respect to SB SEFs and
Section 3C(h) of the Exchange Act imposes a well-developed body of their own rules, SBS exchanges, including the listing
mandatory trading requirement, which provides
that counterparties shall execute a transaction in a
as well as Commission rules, and and trading of security-based swaps on
security-based swap subject to the clearing compete actively with each other and SB SEFs and SBS exchanges. Has the
requirement of Section 3C(a)(1) on an exchange or with other non-exchange trading venues Commission identified all of the
a registered SB SEF or a SB SEF that is exempt from for market share and revenues significant potential conflicts concerns?
registration pursuant to Section 3D(e) of the associated with trading volume. The
Exchange Act.
Do commenters disagree with any
73 Within the past several years, the Commission markets for cash equity securities and potential conflicts concerns that the
has reviewed and assessed comprehensively the Commission has identified? What other
governance structure of each national securities Exchange, Inc. (‘‘ISE’’) by Eurex Frankfurt AG); conflicts concerns may exist, if any?
exchange, either in connection with a significant Exchange Act Release No. 58375, 73 FR at 49500, As discussed above, the Commission
transaction by the exchange or as part of its supra note 59; 61152 (December 10, 2009), 74 FR
application for registration as a national securities 66699 (December 16, 2009) (order approving seeks to minimize the conflicts of
exchange. See, e.g., Securities Exchange Act Release application of C2 Options Exchange, Incorporated interest for national securities
Nos. 58324 (August 7, 2008), 73 FR 46936 (August to register as a national securities exchange); exchanges through ownership
12, 2008) (order approving The NASDAQ OMX Exchange Act Release No. 61698, 75 FR at 13156,
supra note 59; 53128 (January 13, 2006), 71 FR 3550
limitations and governance
Group, Inc.’s (‘‘Nasdaq OMX’’) acquisition of the
Boston Stock Exchange, Inc. (‘‘BSE’’)); 58179 (July (January 23, 2006) (order approving Nasdaq’s requirements. Are the conflicts of
17, 2008), 73 FR 42874 (July 23, 2008) (order application to register as a national securities interest relating to exchanges, which
approving Nasdaq OMX’s acquisition of the exchange). could elect to trade swaps and thus
74 See supra note 40.
Philadelphia Stock Exchange, Inc. (‘‘Phlx’’)); 55293 become SBS exchanges, different than
(February 14, 2007), 72 FR 8033 (February 22, 2007) 75 As of the date of this release, the Commission
(order approving the business combination between has not proposed rules regarding the scope,
the conflicts of interest relating to SB
NYSE and Euronext N.V.); 56955 (December 13, registration requirements, and operation of a SB
2007), 72 FR 71979 (December 19, 2007) (order SEF, including the types of entities that would 76 See Section 763(c) of the Dodd-Frank Act,
approving acquisition of International Securities qualify for registration as a SB SEF. Public Law 111–203, Section 763(c).
SEFs, and, if so, how? To what extent, potential changes in the clearing of IV. Discussion of Proposed Regulation
if any, should the Commission draw on security-based swaps affect conflicts of MC: Mitigation of Conflicts of Interest
its experience with conflicts of interest interest at SB SEFs and SBS exchanges? of Security-Based Swap Clearing
that may arise in the exchange context In addition, competitive forces within Agencies
and with efforts to mitigate those the security-based swaps market may Section 765 directs the Commission to
conflicts and apply that experience in help to mitigate conflicts of interest, for adopt rules to mitigate conflicts of
assessing conflicts of interest that may example, by increasing the number of interest, which rules may include
arise in the context of SB SEFs and SBS institutions that trade security-based numerical limits on control of, or voting
exchanges? What are the differences and swaps and creating a broader market for rights with respect to, any security-
similarities between the conflicts of based swap clearing agency. The
security-based swaps. How will
interest that the Commission has Commission preliminarily believes that
competition issues affect or change
encountered with respect to national requirements applicable to both
securities exchanges and the conflicts of current or identified conflicts of
interest? Will competition potentially governance and voting interests can
interest that it has identified with play an essential role in mitigating
respect to SB SEFs and SBS exchanges? create different or additional conflicts of
interest that the Commission should conflicts of interests. However, the
Further, are the conflicts of interest Commission recognizes that the nature
relating to SBS exchanges different than consider? Would the Commission’s
of the governance, ownership and
the conflicts of interest relating to proposal to apply to SB SEFs and SBS
voting requirements to mitigate conflicts
exchanges that do not post or make exchanges standards to mitigate
may differ depending on the conflicts of
available for trading security-based conflicts of interest that are similar to interest of the persons making decisions
swaps? If there are no differences, those approved for national securities on behalf of the security-based swap
should the Commission propose to exchanges influence whether those clearing agency. In particular, the nature
adopt rules to mitigate conflicts of conflicts of interest will increase, of the ownership and voting power of
interest with respect to national diminish, or remain unchanged over stockholders of the security-based swap
securities exchanges that are not SBS time? clearing agency plays a role in
exchanges or are the existing determining the nature of the conflicts
approaches to mitigating conflicts of Are there any other conflicts of
interest that warrant examination? What of interest that directors of the security-
interest for such exchanges sufficient? based swap clearing agency will face.
The Commission also requests other parties may have conflicts of
interest that would affect whether they As previously noted, the Commission
comment on potential changes in these preliminarily believes that conflicts of
conflicts of interest. The Commission should control or participate in the
interest may arise when a small number
recognizes that the conflicts of interest governance of a SB SEF or SBS
of participants exercise control or undue
that may exist today with respect to the exchange? In what circumstances would
influence over a security-based swap
trading of security-based swaps by SB these conflicts of interest arise? For clearing agency. Conflicts of interest
SEFs and SBS exchanges may evolve example, might non-participant or non- may also arise, however, simply because
over time and that, as this market member shareholders have a conflict of directors and other decision-makers at a
evolves, the conflicts of interest that the interest? What would be the differences security-based swap clearing agency
Commission has identified for SB SEFs in conflicts of interest between have multiple interests and goals,
and SBS exchanges may change. The participants and non-participants or including maximizing profit for the
centralized trading of security-based members and non-members that would benefit of shareholders and imposing
swaps is still developing and may affect the SB SEF or SBS exchange? risk restraints that may limit short-term
change significantly as the market for
Would persons who are selected to be profits, among others.
security-based swaps develops. In In seeking to address conflicts of
particular, the provisions in the Dodd- directors of a SB SEF or SBS exchange
by participants or members have interests, the imposition of governance
Frank Act relating to the centralized restrictions may lessen the need to
trading of security-based swaps are not conflicts of interest based on their status
as directors that would affect their impose certain voting limitations, while
yet effective. Once they become
the imposition of certain voting
effective, market participants that trade ability to act in the best interest of the
limitations may alleviate the need to
security-based swaps will be subject to entity or in conformity with the
impose certain governance restrictions.
substantially more regulation, which Exchange Act, or to act to meet the Accordingly, the Commission is
may have an effect on the conflicts of policy objectives in Section 765 of the proposing two alternative approaches
interest at SB SEFs and SBS exchanges. Dodd-Frank Act? Would directors be with respect to voting limitations and
What are commenters’ views on less likely to act to meet the policy governance that would place differing
whether and how conflicts of interest objectives in Section 765 of the Dodd- levels of emphasis on each of these
for SB SEFs and SBS exchanges may Frank Act if they are selected by factors.77
evolve over time and how the shareholders seeking to maximize the The proposed rule would allow the
Commission should respond to such profits of the SB SEF or SBS exchange? security-based swap clearing agency to
changes? How are conflicts of interest
How would participants’ or members’ elect between the two alternatives. The
likely to change as the centralized
potential conflicts of interest concerning first alternative places an emphasis on
trading of security-based swaps and SB
open access and products traded voting limitations while also imposing
SEFs and SBS exchanges become more

compare to non-participants’ or non- certain governance restrictions (‘‘Voting
established? Are the conflicts of interest
members’ conflicts on such issues? How Interest Focus Alternative’’).78 The
identified by the Commission likely to
do the incentives of independent second alternative places an emphasis
change as the trading of security-based
directors differ from those of non- on governance restrictions while also
swaps moves to regulated markets that
must provide for impartial access and, independent directors with respect to
77 See proposed Rule 701(a) and (b) of Regulation
if so, how? What potential new conflicts increasing access or promoting MC.
of interest could arise that the competition? 78 See proposed Rule 701(a) under Regulation
Commission should consider? How will MC.
imposing certain voting limitations participant voting interest is designed to the securities markets for which clearing
(‘‘Governance Focus Alternative’’).79 prevent any individual participant from agencies currently registered with the
Although the Commission is proposing owning, on a direct or indirect basis, a Commission provide clearance and
two separate alternatives, the voting interest that would allow it to act settlement services,84 there are
Commission may also consider adopting on conflicts of interest in the security- significantly more dealers and
only one alternative as the final rule or based swap clearing agency to the participants. The incentives of
may combine aspects of each proposed detriment of such security-based swap participant-owners of these registered
alternative and adopt it as a single clearing agency and the security-based clearing agencies are generally aligned
rule.80 swaps market. with those of the clearing agency: To
In addition, the existing standards in The terms ‘‘beneficial ownership,’’
accept for clearing as many participants
Section 17A of the Exchange Act also ‘‘beneficially owns’’ or any derivatives
help to mitigate conflicts of interest at thereof would be defined in reference to that can meet reasonable participation
registered clearing agencies and will be Rule 13d–3 under the Exchange Act, standards and as many transactions that
applied in addition to any standards Determination of Beneficial fit into the clearing agencies’ risk
adopted by the Commission under the Ownership.83 The concept of beneficial management structure. Furthermore, the
Dodd-Frank Act.81 ownership in Rule 13d–3 is designed to OTC derivatives market has a relatively
encompass any person or group of high concentration of market activity
A. Alternative I: Voting Interest Focus among a limited number of dealers 85
persons that may be able to act to
Alternative that earn significant revenues from the
influence or control an issuer. The
As more fully described below, under Commission proposes to use the same currently opaque OTC market.86 The
the Voting Interest Focus Alternative, definition of beneficial ownership in existing cash equities and listed options
the Commission is proposing limitations this rule because it also would describe markets, on the other hand, are
on the voting interests held by those persons or groups of persons that transparent and widely disbursed over a
individual participants of a security- may be able to act to influence or range of market participants. As
based swap clearing agency and by control a security-based swap clearing previously discussed, participants in a
participants acting collectively as a agency. However, to the extent any security-based swap clearing agency
group. In addition, the Commission is participant beneficially owns any may have incentives to limit
proposing certain requirements related security or other ownership interest participation in the clearing agency and
to governance that would give solely because such participant is a to limit the scope of products cleared.
independent directors a strong role in member of a group within the meaning Moreover, the Commission’s experience
overseeing the security based-swap of Section 13(d)(3) of the Exchange Act,
clearing agency. regulating security-based swap clearing
such participant would not be deemed agencies along with the views expressed
1. Voting Interest Focus Alternative: to beneficially own such security or by market participants suggest that
Individual Voting Limitation other ownership interest for purposes of security-based swap clearing agencies
this section, unless such person had the may be particularly susceptible to
The Voting Interest Focus Alternative
power to direct the vote of such security conflicts of interest.87 The Commission
would provide that a security-based
or other ownership interest. The
swap clearing agency may not permit a preliminarily believes that prohibiting a
Commission proposes to exclude
participant, either alone or together with participant and its affiliates and related
beneficial ownership that results solely
its related persons, to (1) beneficially persons from having more than a 20%
from being a member of a group to
own, directly or indirectly, any interest voting interest in a security-based swap
provide more certainty to those that
in the security-based swap clearing clearing agency, taking into account the
agency that exceeds 20% of any class of would be required to comply with the
limitations, in light of the effect of other requirements under the Voting
securities, or other ownership interest, Interest Focus Alternative as described
entitled to vote of such security-based exceeding the ownership limit—i.e.,
that the participant will be divested of below, would establish a sufficiently
swap clearing agency or (2) directly or high threshold to preclude any one
indirectly vote, cause the voting of, or the excess interest.
While the Commission has not participant from exerting undue
give any consent or proxy with respect influence over the security-based swap
previously adopted voting interest
to the voting of, any interest in the clearing agency. The 20% threshold
limitations for registered clearing
security-based swap clearing agency
agencies in the other securities markets, proposed for participant voting interests
that exceeds 20% of the voting power of
the security-based swaps market in a security-based swap clearing agency
any class of securities or other
presents a different potential concern is similar to the threshold that the
ownership interest of such security-
based swap clearing agency.82 This with respect to conflicts of interests. In Commission previously proposed for
proposed limitation on individual national securities exchanges and
83 See proposed Rule 700(b) under Regulation
national securities associations, is the
MC, which provides that the terms ‘‘beneficial same as the threshold now being
79 See proposed Rule 701(b) under Regulation ownership,’’ ‘‘beneficially owns,’’ or any derivative
MC. thereof would be defined as having the same proposed for SBS exchanges and SB
80 See infra Section VIII requesting comment on meaning, with respect to any security or other SEFs, and is consistent with the limits
whether alternatives with or without modifications ownership interest, as set forth in § 240.13d–3, as
should be allowed and whether certain if (and whether or not) such security or other 84 The four clearing agencies registered with the
requirements in each alternative should be ownership interest were a voting equity security
combined to form a single approach. registered under Section 12 of the Exchange Act (15 Commission that have active business operations
81 See discussion infra Section IV.C. Security-
U.S.C. 78l); provided that to the extent any person include: The Depository Trust Company, The
based swap clearing agencies will be required to be beneficially owns any security or other ownership National Securities Clearing Corporation, The Fixed
registered with the Commission under Section 17A interest solely because such person is a member of Income Clearing Corporation, and The Options
of the Exchange Act upon the effective date of Title a group within the meaning of Section 13(d)(3) of Clearing Corporation.
VII and, as a result, must comply with the standards the Exchange Act (15 U.S.C. 78m(d)(3)), such
in Section 17A that are applicable to all registered 86 Id. (stating that U.S. commercial banks reported
person shall not be deemed to beneficially own
clearing agencies. such security or other ownership interest, unless trading revenues of $8.3 billion in the first quarter
82 See proposed Rule 701(a)(1)(i) and (ii) under such person has the power to direct the vote of such of 2010).
Regulation MC. security or other ownership interest. 87 See supra notes 26 and 34.
currently in place with respect to voting interests could be circumvented (iii) any immediate family member 95 of
national securities exchanges.88 by holding the interest through an a participant in the security-based swap
affiliated party or by holding an interest clearing agency that is a natural person,
2. Voting Interest Focus Alternative:
in a controlling entity. For purposes of or any immediate family member of the
Aggregate Voting Limitation
determining a security-based swap spouse of such person, who, in each
The Voting Interest Focus Alternative clearing agency participant’s voting case, has the same home as the
would provide that a security-based interest, the proposed rule would, as participant in the security-based swap
swap clearing agency may not permit a indicated in the description of the rules clearing agency, or who is a director or
participant, either alone or together with above, combine such person’s interest officer of the security-based swap
its related persons, to in the aggregate with those of its ‘‘related persons.’’ 92 clearing agency or any of its parents or
with any other security-based swap subsidiaries; and (iv) any immediate
clearing agency participants and their The Commission proposes to define
the term ‘‘related person’’ to include family member of a person associated
related persons (1) beneficially own, with a participant in the security-based
directly or indirectly, any interest in the persons whose relationship with respect
to a participant would likely cause them swap clearing agency that is a natural
security-based swap clearing agency person, or any immediate family
that exceeds 40% of any class of to have the same conflicts of interest
with respect to the security-based swap member of the spouse of such person,
securities, or other ownership interest, who, in each case, has the same home
entitled to vote of such security-based clearing agency (e.g., ‘‘affiliate,’’
‘‘immediate family member,’’ and as the person associated with the
swap clearing agency or (2) directly or participant in the security-based swap
indirectly vote, cause the voting of, or ‘‘person associated with a participant in
a security-based swap clearing agency’’). clearing agency, or who is a director or
give any consent or proxy with respect officer of the security-based swap
to the voting of, any interest in the Specifically, proposed Rule 700(u)
would define ‘‘related person’’ as that clearing agency, or any of its parents or
security-based swap clearing agency subsidiaries.
that exceeds 40% of the voting power of term relates to security-based swap A voting interest limitation of 20% for
any class of securities or other clearing agencies as: (i) Any affiliate 93
an individual participant of a security-
ownership interest of such security- of a participant in a security-based swap
based swap clearing agency and an
based swap clearing agency.89 Under the clearing agency; (ii) any person aggregate voting interest limitation of
individual participant voting limitation associated with a participant in a
40% for all participants of a security-
and without this aggregate limitation on security-based swap clearing agency;
94
based swap clearing agency is intended
voting interest, five entities that have to restrict the ability of security-based
voting interests of 20% could control 92 See proposed Rule 700(u) of Regulation MC.
swap clearing agency participants to
93 The term ‘‘affiliate’’ would be defined as any
the security-based swap clearing agency. exercise undue influence over the
person that, directly or indirectly, controls, is
Since a small number of dealers controlled by, or is under common control with, the governance of a security-based swap
currently control the OTC derivatives person. See proposed Rule 700(a) under Regulation clearing agency for their own self-
market, the Commission preliminarily MC. ‘‘Control’’ would be defined as the possession,
90
interest. At the same time, these voting
believes that this aggregate limitation on direct or indirect, of the power to direct or cause limitations would still permit
the direction of the management and policies of a
voting interest is a necessary corollary person, whether through the ownership of voting participants to hold significant
to the individual participant voting securities, by contract, or otherwise. Any person economic interests in a security-based
limitation. The 40% aggregate limitation that (i) is a director, general partner, or officer swap clearing agency.
on voting interest, which is consistent exercising executive responsibility (or having
with limits used in similar contexts,91 similar status or function); (ii) directly or indirectly 4. Voting Interest Focus Alternative:
has the right to vote 25% or more of a class of
would restrict participants’ ability to voting securities or has the power to sell or direct
Divestiture and Voting Restriction
collectively acquire a majority voting the sale of 25% or more of a class of voting Requirement
interest, while maintaining the integrity securities; or (iii) in the case of a partnership, has In order to assure that a security-
of the 20% individual participant the right to receive, upon dissolution, or has
contributed, 25% or more of the capital, is based swap clearing agency maintains
limitation. presumed to control that person. See proposed Rule the proposed voting interest limitations,
3. Voting Interest Focus Alternative: 700(e) under Regulation MC. the Commission is proposing to require
94 There is currently not a definition for a ‘‘person
Indirect or Affiliate Ownership and security-based swap clearing agencies to
associated with a participant in a clearing agency’’
Ownership Through Related Persons in the Exchange Act or in Commission rules.
have rules in place for the divestiture of
However, the Commission believes that the voting interests that exceed the
The Voting Interest Focus Alternative definition for the term ‘‘person associated with a prescribed limitations.96 The
would also address conflicts of interest member’’ in Section 3(a)(21) of the Exchange Act Commission preliminarily believes that
created by indirect voting interests of should be used as the basis for the definition of the
in order for the voting limitations to be
the security-based swap clearing agency term ‘‘person associated with a participant in a
security-based swap clearing agency,’’ as the effective, the rule must require security-
because a rule that limits only direct
purposes of the two defined terms are similar. based swap clearing agencies to take
Accordingly, the Commission proposes to define action to reduce participants’ and
88 As previously noted, national securities
the term ‘‘person associated with a participant in a
exchanges generally prohibit exchange members, security-based swap clearing agency’’ as (1) any
participants’ related persons’ voting
alone or together with their related persons, from partner, officer, director, or branch manager of such interests.
owning more than 20% of the exchange or being security-based swap dealer or major security-based The Commission is proposing to
entitled to vote shares in excess of 20%. See, e.g., swap participant (or any person occupying a similar provide security-based swap clearing
Securities Exchange Act Release No. 61698, 75 FR
status or performing similar functions); (2) any

at 13156, supra note 59. person directly or indirectly controlling, controlled
agencies flexibility in determining how
89 See proposed Rule 701(a)(1)(iii) and (iv) under
by, or under common control with such security-
Regulation MC. based swap dealer or major security-based swap 95 The term ‘‘immediate family member’’ would be
90 See supra note 40. participant; or (3) any employee of such security- defined in the proposed rules as a person’s spouse,
91 As previously noted, the Commission has based swap dealer or major security-based swap parents, children, and siblings, whether by blood,
generally prohibited any person, alone or together participant. This term does not include any person marriage, or adoption, or anyone residing in such
with its related persons, from owning more than associated with a participant in a security-based person’s house. See proposed Rule 700(i) under
40% of a national securities exchange. See, e.g., swap clearing agency whose functions are solely Regulation MC.
Securities Exchange Act Release No. 61698, 75 FR clerical or ministerial. See proposed Rule 700(r) of 96 See proposed Rule 701(a)(2) under Regulation
at 13156, supra note 59. Regulation MC. MC.
to implement this divesture independent directors on the Board of a swap clearing agency, or any affiliate of
requirement. Any rules adopted by a security-based swap clearing agency a participant in the security-based swap
security-based swap clearing agency should provide the addition of strong clearing agency. The purpose of this
must assure that the security-based and independent oversight within the proposal is to provide assurance that an
swap clearing agency has a viable, security-based swap clearing agency to independent director candidate does not
enforceable mechanism to divest a serve as a potential check against have any relationships or affiliations
participant and its related persons of conflicts of interest that could pose a that would prevent the candidate from
any voting interest owned in excess of detriment to the security-based swap being independent of the security-based
the 20% limitation, and not to give clearing agency, other firms, or the swap clearing agency. Accordingly, the
effect to the portion of any voting security-based swaps market generally. Commission proposes to define the term
interest in excess of the 20% individual The Commission preliminarily believes ‘‘independent director,’’ as it is used
limitation or the 40% aggregate that a level below 35% independent with respect to a security-based swap
limitation. The Commission is also directors may not be sufficient to assure clearing agency, as a director who has
proposing to require a security-based that independent directors have a no material relationship with:
swap clearing agency’s procedures to significant voice.100 A requirement (1) The security-based swap clearing
provide a mechanism for the security- lower than 35% would potentially place agency;
based swap clearing agency to obtain independent directors in a small enough (2) Any affiliate of the security-based
information relating to the voting minority that, relative to the remaining swap clearing agency;
interests in the security-based swap director slots that could potentially be (3) A participant in the security-based
clearing agency held by its participants filled by participant or management swap clearing agency; or
and their related persons.97 The directors, the views of the independent (4) Any affiliate of a participant in the
Commission believes that this directors would not be given enough security-based swap clearing agency.102
requirement is essential to a security- consideration. While independent Some relationships or affiliations
based swap clearing agency’s ability to directors would have less than a would clearly exclude a director from
monitor the voting interest held by its majority representation on the Board qualifying as independent of a security-
participants and their related persons in under the Voting Interest Focus based swap clearing agency. For
relation to the proposed voting Alternative, they would have a example, a director would not be
limitations. meaningful opportunity to contribute to considered independent if any of the
determinations made by the Board and following circumstances exists:
5. Voting Interest Focus Alternative: • The director, or an immediate
the various Board committees. The
Independent Directors on Board family member, is employed by or
Commission is proposing to require at
The Commission’s Voting Interest least 35% independent directors otherwise has a material relationship
Focus Alternative would impose combined with the proposal to limit with the security-based swap clearing
substantive requirements on the participant voting interests in a security- agency or any affiliate thereof; or within
governance of security-based swap based swap clearing agency, both on an the past three years was employed by or
clearing agencies that are designed to individual and aggregate basis, as a otherwise had a material relationship
address the concern that participants’ means of effectively mitigating conflict with the security-based swap clearing
conflicts of interest may lead them to of interest concerns while also agency or any affiliate thereof;
take actions that would potentially limit permitting a greater proportion of • The director is a participant in the
fair and open access and product participants to serve on the Board of a security-based swap clearing agency or
eligibility for central clearing, as well as security-based swap clearing agency.101 within the past three years was
potentially weaken the risk management This aspect of the proposal may address employed by or affiliated with a
of security-based swap clearing potential concerns that requiring a participant or any affiliate thereof, or
agencies. The proposed governance majority independent Board would the director has an immediate family
provisions, as discussed below, are affect the Board’s ability to effectively member that is, or within the past three
intended to help mitigate potential perform risk management functions. years was, an executive officer of a
conflicts of interest and assure the fair The Commission also proposes that participant in the security-based swap
administration and governance of a no director may qualify as an clearing agency or any affiliate thereof;
security-based swap clearing agency by independent director unless the Board • The director, or an immediate
limiting the control that any one affirmatively determines that the family member, has received during any
participant or group of participants may director does not have a material twelve-month period within the past
exercise over the security-based swap relationship with the security-based three years payments that reasonably
clearing agency. swap clearing agency or any affiliate of could affect the independent judgment
The Commission proposes under the the security-based swap clearing agency, or decision-making of the director from
Voting Interest Focus Alternative to or a participant in the security-based the security-based swap clearing agency
require the Board 98 of a security-based or any affiliate thereof or from a
swap clearing agency to be composed of 100 Other regulators have previously chosen 35%
participant in the security-based swap
at least 35% independent directors.99 as an appropriate level for independent
clearing agency or any affiliate thereof,
The presence of a significant number of representation on the Board of self-regulatory
organizations. See 72 FR 6936 (February 14, 2007), other than the following:
which adopts final rules to address conflicts of Æ Compensation for Board or Board
97 Id.
interest at self-regulatory organizations regulated by committee services;
98 The term ‘‘Board’’ would be defined as the the CFTC. Specifically, the final rules establish
Board of Directors or Board of Governors of the SB acceptable practices under Core Principle 15 Æ Compensation to an immediate
SEF, SBS exchange or facility thereof that posts or applicable to DCMs and that provide that the Board family member who is not an executive
makes available for trading security-based swaps, or is composed of at least 35% public directors. officer of the security-based swap
security-based swap clearing agency, as applicable, 101 Proposed Rule 700(c) under Regulation MC
clearing agency or any affiliate thereof
or any equivalent body. See proposed Rule 700(c) does not prescribe the number of participant
under Regulation MC. directors that are required to be on the Board. A
or of a participant in the security-based
99 The term ‘‘director’’ would be defined as any security-based swap clearing agency may choose to
member of the Board. See Proposed Rule 700(f) have the majority of the Board be composed of 102 See proposed Rule 700(j) under Regulation
under Regulation MC. independent directors. MC.
swap clearing agency or any affiliate director.104 This definition is intended independent directors.107 Directors
thereof; or to encompass all significant instances in serving on the nominating committee
Æ Pension and other forms of deferred which a director’s independence is that are not independent may be more
compensation for prior services, not compromised.105 In determining likely to select Board candidates whose
contingent on continued service. whether a ‘‘material relationship’’ exists, views align with such directors’
• The director, or an immediate security-based swap clearing agencies interests instead of the interests of the
family member, is a partner in, or should consider the known security-based swap clearing agency or
controlling shareholder or executive relationships between a director and the the markets generally. Having a
officer of, any organization to or from security-based swap clearing agency to nominating committee that is composed
which the security-based swap clearing determine whether the relationship is of majority independent directors
agency or any affiliate thereof made or likely to impair the independence of the should help to address and facilitate the
received payments for property or director in making decisions that affect selection of independent directors.
services in the current or any of the past the security-based swap clearing agency. The Voting Interest Focus Proposal
three full fiscal years that exceed 2% of The proposed definitions of would also require that the nominating
the recipient’s consolidated gross ‘‘independent director’’ and ‘‘material committee identify candidates for Board
revenues for that year, other than the relationship’’ should help to reduce the membership through a consultative
following: potential that the independent directors process with the participants of the
Æ Payments arising solely from on the Board of the security-based swap security-based swap clearing agency
investments in the securities of the clearing agency are subject to conflicts consistent with criteria approved by the
security-based swap clearing agency or of interest. Board.108 This should help assure that
affiliate thereof; or the selection of directors of the Board is
Under the Voting Interest Focus conducted in a prudent manner while at
Æ Payments under non-discretionary Alternative, the security-based swap
charitable contribution matching the same time allowing for the
clearing agency would be required to participants of the security-based swap
programs.
establish policies and procedures to clearing agency to have fair
• The director, or an immediate require each director, on his or her own
family member, is, or within the past representation in the selection of the
initiative or upon request of the directors of the Board.109
three years was, employed as an
security-based swap clearing agency, to
executive officer of another entity where b. Other Board Committees
inform the security-based swap clearing
any executive officers of the security-
agency of the existence of any The Voting Interest Focus Alternative
based swap clearing agency serve on
relationship or interest that may would require that other Board
that entity’s compensation committee;
reasonably be considered to bear on committees of a security-based swap
• The director, or an immediate
whether such director is an independent clearing agency that are delegated
family member, is a current partner of
director.106 The security-based swap authority to act on the Board’s behalf,
the outside auditor of the security-based
clearing agency would be expected to including but not limited to the risk
swap clearing agency or any affiliate
take reasonable measures to confirm the committee, consist of at least 35%
thereof, or was a partner or employee of
accuracy of the information provided. independent directors similar to the
the outside auditor of the security-based
This requirement should help the requirement that would be imposed on
swap clearing agency or any affiliate
security-based swap clearing agency to the Board itself.110 This requirement
thereof who worked on the audit of the
assure that it is informed of the should give independent directors a
security-based swap clearing agency or
existence of any relationship or interest meaningful voice, similar to the one
any affiliate thereof, at any time within
the past three years; or that may reasonably be considered to they would have in the Board itself,
bear on whether a director is within Board committees that
• In the case of a director that is a
independent as soon as possible and essentially perform the functions of a
member of the audit committee, such
director (other than in his or her without requiring the security-based Board. The proposed requirement
capacity as a member of the audit swap clearing agency to investigate for would also apply to an ‘‘advisory
committee, the Board, or any other such information. committee’’ to the extent that the
Board committee), accepts, directly or committee is authorized to act on behalf
indirectly, any consulting, advisory, or of the Board, including instances where
Board Committees
other compensatory fee from the the Board is required to seek approval
security-based swap clearing agency or a. Nominating Committee from the committee before making a
any affiliate thereof or a participant in determination. However, the
The Voting Interest Focus Alternative Commission preliminarily believes that
the security-based swap clearing agency would require security-based swap
or any affiliate thereof, other than fixed the independence requirement should
clearing agencies to create and maintain not extend to a committee that functions
amounts of pension and other forms of a nominating committee for the
deferred compensation for prior service, in a purely advisory role, because
selection of Board members, and would members of those committees are not in
provided such compensation is not require that such nominating committee
contingent in any way on continued a position to exercise powers of the
be composed of a majority of
service.103 107 See proposed Rule 701(a)(4)(i) under
Under the proposed rule, the term 104 See Regulation MC.
proposed Rule 700(l) under Regulation
‘‘material relationship’’ would be MC. 108 See proposed Rule 701(a)(4)(ii) under
defined as a relationship, whether 105 See Securities Exchange Act Release No. Regulation MC.
compensatory or otherwise, that 48745 (November 4, 2003), 68 FR 64154 (November 109 Section 17A(a)(3)(C) of the Exchange Act
reasonably could affect the independent 12, 2003) (order approving SRO rules that would requires fair representation among participants of a
find a director independent only where that clearing agency by providing them with a
judgment or decision-making of the director does not have a relationship with the meaningful opportunity to participate in the
company that would impair her independence). selection of directors. 15 U.S.C. 78q–1(a)(3)(C).
103 See proposed Rule 700(j)(2) under Regulation 106 See proposed Rule 701(a)(3)(iii) under 110 See proposed Rule 701(a)(5) under Regulation
MC. Regulation MC. MC.
Board or exert influence over the Board 40% limitations be lower given the have on the ability to form new security-
by dictating how the Board will act. existing concentration of the industry in based swap clearing agencies?
a small number of large dealers? If so, The Voting Interest Focus Alternative
c. Disciplinary Panels would require that voting limitations be
what limitations would be appropriate
The Commission’s Voting Interest and why? Are there other conflicts of determined by including interests held
Focus Alternative would impose special interest not discussed in this release directly by a participant in the security-
requirements on the composition of that the Commission should consider based swap clearing agency, by
disciplinary panels (or their generally and specifically with respect including indirect interests of a
equivalents) of security-based swap to voting limitations? Would the participant in the security-based swap
clearing agencies that have not been proposed restrictions have an effect on clearing agency, and by including
delegated authority to act on the Board’s the ability to form new security-based interests held by related persons of a
behalf.111 The Commission believes that swap clearing agencies or to effectively participant in the security-based swap
participants of a security-based swap operate existing security-based swap clearing agency. The Commission
clearing agency should be appropriately clearing agencies? requests comment on whether its
disciplined for failure to comply with The Commission also requests formulation for calculating the aggregate
the rules of a security-based swap comment on whether there may be other and individual limits is appropriate.
clearing agency, particularly as they ways to structure the interests in a Specifically, the Commission requests
relate to the ongoing risk management security-based swap clearing agency to comment on whether the scope of the
related requirements applicable to mitigate potential conflicts of interest. definitions of ‘‘affiliate,’’ ‘‘immediate
participants. Accordingly, the Are there other thresholds for voting family member,’’ and ‘‘related person’’
Commission is proposing that the limitations or approaches that the are over-inclusive or under-inclusive
disciplinary processes of a security- Commission should consider? Are there and, if either, why? Is there a different
based swap clearing agency preclude other methods for mitigating conflicts of methodology to reach the interest of any
any group or class of persons that are interest the Commission should person with whom a security-based
participants in the security-based swap consider, such as limitations on holding swap clearing agency participant may be
clearing agency from exercising non-voting interests in a security-based able to act in concert with to unduly
disproportionate influence on any swap clearing agency? How would non- influence or control a security-based
disciplinary panels. In other words, to voting interests affect the potential for swap clearing agency that the
the extent that there is more than one conflicts of interests? Commission should consider?
type of group or class of persons that are Section 765 enumerates Specified The Commission seeks comment on
participants in a security-based swap Entities for the Commission to consider whether requiring the Board of a
clearing agency, the composition of the in its rulemaking. The proposed rule security-based swap clearing agency to
disciplinary panel shall include would apply only to Specified Entities be composed of at least 35%
representation of each group or class that are participants of the security- independent directors would improve
and shall not allow one group or class based swap clearing agency and not to governance of the security-based swap
to have representation on the other Specified Entities, because the clearing agency and mitigate potential
disciplinary panel that is out of Commission preliminarily believes that conflicts of interest. Is 35% sufficient to
proportion as compared to other groups those entities that are participants of a give independent directors a meaningful
or classes of persons that are clearing agency are most likely to have voice within the Board, or would a
participants in the security-based swap a conflict of interest that would affect higher or lower level be appropriate?
clearing agency. Furthermore, the the access, product eligibility, and risk Should the Commission require that a
disciplinary panel of the security-based management issues discussed in this majority of the Board be composed of
swap clearing agency would include at release. However, the Commission independent directors? How are these
least one person who would qualify as requests comment on whether all independent directors likely to affect
an independent director. Specified Entities, regardless of the activities of the security-based swap
participant status, should be subject to clearing agency? What are their
the proposed restrictions on voting incentives to assure open and fair
Request for Comment
interests. What are the potential access, increased product eligibility,
The Commission requests comment conflicts of interest associated with and sound risk management at a
on all aspects of the voting limitations Specified Entities that are not security-based swap clearing agency? Do
under the Voting Interest Focus participants? Might Specified Entities independent directors have any
Alternative, including whether the 20% that are not participants in a security- conflicts of interest that would affect
limitations on individual participant based swap clearing agency have an their ability to facilitate these
voting interest and the 40% aggregate interest in limiting the number or type objectives?
limitation on participant voting interest of security-based swaps that are The Commission also requests
are sufficient to limit the ability of a accepted for clearing to the extent that comment on whether other measures
participant or a group of participants to they may profit from trading security- concerning governance should be used
exercise undue influence or control over based swaps that are not centrally to mitigate conflicts of interest at
the governance of a security-based swap cleared? Are there any other classes of security-based swap clearing agencies,
clearing agency. Should the 20% and persons, such as participants or either in addition to or instead of the
members of SB SEFs or SBS exchanges, proposals outlined in this release. In

111 See proposed Rule 701(a)(6) under Regulation
that should also be subject to the particular, what other approaches
MC. If the security-based swap clearing agency does
not have a disciplinary panel, these requirements
proposed restrictions even though they would improve governance and mitigate
should be interpreted as applying to the equivalent are not participants of a security-based conflicts of interest for security-based
of a disciplinary panel in the security-based swap swap clearing agency? What effect swap clearing agencies? For example,
clearing agency’s internal processes, unless the would such restrictions have on would State laws governing the
disciplinary panel (or its equivalent) has been
delegated authority to act on the Board’s behalf, in
mitigating conflicts of interest at fiduciary duty owed by the Board to a
which case it would be subject to the 35% security-based swap clearing agencies? corporation help to mitigate conflicts of
independent director requirement. What effect would such restrictions interest? Should the Commission
consider any additional requirements security-based swap clearing agency respect to customers of participants? If
related to fiduciary duties? The policies that the Commission should consider so, how many customers should serve
and charter documents of individual with respect to the nominating on the risk subcommittee relative to
corporations also often impose committee? Should end-users or any independent directors and participant
additional responsibilities and other group be given guaranteed rights directors? What definition of customer
obligations on directors. Should of participation in the governance of the should be used for these purposes? Are
security-based swap clearing agencies security-based swap clearing agency? there distinctions that should be made
be required to put in place specific Should the Commission participate in between the different types of customer
policies or charters to address conflicts the Board selection process, such as by firms for this purpose?
of interest by the Board? What policies requiring consultation on Another possible alternative approach
or charters would be necessary to appointments? Should the Commission could be to limit the applicable
provide assurance that participant consider an alternative to a restrictions on the risk committee to
directors will act in the best interests of compositional requirement for a circumstances where a specific range of
the security-based swap clearing nominating committee, such as allowing topics is being addressed. For example,
agency? What other requirements, if a security-based swap clearing agency to restrictions on participation in a risk
any, should be in place with respect to have a board of trustees responsible for committee could be limited to only
the duties owed by the Board in order nominating candidates for the Board? If those circumstances in which a
to mitigate conflicts of interest at this were a viable alternative, should determination about issues such as
security-based swap clearing agencies? there be compositional requirements or participant standards and product
In addition, the Commission requests other limits imposed on the board of eligibility were being made. What are
comment on its proposed definitions, trustees? How should such a board of the potential advantages or
including the definitions of trustees be appointed? Would the disadvantages of such an approach?
‘‘independent director’’ and ‘‘material alternative of a board of trustees to Would it be possible to separate
relationship.’’ Are there other ways to nominate directors provide greater activities of a committee based on
define ‘‘independent director’’ or assurance that independent directors are topics? Are there certain issues that
‘‘material relationship?’’ If so, what are truly independent not only at the time pose more or less of a concern with
they? Should the Commission adopt of their nomination but during their respect to conflicts of interests?
other provisions that contain particular service on the Board as well? The Commission also requests
circumstances that would preclude a comment regarding whether any
finding that a director is independent or With respect to governance as it requirements should be imposed on
that would deem a relationship relates to the risk committee, should advisory committees. Would an
material? Should the Commission take there be special requirements relating to independence requirement on a purely
into account a director’s salary or the risk committee, or its equivalent, of advisory committee mitigate potential
benefits he or she receives for being a the Board? For instance, one possible conflicts of interest? Are there
director in order to consider whether an alternative approach could be to provide circumstances in which a purely
interest in keeping the directorship separate requirements applicable only to advisory committee exercises
could make a director more likely to act the risk committee that reflect the substantial power over the Board?
favorably toward those that control the highly specialized risk management The Commission requests comment
Board? Should the Commission adopt a expertise required of directors serving on the composition of the disciplinary
specific look-back period within which on that committee. For example, instead panel of the security-based swap
to determine whether a ‘‘material of requiring that the risk committee be clearing agency. Would the proposed
relationship’’ exists? Should additional composed of at least 35% independent rule be sufficient to address potential
terms used in the proposed rule be directors (where such committee is conflicts of interest that may interfere
defined? delegated authority to act on the Board’s with the fair and effective disciplinary
The Commission requests comment behalf), the requirement could apply to processes of a security-based swap
on the proposed compositional a smaller number of independent clearing agency? Should different
requirements of committees of the Board directors, and also explicitly require restrictions be imposed?
under the Voting Interest Focus that other interested persons, such as Although independent directors may
Alternative. Is the requirement that customers of participants, be address some of the conflicts of interest
Board committees that are delegated represented on the risk committee. The concerns that underlie Section 765 of
authority to act on behalf of the Board Commission requests comment on the Dodd-Frank Act, they may not
be composed of at least 35% whether a more prescriptive approach effectively eliminate all conflicts. The
independent directors appropriate? The such as the one described above would Commission, however, believes that
Commission also requests comment on be appropriate for the risk committee effective governance via a partially
whether there may be other ways to and what levels of participation by independent Board is compatible with
structure governance restrictions for participants, customers of participants, the characteristics of security-based
security-based swap clearing agencies to or others would be appropriate. Are swap clearing agencies, and the types of
mitigate potential conflicts of interest. there factors that warrant treating the conflicts that may be inherent with
In particular, the Commission requests risk committee differently from other respect to such entities.
comment on the proposed Board committees? Should the
B. Alternative II: Governance Focus
compositional requirements of the Commission require the Board to report

nominating committee. What is the to the Commission if the Board Alternative
potential effect of requiring a security- disagrees with a recommendation of the As more fully described below, under
based swap clearing agency to have a risk committee? Is the risk committee the Governance Focus Alternative, the
majority independent nominating more or less prone to conflict of interest Commission is proposing governance
committee? Are there other processes issues? Are there factors other than restrictions including requiring a
for the selection of independent conflicts of interest that should be taken majority of independent directors on the
directors and the fair representation of into consideration? Is it desirable to Board and voting restrictions that would
the participants and shareholders of a have an explicit requirement with be applicable only to individual
participants of a security-based swap Voting Interest Focus Alternative would the formation of new security-based
clearing agency. The Governance Focus permit a higher individual participant swap clearing agencies and thereby
Alternative differs from the Voting voting interest of 20%, but would limit increase the potential for competition
Interest Focus Alternative in that it the aggregate voting interests held by all among security-based swap clearing
provides greater emphasis on participants to 40%. However, the agencies. In addition, the 5% voting
requirements regarding the governance Voting Interest Focus Alternative would interest limitation may encourage open
arrangements of a security-based swap allow a security-based swap clearing access by creating incentives for a larger
clearing agency as the primary means to agency to have a Board with a majority number of participants to acquire a
mitigate conflicts of interest. As with of directors selected by participants. voting interest in the security-based
the Voting Interest Focus Alternative, The Commission believes that the 5% swap clearing agency. While the
the Commission is proposing rules limit per participant, in combination Commission has not previously adopted
related to the governance of a security- with the requirements related to voting limitations or governance rules
based swap clearing agency and the governance arrangements described for registered clearing agencies in the
voting interests held by participants below, is sufficiently low that there is other securities markets, as previously
because the Commission believes each no need for the 40% aggregate cap on discussed under the Voting Interest
contributes to conflict of interest the voting interests held by all Focus Alternative, the security-based
concerns. However, the Voting Interest participants. swaps market presents different
Focus Alternative places greater Furthermore, the Commission notes concerns with respect to potential
emphasis on the ability of participants that the 40% aggregate cap on conflicts of interests that warrant
to hold voting interests in the security- participant voting interests proposed in additional scrutiny and efforts to
based swap clearing agency than it does the Voting Interest Focus Alternative mitigate such conflicts.
on participants’ ability to participate in may restrict the potential formation of
the governance of the security-based participant-owned security-based swap 2. Governance Focus Alternative:
swap clearing agency, while the clearing agencies. Some clearing Indirect or Affiliate Ownership and
Governance Focus Alternative, as agencies currently registered with the Ownership Through Related Persons
described in more detail below, places Commission are user-owned or user-
greater emphasis on the ability of The Commission believes that a rule
controlled institutions that function as
participants to participate in the that limits only direct voting interests
quasi-utilities. This structure may
governance of the security-based swap could be circumvented by holding the
provide certain benefits to the
clearing agency than it does on the interest through an affiliated party or by
participants and the securities markets
ability of participants on a collective generally because such clearing agencies holding an interest in a controlling
basis to hold a voting interest in the generally seek to match the fees charged entity. Accordingly, similar to the
security-based swap clearing agency. to participants to the clearing agency’s Voting Interest Focus Alternative,115 the
costs and not to maximize profits.114 Governance Focus Alternative would
1. Governance Focus Alternative: Voting address conflicts of interest created by
Limitation In addition, potential users may have
a strong incentive to form a new indirect voting interests of the security-
The Governance Focus Alternative based swap clearing agency and would
clearing agency if they believe an
would require that a security-based require aggregation of a security-based
existing clearing agency is not
swap clearing agency may not permit a swap clearing agency participant’s
participant, either alone or together with effectively serving the security-based
swaps market. Not imposing an voting interest with its related
its related persons, to (1) beneficially persons’ 116 voting interests.117
own, directly or indirectly, any interest aggregate cap on participant voting
in the security-based swap clearing interests in a security-based swap 3. Governance Focus Alternative:
agency that exceeds 5% of any class of clearing agency could help encourage Divestiture and Voting Restriction
securities, or other ownership interest, Requirement
organization. See Rule 13d–1(a) under the Exchange
entitled to vote of such security-based Act, 17 CFR 240.13d–1(a) (‘‘Any person who, after Similar to the Voting Interest Focus
swap clearing agency or (2) directly or acquiring directly or indirectly the beneficial
Alternative,118 the Governance Focus
indirectly vote, cause the voting of, or ownership of any equity security of a class which
is specified in paragraph (i) of this section, is Alternative would require security-
give any consent or proxy with respect
to the voting of, any interest in the directly or indirectly the beneficial owner of more based swap clearing agencies to have
than 5% of the class shall, within 10 days after the rules in place for the divestiture of
security-based swap clearing agency acquisition, file with the Commission, a statement
that exceeds 5% of the voting power of containing the information required by Schedule
voting interests that exceed the 5%
any class of securities or other 13D’’). In addition, investors acquiring more than a limitation and a mechanism to not give
ownership interest of such security- 5% interest in a company must file a form certifying effect to the portion of any voting
that they acquired that interest without ‘‘the effect interest held by a participant in excess
based swap clearing agency.112 The 5% of changing or influencing the control of the issuer
limitation on participant voting interest * * *’’ Rule 13d–1(c)(1) under the Exchange Act, 17
of the 5% voting limitation.119 The
is intended to help mitigate conflicts of CFR 240.13d–1(c)(1). See, also, Gaf Corp. v. Commission believes that this
interest because each individual Milstein, 453 F.2d 709 (2d Cir. N.Y. 1971), stating requirement is essential to a security-
that ‘‘[T]he purpose of section 13(d) is to alert the based swap clearing agency’s ability to
participant’s voting interest would be marketplace to every large, rapid aggregation or
substantially limited and, therefore, its accumulation of securities, regardless of technique
monitor voting interests by its
participants in relation to the proposed
ability to control the security-based employed, which might represent a potential shift
swap clearing agency would also be in corporate control. * * *’’ Id. at 717. voting limitations.
114 See, e.g., ‘‘The US Model for Clearing and
limited.113 As discussed previously, the Settlement: An Overview of DTCC,’’ available at: 115 Seesupra Section I.A.3.
http://www.dtcc.com/downloads/about/ 116 See
112 See proposed Rule 701(b)(1) under Regulation US%20Model%20for%20Clearing% supra note 92 and accompanying text.
117 See proposed Rule 701(b)(1) under Regulation
MC. 20and%20Settlement.pdf. (‘‘[O]wnership and
113 The 5% threshold level for ownership has governance of [The National Securities Clearing MC.
118 See supra Section I.A.4.
previously been found by the Commission in other Corporation] and [The Depository Trust Company]
contexts to trigger reporting requirements to the were from the outset those typical of market 119 See proposed Rule 701(b)(2) under Regulation
Commission related to the ability to control an utilities.’’). MC.
4. Governance Focus Alternative: governance ‘‘best practices.’’ 122 may be an effective mechanism to
Majority Independent Board Furthermore, requiring a majority of the address certain types of conflicts in
Board of a security-based swap clearing certain types of institutions but not
As discussed previously, the
agency to be independent would still necessarily in all instances nor for all
Governance Focus Alternative differs
permit the security-based swap clearing institutions. The Commission, however,
from the Voting Interest Focus believes that effective governance via a
agency to provide participants with fair
Alternative by placing greater emphasis representation in the selection of majority independent Board is
on the governance arrangements of the directors and the administration of the compatible with the characteristics of
security-based swap clearing agency. affairs of the security-based swap security-based swap clearing agencies,
Each alternative approach seeks to strike clearing agency as required under the and the types of conflicts that may be
a balance between the appropriate Exchange Act.123 inherent with respect to such entities.
restrictions imposed on a security-based The Commission also proposes that To help address these concerns, the
swap clearing agency relating to no director may qualify as an proposed rules would require each
governance and voting rights held by independent director unless the Board security-based swap clearing agency to
participants. Under the Governance affirmatively determines that the establish policies and procedures to
Focus Alternative, participants on a director does not have a material require each director, on his or her own
collective basis could potentially own relationship with the security-based initiative or upon request of the
all voting interests in a security-based swap clearing agency or any affiliate of security-based swap clearing agency, to
swap clearing agency. While this option the security-based swap clearing inform the security-based swap clearing
allows for potential benefits in terms of agency,124 or a participant in the agency of the existence of any
participants’ ability to form new security-based swap clearing agency, or relationship or interest that may
clearing agencies, it also allows any affiliate of a participant in the reasonably be considered to bear on
participants’ to control 100% of the security-based swap clearing agency.125 whether such director is an independent
voting interest in a security-based swap The proposed definitions of director.126 This requirement should
clearing agency, in contrast to the ‘‘independent director’’ and ‘‘material keep the security-based swap clearing
Voting Interest Focus Alternative, which relationship’’ are designed to reduce the agency informed of the existence of any
would limit participants to holding no potential that the Board of the security- relationship or interest that may
more than 40% of the voting interest. based swap clearing agency is reasonably be considered to bear on
Accordingly, in order to balance the controlled by persons who are subject to whether a director is independent as
increased voting interest that may be conflicts of interest. soon as possible without requiring the
held by participants collectively, the While the proposal that a majority of security-based swap clearing agency to
Commission proposes that a greater the Board be composed of independent investigate for such relationships or
proportion of the Board be composed of directors should help to mitigate certain interest.
independent directors under the conflicts of interest, and particularly
Governance Focus Alternative. 5. Governance Focus Alternative: Board
those conflicts that are most likely to
Committees
The Governance Focus Alternative is result in an adverse effect on the
intended to mitigate conflicts of interest security-based swap clearing agency, the a. Nominating Committee
by limiting the influence participants Commission recognizes that it would The Governance Focus Alternative
may have in the determinations of the not completely eliminate conflicts of would require security-based swap
Board or in the administration of a interest. Participant directors would still clearing agencies to create and maintain
security-based swap clearing agency. be permitted to serve on the Board. The a nominating committee composed
Specifically, the Governance Focus Commission believes that participants entirely of independent directors.127
Alternative would require the Board 120 may have operational, risk management, This is consistent with the purpose of
of a security-based swap clearing agency and market expertise that may be useful the Governance Focus Alternative to
to be composed of a majority of for effective oversight of a security- place enhanced requirements on the
independent directors.121 The presence based swap clearing agency. governance arrangements of a security-
of a majority of independent directors In addition, independent directors based swap clearing agency, including
on the Board of a security-based swap themselves may not be free of conflicts the composition of the Board and Board
clearing agency is intended to reduce of interest. Although the independent committees, with less emphasis on the
the ability of non-independent directors directors would not have a material requirements with respect to the voting
to influence the operation of the relationship with the clearing agency or interests held by participants. Non-
security-based swap clearing agency in any of its participants, they could still independent directors on the
favor of their own self-interests and to be influenced by other sources such as nominating committee could
promote open and fair access, product non-participant shareholders of the circumvent the majority independence
eligibility, and sufficient risk security-based swap clearing agency. requirement by nominating a candidate
management standards. This should in The presence of independent directors that is subject to their influence.
turn benefit non-participant firms that Specifically, directors serving on the
enter into correspondent clearing 122 See, e.g., James H. Cheek III, et al., Report of
nominating committee that are not
arrangements with participants, and the American Bar Association Task Force on
Corporate Responsibility (2003); and The Business independent may be more likely to
SBS exchanges and SB SEFs who will Roundtable, Principles of Corporate Governance select Board candidates whose views
rely on the availability of a security- (May 2010). align with such directors’ interests
based swap clearing agency. A majority 123 Section 17A(b)(3)(C) of the Exchange Act
instead of the interests of the security-
independent Board requirement is requires that the rules of a registered clearing
agency assure a fair representation of its
based swap clearing agency or the
consistent with accepted corporate shareholders (or members) and participants in the markets generally. A requirement that
selection of its directors and administration of its
120 See supra note 98. affairs. 15 U.S.C. 78q–1(b)(3)(C). 126 See proposed Rule 701(b)(3)(iii) under
121 See 124 See supra note 102 and accompanying text. Regulation MC.
proposed Rule 701(b)(3)(i) under
Regulation MC. See supra note 99 for the definition 125 See proposed Rule 701(b)(3)(ii) under 127 See proposed Rule 701(b)(4)(i) under
of ‘‘director.’’ Regulation MC. Regulation MC.
all directors serving on the nominating c. Disciplinary Panels outstanding security-based swap
committee be independent of Similar to the Voting Interest Focus positions at the security-based swap
participants would address these Alternative,131 the Governance Focus clearing agency, or both? Should the
concerns by limiting participants’ Alternative would impose special Commission require the security-based
control over the nomination process. A requirements on the composition of swap clearing agency to consider either
fully independent nominating disciplinary panels (or their volume or outstanding notional value of
committee may be warranted under the equivalents) of security-based swap a participant’s positions held outside of
Governance Focus Alternative because clearing agencies that have not been a security-based swap clearing agency?
the lack of an aggregate cap in this delegated authority to act on the Board’s How often should the Commission
proposal means that participants may behalf.132 require the security-based swap clearing
collectively hold greater voting interests agency to reevaluate its standard? How
6. Governance Focus Alternative: effectively would such an approach
in selecting the independent directors.
Request for Comment address conflict of interest concerns?
The Governance Focus Alternative What would be the advantages and
The Commission requests comment
would also require that the nominating disadvantages of this approach
on all aspects of the 5% participant
committee identify candidates for Board voting interest limitation. Is the 5% compared to the approach proposed
membership through a consultative voting limitation appropriate, or should above? Are there administrative
process with the participants of the the Commission consider a higher or complexities associated with
security-based swap clearing agency lower limitation? How does the relative determining and monitoring the point at
consistent with criteria approved by the concentration of the security-based which a firm reaches large participant
Board.128 This should assure that the swaps market among a small number of status? Are the conflicts of interest
selection of the independent directors of large dealers affect whether a 5% concerns regarding all large participants
the Board is conducted in a prudent limitation is appropriate? Would 5% similar or should there be differences in
manner while at the same time allowing still allow a relatively small number of the voting limitations among large
participants of the security-based swap participants to effectively dominate the participants?
clearing agency to have a fair voice in Board of a clearing agency? Should the Should the restrictions on voting
the selection of the directors of the Commission consider any form of an interests apply to other large entities,
Board.129 aggregate cap under this alternative? such as the Specified Entities listed in
How likely is it that a security-based Section 765, even if they are not
b. Other Board Committees participants in a security-based swap
swap clearing agency would adopt a
utility model, given the status of the clearing agency? What potential
The Governance Focus Alternative
security-based swaps market? Would conflicts of interest could result if
would require that other Board
the 5% limit impede the ability of a Specified Entities that are not large
committees of a security-based swap participants controlled the voting
clearing agency that are delegated clearing agency to adopt a utility model?
What advantages or disadvantages interest in a security-based swap
authority to act on the Board’s behalf, clearing agency? How should such
including but not limited to the risk would such a model have? Are there
other conflicts of interest, not discussed potential conflicts of interest be
committee, consist of a majority of addressed?
independent directors similar to the in this release, that the Commission
should consider generally and Should the Commission consider a
requirement that would be imposed on limitation on the non-voting interests
specifically with respect to voting
the Board itself.130 This requirement owned by participants? Should the
interest limitations? Would the
should prevent the dilution of the Commission consider a limitation on
proposed restrictions have an effect on
majority Board independence the voting and non-voting interests held
the ability to form new security-based
requirement that may result if Board by Specified Entities?
swap clearing agencies?
committees that essentially perform the Are there other ways to more The Commission seeks comment on
functions of a Board are not themselves narrowly target voting limitations? whether requiring the Board of a
subject to a similar requirement. The Should the Commission impose voting security-based swap clearing agency to
proposed requirement would also apply restrictions on only the largest be composed of a majority of
to an ‘‘advisory committee’’ to the extent participants because those participants independent directors would improve
that such a committee is authorized to governance of the security-based swap
control the majority of the security-
act on behalf of the Board, including clearing agency and mitigate potential
based swaps market (based on either the
instances where the Board is required to conflicts of interest. Would a majority
volume of transactions cleared at the
seek approval from the committee independent Board be helpful in
security-based swap clearing agency or
before making a determination. mitigating conflicts of interest if the
the notional value of the participant’s
However, the Commission preliminarily voting interest of a security-based swap
outstanding security-based swap
believes that this majority independence clearing agency is owned by
positions)? If such an approach is
requirement should not extend to a participants? If a majority independent
preferable, what should the threshold be
committee that functions in a purely Board is not appropriate to mitigate
for determining whether a participant is
advisory role, because members of those conflicts, what percentage of the Board
‘‘large’’? Should the Commission require should be independent? What are the
committees are not in a position to the security-based swap clearing agency
costs and benefits of requiring the

exercise powers of the Board or exert to consider the participant’s volume of Boards of security-based swap clearing
influence over the Board by dictating cleared transactions at the security- agencies to be composed of a majority
the actions of the Board. based swap clearing agency, the of independent directors? How do these
notional value of the participant’s costs and benefits differ from the
128 See proposed Rule 701(b)(4)(ii) under
Regulation MC. 131 See

proposal that 35% of the Board be
supra Section I.A.8.d. and accompanying
129 See supra note 123. text. composed of independent directors?
130 See proposed Rule 701(b)(5) under Regulation 132 See proposed Rule 701(b)(6) under Regulation Would independent directors be likely
MC. MC. to have the necessary experience and
expertise to serve on the Board? Could clearing agency be able to exercise The Commission also requests comment
less experience or expertise negatively undue influence over a security-based on whether there are other ways to
affect risk management practices or the swap clearing agency through a voting structure governance arrangements for
efficiency of the clearing agency and, if interest even if a majority of the Board security-based swap clearing agencies to
so, how? If any such experience or is independent? Are requirements mitigate potential conflicts of interest.
efficiency issues exist, how could they related to the governance structure of a The Commission requests comment
be overcome? What are the independent security-based swap clearing agency on the composition of the disciplinary
directors’ incentives regarding fair and more or less effective than voting panel of the security-based swap
open access, product eligibility, and limitations at addressing conflicts of clearing agency. Would the proposed
sound risk management? How are these interest? rule be sufficient to address potential
incentives different from those of The Commission requests comment conflicts of interest that may interfere
participants? Do they result in conflicts on the proposed compositional with the fair and effective disciplinary
of interest? If so, how are the conflicts requirements of the nominating processes of a security-based swap
of interest different from those of committee. What is the potential effect clearing agency? Should different
participants? How should they be of requiring a security-based swap restrictions be imposed?
addressed by the Commission? clearing agency to have an entirely
C. Existing Standards for Registered
Should the Commission consider independent nominating committee?
Clearing Agencies
alternative limits, or alternative Would requiring an entirely
combinations of limits, on voting independent nominating committee, In addition to any new rules adopted
interests or independent directors? For which is required to consult with by the Commission with respect to
example, should the voting interest participants of the security-based swap conflicts of interest at security-based
restrictions of 20% on individual clearing agency, be consistent with the swap clearing agencies, the standards in
interests and 40% in the aggregate be fair representation requirement under the Exchange Act that apply to all
combined with the requirements for a the Exchange Act? Should end-users or securities clearing agencies registered
majority independent Board and a 100% any other group be given guaranteed with the Commission will apply to
independent nominating committee? rights of participation in the governance security-based swap clearing agencies.
Would an alternative combination of of the security-based swap clearing The Dodd-Frank Act requires security-
requirements related to voting interests agency? Should the Commission have based swap clearing agencies to be
and independent directors be more some oversight of the Board selection registered as clearing agencies with the
effective? For example, would a higher process? Should the Commission Commission under Section 17A of the
requirement in each case (e.g., a 10% consider an alternative to a Exchange Act.133 Thus, security-based
limit on individual voting interests and compositional requirement for a swap clearing agencies will be required
a requirement for 60% independent nominating committee, such as allowing to comply with the standards in Section
directors) be more effective? Or would a security-based swap clearing agency to 17A of the Exchange Act. Some of these
other combinations be more effective? have a board of trustees responsible for standards may be used to address
Should the Commission reduce the nominating candidates for the Board? If concerns related to conflicts of interest,
restrictions over time if conflict of this were a viable alternative, should regardless of whether a security-based
interest concerns are lessened as the there be compositional requirements or swap clearing agency elects the Voting
security-based swaps market develops? other limits imposed on the board of Interest Focus Alternative or the
For example, if participation in the trustees? How should such a board of Governance Focus Alternative. As a
security-based swaps market becomes trustees be appointed? Would the result, the standards in Section 17A
more open and includes a broader range alternative of a board of trustees to would be used in addition to specific
of participants, the interests of the nominate directors provide greater conflict of interest rules adopted under
participants may become more aligned assurance that independent directors are Section 765 of the Dodd-Frank Act.134
with those of the clearing agency and truly independent not only at the time The Section 17A standards may be
the markets generally. Would of their nomination but during their used to mitigate conflicts of interest or
restrictions on voting interests and service on the Board as well? the effects of conflicts of interest in a
governance still be needed in this The Commission requests comment
133 Depository institutions or derivatives clearing
circumstance? Are there other on the proposed compositional
organizations that have previously cleared swaps
circumstances where the voting interest requirements of committees of the Board pursuant to an exemption from registration as a
and governance restrictions may be under the Governance Focus clearing agency will be deemed to be registered
reduced or eliminated altogether? If, Alternative. Is the requirement that with the Commission under Section 17A of the
over time, the security-based swaps Board committees that are delegated Exchange Act. See Public Law 111–203, Section
763(l).
market does not become more authority by the Board be composed of 134 See Section 17A(b)(3) of the Exchange Act,
competitive, should the Commission a majority of independent directors which sets forth the standards for registered
consider additional governance and appropriate? Should there be special clearing agencies. 15 U.S.C. 78q–1(b)(3). See also
voting measures to promote open access requirements relating to the risk Securities Exchange Act Release No. 16900
committee, or its equivalent, of the (‘‘Standards Release’’) (June 17, 1980), 20 FR 416
and competition? What measures would (July 1, 1980). The Standards Release provides
be appropriate? What standards should Board? The Commission requests guidance on the standards to be used by the
the Commission use to determine comment on the possible alternatives for Commission’s Division of Trading and Markets in
whether additional restrictions should risk committee governance as discussed connection with the registration of clearing
in Section IV.A.7. Would the possible agencies. The standards also serve as staff
or should not be imposed? guidelines to assist clearing agencies in modifying
Could restrictions regarding the alternatives for the risk committee be their organizations, capacities, and rules to comply
governance structure of a security-based more or less desirable with respect to with the clearing agency registration provisions of
swap clearing agency alone be sufficient the Governance Focus Alternative? the Exchange Act.
to address conflict of interest concerns Under the Governance Focus The Commission is also considering matters
related to conflicts of interests as part of broader
or are both restrictions on governance Alternative, should the percentage of standards that would be applicable to clearing
and voting interests needed? Would directors on the risk committee be agencies in association with requirements under
participants of a security-based swap higher or lower than what is proposed? Sections 763(b) and 805(a) of the Dodd-Frank Act.
number of ways. As part of the initial influence to amend the rules of the focusing new requirements under
registration process, the Commission clearing agency in a manner that favors Section 765 of the Dodd-Frank Act on
approves the organizational structure of its own institution to the disadvantage Section 17A standards alone, such as by
a clearing agency.135 The Commission of other participants because the rules of having requirements addressing only
also reviews and approves significant a clearing agency may not be applied on membership standards and
changes to a clearing agency’s a discriminatory basis.141 determinations whether to clear
governance structure after it is Finally, the Section 17A standards products? Would such an approach
registered.136 In addition, a clearing help to mitigate conflict of interest sufficiently address conflicts of
agency must admit persons such as concerns by providing that the rules of interests? If not, are the proposed rules
banks and broker-dealers, and other a registered clearing agency may not sufficient to address potential gaps in
entities that the Commission may impose a burden on competition that is the way Section 17A alone would
designate by rule, as participants,137 not necessary or appropriate in address conflicts of interest with respect
subject to the participation standards of furtherance of the purposes of the to security-based swap clearing
the clearing agency.138 Exchange Act. This helps assure that the agencies? Should additional rules be
Clearing agencies also may not permit clearing agency operates in a manner proposed under Section 17A to further
unfair discrimination in the admission that is consistent with the public address conflict of interest concerns?
of participants or among participants in interest and is not used by participants Should the Commission extend the
the use of the clearing agency.139 These or other interested parties to gain an application of the proposed rules for
standards in Section 17A help to unfair competitive advantage.142 The security-based swap clearing agencies to
mitigate concerns related to conflicts of Commission staff has previously all registered clearing agencies? To what
interest by promoting access to and use interpreted these standards as requiring extent would competitive pressures in
of a clearing agency by all qualified that a clearing agency must justify any the security-based swaps market,
persons on an equivalent basis.140 The anticompetitive effect of membership particularly as it continues to develop,
Section 17A standards also help to criteria and that it will evaluate an help to mitigate conflicts of interest?
prevent a participant from using its anticompetitive effect in light of the Would the standards under Section 17A
following factors: (1) The essential help to promote competition in a way
135 Section 17A(b)(3)(A) provides in full a nature of the service; (2) the number and that would help to mitigate conflicts of
clearing agency shall not be registered unless the type of potential participants denied
Commission determines that the ‘‘clearing agency is interest? To what extent does the
so organized and has the capacity to facilitate the access to clearance and settlement Commission’s oversight of clearing
prompt and accurate clearance and settlement of services; (3) the number of entities agencies pursuant to the standards
securities transactions and derivative agreements, providing comparable clearance and under Section 17A alleviate the need for
contracts, and transactions for which it is settlement services; and (4) the
responsible, to safeguard securities and funds in its ownership limitations and governance
custody or control or for which it is responsible, to availability of correspondent clearing requirements?
comply with the provisions of [the Exchange Act] arrangements to provide indirect access
and the rules and regulations thereunder, to enforce to a clearing agency’s services.143 The V. Discussion of Proposed Rule 702
(subject to any rule or order of the Commission Commission believes these factors Under Regulation MC for Security-
pursuant to section 17(d) or 19(g)(2) of [the Based Swap Execution Facilities and
Exchange Act]) compliance by its participants with should also be used to evaluate the
the rules of the clearing agency, and to carry out anticompetitive effect of the National Securities Exchanges That
the purposes of [Section 17A of the Exchange Act].’’ membership standards of security-based Post or Make Available for Trading
15 U.S.C. 78q–1(a)(3)(C). swap clearing agencies once they are Security-Based Swaps
136 See Securities Exchange Act Release Nos.
612194 (December 22, 2009), 74 FR 68883

registered clearing agencies under A. Ownership and Voting Limitations
(December 22, 2009) (File No. SR–FICC–2009–10); Section 17A of the Exchange Act.
61215 (December 22, 2009), 74 FR 68888 (December The Commission requests comment Section 765 requires the Commission
29, 2009) (File No. SR–NSCC–2009–10); and 61216 on the application of the standards to adopt rules to mitigate conflicts of
(December 22, 2009), 74 FR 68877 (December 29, under Section 17A to security-based interest, which may include numerical
2009) (File No. SR–DTC–2009–16), notice and order limits on control of, or the voting rights
granting accelerated approval of proposed rule swap clearing agencies in conjunction
changes filed by the clearing agency subsidiaries of with the proposed rules to address with respect to, any clearing agency that
the Depository Trust and Clearing Corporation conflicts of interest. Will the proposed clears security-based swaps, or on the
(DTC, NSCC, and FICC) to permit DTCC to rules effectively build on the Section control of any SB SEFs or SBS
nominate non-participant candidates for election to
its Board. 17A standards? Should the Commission exchanges. Pursuant to this directive,
137 15 U.S.C. 78q–1(b)(3)(B). take a more targeted approach by the Commission is proposing ownership
138 Id. See also Section 17A(b)(4)(B), which and voting limits for a SB SEF that
provides that a registered clearing agency may deny 141 Id at 418. The provisions in Section 17A would apply to any SB SEF participant
participation to, or condition the participation of, recognize that a clearing agency may discriminate and for a SBS exchange or facility of a
any person if such person does not meet such among persons in the admission to, or the use of,
standards of financial responsibility, operational the clearing agency, by requiring that participants
national securities exchange that posts
capability, experience, and competence as are meet certain financial, operational, and other fitness or makes available for trading security-
prescribed by the rules of the clearing agency. A standards. However, Section 17A also requires that based swaps (‘‘SBS exchange facility’’)
registered clearing agency may examine and verify sanctioned discriminations must not be unfair. In that would apply to any SBS exchange
the qualifications of an applicant to be a participant addition, the Commission must find that clearing
in accordance with procedures established by the agency rules embodying any discriminations are in member. Specifically, the Commission
rules of the clearing agency. 15 U.S.C. 78q– the public interest and are consistent with the proposes that a SB SEF, SBS exchange,
1(b)(4)(B). requirements of the Exchange Act. or SBS exchange facility shall not
139 15 U.S.C. 78q–1(b)(3)(F). 142 The standard does not prohibit all burdens on
permit any SB SEF participant or SBS
140 See Standards Release, supra note 134, at 419. competition. However, if a proposed rule of a
clearing agency would impose a burden on
exchange member, as applicable, either
All participants utilizing similar clearing agency
services, with the exception of participants that are competition, the burden must be weighed against alone or together with its related
registered clearing agencies for which specialized the benefits of the rule in achieving the purposes persons, to: (1) Beneficially own,
requirements apply, should be required to comply of the Exchange Act. For example, a clearing agency directly or indirectly, any interest in the
fully with the clearing agency’s internal financial may impose participation standards that have an
and operational rules such as clearing fund anticompetitive effect as long as any such SB SEF, SBS exchange, or SBS exchange
deposits, mark-to-market payments, and margin anticompetitive effect is justified. facility, as applicable, that exceeds 20%
deposits related to the services used. 143 See Standards Release, supra note 134, at 419. of any class of securities, or other
ownership interest, entitled to vote of clearing agencies, the Commission is not For purposes of calculating a SB SEF
such SB SEF, SBS exchange, or SBS proposing an aggregate 40% voting participant’s or SBS exchange member’s
exchange facility; or (2) directly or interest limit collectively on all SB SEF ownership and voting interests, the
indirectly vote, cause the voting of, or participants (with respect to SB SEFs) proposed rule would aggregate such
give any consent or proxy with respect and SBS exchange members (with person’s ownership and voting interests
to the voting of, any interest in the SB respect to SBS exchanges) or a 5% with those of its related persons. When
SEF, SBS exchange, or SBS exchange individual voting interest limit, used with respect to a SB SEF, proposed
facility, as applicable, that exceeds 20% respectively. The Commission Rule 700(u) under Regulation MC would
of the voting power of any class of recognizes that, as with security-based define the term ‘‘related person’’ to
securities or other ownership interest of swap clearing agencies, the proposed mean: (1) Any affiliate of a security-
such SB SEF, SBS exchange, or SBS rule would limit, but not eliminate, the based swap execution facility
exchange facility.144 ability of a small group of SB SEF participant; (2) any person associated
The Commission is concerned that if participants or SBS exchange members, with a security-based swap execution
a SB SEF participant or SBS exchange as applicable, to own a SB SEF, SBS facility participant; (3) any immediate
member, either alone or together with exchange, or SBS exchange facility. family member of a security-based swap
its related persons, were to own a Specifically, as few as five entities could execution facility participant or any
significant stake in the SB SEF, SBS own SB SEFs, SBS exchanges, and SBS immediate family member of the spouse
exchange, or SBS exchange facility, exchange facilities under this proposal. of such person, who, in each case, has
respectively, the SB SEF participant or However, the Commission’s concerns the same home as the security-based
SBS exchange member could use its with respect to concentration of swap execution facility participant or
significant ownership interest to ownership in security-based swap who is a director or officer of the
influence the operations of the SB SEF, clearing agencies and SB SEFs, SBS security-based swap execution facility
SBS exchange, or SBS exchange facility exchanges, and SBS exchange facilities or any of its parents or subsidiaries; or
to unduly derive benefits at the expense are informed by the differences in the (4) any immediate family member of a
of other owners and market participants. structure for clearing and trading of person associated with a security-based
The Commission is particularly security-based swaps. The swap execution facility participant or
concerned that a SB SEF participant or Commission’s experience has been that any immediate family member of the
SBS exchange member may have the central clearing model in the spouse of such person, who, in each
financial incentives to limit the level of securities markets historically has case, has the same home as the person
access to, and the scope of products associated with the security-based swap
tended toward convergence to a single
traded on, these trading venues as a execution facility participant or who is
clearing agency for each type of cleared
means to impede competition from a director or officer of the security-based
product, while the market structure for
other market participants. For example, swap execution facility or any of its
securities trading historically has not
the Commission understands that many parents or subsidiaries.
necessarily tended toward a similar
of the electronic multi-dealer trading
model.147 The Commission also notes Further, when used with respect to a
platforms that exist today for OTC
that security-based swap clearing SBS exchange or SBS exchange facility,
derivatives or fixed income products
agencies perform a critical function in proposed Rule 700(u) under Regulation
limit the number of dealers from which
mitigating financial risk for security- MC would define the term ‘‘related
a customer can request a quote. The
Commission believes that a fewer based swaps market participants. person’’ to mean: (1) Any affiliate of a
number of dealers participating on a Although SB SEFs, SBS exchanges, and member of the national securities
platform or exchange could result in SBS exchange facilities are critical to exchange that posts or makes available
less competition on pricing. The promoting price transparency and for trading security-based swaps; (2) any
Commission believes that imposing therefore market efficiency, the person associated with a member of the
ownership and voting limits, as Commission does not believe that the national securities exchange that posts
described above, could mitigate operation of SB SEFs, SBS exchanges, or makes available for trading security-
potential conflicts of interest with and SBS exchange facilities would pose based swaps; (3) any immediate family
respect to the level of access to the the same level of systemic risk as member of a member of the national
market and determinations as to which security-based swap clearing agencies. securities exchange that posts or makes
products are traded by limiting the There generally will be a lower barrier available for trading security-based
ability of a small group of persons (such to entry with respect to trading swaps or any immediate family member
as dealers) to control the Board 145 and platforms because participants of a SB of the spouse of such person, who, in
thus the governance of the SB SEF, SBS SEF or members of an SBS exchange each case, has the same home as the
exchange, or SBS exchange facility.146 would not incur the margin, guaranty member of the national securities
Unlike the Voting Interest Focus fund, or other obligations that members exchange that posts or makes available
Alternative or the Governance Focus of a clearing agency would incur, and for trading security-based swaps or who
Alternative for security-based swap thus multiple venues for the trading of is a director or officer of the national
security-based swaps are more likely to securities exchange or facility thereof
144 See proposed Rule 702(b) under Regulation emerge. Thus, the Commission is not that posts or makes available for trading
MC. proposing identical ownership security-based swaps, or any of its
requirements for security-based swap
145 See supra note 98 for the proposed definition

parents or subsidiaries; or (4) any
of ‘‘Board.’’ clearing agencies and SB SEFs, SBS immediate family member of a person
146 The Commission also believes that such limits
exchanges, and SBS exchange facilities. associated with a member of the
would further the ability of the SB SEF and SBS
exchange to effectively carry out its obligations. national securities exchange that posts
Section 763(c) of the Dodd-Frank Act and Section 147 The Commission has not made any or makes available for trading security-
6 of the Exchange Act, respectively, and, in determinations about whether security-based swap based swaps or any immediate family
particular, provide market participants with clearing agencies will also tend to converge to a
impartial access to SB SEFs. See Section 763(c) of single clearing agency or even a small number of
member of the spouse of such person,
the Dodd-Frank Act, Public Law 111–203, Section clearing agencies, as the central clearing of security- who, in each case, has the same home
763(c), and 15 U.S.C. 78f. based swaps is still a developing area. as the person associated with the
national securities exchange that posts reasonably designed not to give effect to Thus, the proposed ownership and
or makes available for trading security- a SB SEF participant’s or SBS exchange voting limits should strike an
based swaps or who is a director or member’s voting interest that, alone or appropriate balance between the
officer of the national securities together with its related persons, objectives of mitigating conflicts of
exchange or facility thereof that posts or exceeds 20%.149 The Commission interest and refraining from
makes available for trading security- believes that in order for the ownership unnecessarily hindering the ability of
based swaps or any of its parents or and voting limits to be effective, each entities to form new trading venues. In
subsidiaries. To further the purpose of SB SEF, SBS exchange, and SBS addition, there may be incentives to
the proposed limits, the Commission exchange facility must take measures to create a new SBS exchange or SB SEF
preliminarily believes that it would be reduce a SB SEF participant’s or because a SBS exchange or SB SEF may
important to aggregate the SB SEF member’s ownership interest or not give draw significant new business by
participant’s or SBS exchange member’s effect to any voting interest that exceeds making available to trade a security-
ownership and voting interests with the the proposed limits. The Commission based swap that is required to be cleared
interest of any person with whom such intends to provide SB SEFs, SBS under Section 763(a).153 Furthermore,
person may be able to act together to exchanges, and SBS exchange facilities the risk management and economies of
influence or control the SB SEF, SBS flexibility in determining how to scale issues that may create a barrier to
exchange, or SBS exchange facility. implement these requirements. Any entry with respect to new security-based
The proposed rule would restrict rules adopted by these trading venues, swap clearing agencies generally would
indirect as well as direct ownership and however, must assure that they have a not affect the creation of SBS exchanges
voting of a SB SEF, SBS exchange, or viable, enforceable mechanism to divest or SB SEFs.
SBS exchange facility. Because the a SB SEF participant or SBS exchange While the Commission believes that
proposed rule could be easily member of any interest held in excess of the proposed 20% ownership and
circumvented if the Commission were to the 20% limit and to not give effect to voting limits are appropriate, it also
limit solely direct ownership and the portion of voting interest held in understands that the movement of
voting, the Commission preliminarily excess of the 20% limit. The trading of security-based swaps onto SB
believes it would be important to further Commission also proposes to require SEFs, SBS exchanges, or SBS exchange
the purpose of imposing ownership and each SB SEF, SBS exchange, or SBS facilities will foster enhanced
voting limits to also restrict the indirect exchange facility to have rules to transparency and market efficiency. The
ownership and voting interests of SB provide a mechanism to obtain Commission does not intend to
SEF participants and SBS exchange information relating to its ownership unnecessarily impede the emergence of
members. For example, if the and voting interests.150 The Commission what could be vital sources of, among
Commission simply proposed to believes that a requirement to collect other things, liquidity and pricing
prohibit a SB SEF participant from information regarding ownership and transparency for security-based swaps.
directly owning or voting shares, the voting interests of SB SEF participants However, imposing on SB SEFs and SBS
participant could hold its ownership and SBS exchange members is essential exchanges ownership and voting limits
interests in the SB SEF through a for registered trading venues to monitor similar to those that shareholder-owned
holding company, thus easily and comply with the proposed cash equities and options exchanges
circumventing the intent of the ownership and voting limits.151 have in place could have the
proposed rule. Accordingly, the The Commission believes that an unintended consequence of deterring
ownership and voting limits would ownership and voting limit of 20% is an new, competitive trading venues at a
apply to ownership and voting of appropriate threshold. On the one hand, time when organized markets for
interests in a parent company of the SB the restriction would limit the ability of security-based swaps are just beginning
SEF, SBS exchange, or SBS exchange a SB SEF participant or SBS exchange to develop. A trading platform that
facility. For example, if the SB SEF were member to exert undue influence over currently trades security-based swaps in
wholly-owned by a holding company, a the governance of a SB SEF, SBS the OTC market but would not meet the
SB SEF participant would be prohibited exchange, or SBS exchange facility, proposed ownership and voting limits
from owning or voting more than 20% respectively. On the other hand, such an would need to revise its ownership
of the voting interest in the parent ownership and voting limit should not structure if it chooses to become a SB
company. Finally, the proposed limits overly interfere in such an entity’s SEF. There could be costs and delays as
also would apply to a SB SEF organizational structure or the ability of the potential SB SEF seeks to find one
participant or SBS exchange member a SB SEF participant or SBS exchange or more additional owners to satisfy the
that beneficially owns more than 25% of member to acquire a substantial equity proposed limits, with a possible
an entity that itself owns more than interest in a SB SEF, SBS exchange, or diminution in the value of the original
20% of a SB SEF, SBS exchange, or SBS SBS exchange facility, as applicable.152 owner(s)’ investment. Moreover, it is
exchange facility.148 possible that imposing these limits may
To assure that SB SEFs, SBS 149 See proposed Rules 702(c)(1) and (2) under
affect the security-based swaps market
exchanges, and SBS exchange facilities Regulation MC. differently than the cash equities and
150 See proposed Rule 702(c)(3) under Regulation
maintain an ownership structure MC. listed options markets. Ownership and
consistent with the proposed ownership 151 See supra Section IV.A.4.
and voting limits, the Commission 152 National securities exchanges that may trade 153 The counterparties to a transaction in a
proposes that these entities have rules security-based swaps currently prohibit a member security-based swap that is required to be cleared
from owning or voting more than 20% of the under Section 763(a)(2) of the Dodd-Frank Act will
that (1) provide an effective mechanism exchange, although an exchange’s method of be required to execute the transaction on a SBS
to divest a SB SEF participant’s or SBS calculating the 20% interest, aggregated with any exchange or on a SB SEF. There is an exception
exchange member’s ownership that, person with whom such person may be able to act from the execution requirement if no SBS exchange
alone or together with its related together to influence or control an exchange, may or SB SEF makes the security-based swap available
vary from the Commission’s proposal. See, e.g., to trade. See Public Law 111–203, Section 763(h).
persons, exceeds 20% and (2) are Amended and Restated Certificate of Incorporation The exception from trade execution is also available
of BATS Global Markets, Inc., Article FIFTH; if the exception from mandatory clearing under
148 See supra note 93 for the proposed definition Amended and Restated Certificate of Incorporation Section 763(g) applies. See Public Law 111–203,
of ‘‘control.’’ of NYSE Euronext, Article V. Section 763(g).
voting limits were implemented at exchanges, and SBS exchange facilities Should the Commission require a voting
national securities exchanges at a time specifically to those interests entitled to limit, but not an ownership limit or a
when the trading of exchange-listed vote.155 Consequently, a SB SEF different limit for ownership versus
securities was fairly well established participant or SBS exchange member voting? Even with the prohibition
and competitive. Consequently, a 20% would not be prohibited from owning against owning more than 20% of any
ownership and voting limit may not any percentage of a nonvoting interest interest entitled to vote, a SB SEF
negatively affect the ability of cash in a SB SEF, SBS exchange, or SBS participant or SBS exchange member
equity and options exchanges to exchange facility. In contrast, national could have sufficient ownership of
promote competing trading venues but, securities exchanges generally limit nonvoting interest, either alone or in
if applied to the security based-swaps their members from owning more than addition to voting interest, to exert
market that is in its infancy, could 20% of any interest, voting or otherwise. influence on these trading venues.
retard market development. However, as discussed above, trading Should the Commission require the
The Commission is sensitive to venues for exchange-listed securities are ownership limit to apply to any class of
arguments against imposing ownership well established and highly competitive. equity securities or other ownership
and voting limits for SB SEFs, SBS In this regard, the Commission does not interest rather than any class of
exchanges, and SBS exchange facilities, believe that it is necessary to propose securities, or ownership interest,
some of which were articulated at the the same ownership limits as those entitled to vote? 157 Would the proposed
Conflicts Roundtable. However, it also currently in place at national securities limits impede the number or types of SB
understands that the OTC derivatives exchanges. Further, the proposed 20% SEFs from being established? Should
market is highly concentrated and limit on ownership and voting would the proposed ownership and voting
dealer dominated. Although ownership still allow as few as five entities to own limits be phased in for SB SEFs to
and voting limits arguably may have a a SB SEF, SBS exchange, or SBS provide a grace period for those entities
less negative effect on new entrants to exchange facility. Thus, the proposed that would not meet the requirements
the cash equities and options markets limit by itself would not completely under Regulation MC?
and their ability to compete, there may prohibit a small number of entities from The Commission also seeks comment
also be less need for such limitations in potentially exerting undue influence on whether the proposed ownership and
those markets. In contrast, although over SB SEFs, SBS exchanges, or SBS voting limits would continue to be
ownership and voting limits may more exchange facilities in a way that could important as the market for security-
directly affect the ability of SB SEFs and benefit the few to the detriment of based swaps evolves. If multiple SB
SBS exchanges to start up, the lack of others. SEFs emerge as this market develops,
market characteristics to promote The Commission requests comment would competitive pressures alleviate
competing trading venues for security- on all aspects of the proposed any of the conflicts of interest that are
based swaps may emphasize the greater ownership and voting limits, including the basis for the Commission’s
need for ownership and voting limits. If whether it is necessary and appropriate proposals? In that case, would it be
the market characteristics for security- to have ownership and voting limits at appropriate for the Commission to
based swaps naturally promote dealer all. If commenters believe that it is impose different limits? Should the
domination without robust competing necessary and appropriate to impose Commission reduce the restrictions over
trading venues, there is more need to ownership and voting limits to mitigate time, if conflict of interest concerns are
mitigate the types of concerns that conflicts of interest, the Commission lessened as the security-based swaps
underlie Section 765, such as by requests comment on whether the market develops? For example, if
imposing ownership and voting proposed limits are appropriate, or participation in the trading of security-
limits.154 whether they would unduly hinder the based swaps becomes more open and
The Commission must weigh the development of SB SEFs without includes a broader range of participants,
potential implications of imposing serving to mitigate any conflicts.156 and multiple SB SEFs or SBS exchanges
ownership and voting limits against evolve to trade the same security-based
imposing other requirements that would 155 See supra note 64. swaps, would there still be a need to
allow a dealer-dominated security-based 156 In the SRO Governance Proposing Release, the retain ownership and voting limits or
swaps market to continue. As part of the Commission proposed a similar 20% ownership are there factors that would allow such
balance between mitigating conflicts of and voting limit for members of a national limits to be revised? What factors
securities exchange. A number of commenters
interest without unduly restricting the favored this proposal, including several
should the Commission consider in
ability of a competitive market for commenters that were national securities exchanges assessing whether any ownership and
trading of security-based swaps to or a facility of a registered securities association. voting limits it may impose on SB SEFs
emerge, the Commission proposes to See, e.g., letter from Michael J. Simon, Secretary, should be revisited?
ISE, to Jonathan G. Katz, Secretary, Commission, As mentioned above, each national
limit ownership in SB SEFs, SBS dated March 8, 2005 (‘‘ISE Comment Letter’’) (‘‘[The
ownership limitation] provides SROs with securities exchange currently prohibits
154 In the equities market a small group of broker- flexibility, yet recognizes the unique conflicts that
dealers or single-dealer proprietary firms can and could arise if a member were to own a controlling Letter’’); letter from Edward S. Knight, Executive
do own alternative trading systems (‘‘ATSs’’) and interest in an SRO with regulatory responsibility for Vice President and General Counsel, Nasdaq Stock
thus it can be argued that SB SEFs and SBS the member.’’); letter from Meyer S. Frucher, Market, Inc., to Jonathan G. Katz, Secretary,
exchanges should be permitted to operate similarly. Chairman and Chief Executive Officer, Phlx, to Commission, dated March 8, 2005 (‘‘Nasdaq
See Securities Exchange Act Release No. 60997 Jonathan G. Katz, Secretary, Commission, dated Comment Letter’’). The Commission notes, however,
(November 13, 2009), 74 FR 61208 (November 23, March 8, 2005 (‘‘Phlx Comment Letter’’) (‘‘The that the SRO Governance Proposing Release related
2009) (as of November 2009, there were Exchange unequivocally agrees with the to national securities exchanges that trade equity
approximately 73 ATSs that are subject to Commission that a significant shareholder could securities and listed options and registered
Regulation ATS). However, ATSs exist in the use its voting power to influence the operations of securities associations, and the comments received
context of a marketplace with robust competition an exchange in a way that adversely affects the did not address potential conflicts in other contexts.
among numerous trading venues. Therefore, ATSs mission, integrity or regulatory capacity of the 157 The CFTC has proposed similar ownership
that are owned by one broker-dealer or a small exchange, or otherwise is detrimental to the public and voting limits for DCMs and registered SEFs,
group of broker-dealers, by virtue of their interest.’’); letter from Philip D. DeFeo, Chairman and applies the ownership limit only to any class
ownership structure alone, generally do not present and Chief Executive Officer, Pacific Exchange, Inc. of equity securities entitled to vote. See http://
a concern that they could lessen price competition (‘‘PSX’’), to Jonathan G. Katz, Secretary, www.cftc.gov/ucm/groups/public/@newsroom/
or market efficiency. Commission, dated March 8, 2005 (‘‘PSX Comment documents/file/federalregister_governance.pdf.
its members from owning an interest, proposed ownership and voting limits is may be able to act together to influence
voting or otherwise, or voting more than appropriate. Should the limits on or control a SB SEF or SBS exchange?
20% (or less) of the exchange or a ownership and voting extend to all or Finally, the Commission expects a SB
facility of the exchange.158 Therefore, some of the Specified Entities, SEF, SBS exchange, and SBS exchange
the Commission preliminarily does not regardless of their direct participation facility to have in place an effective
believe that the proposed rules would on the SB SEF or SBS exchange? If so, mechanism for enforcing the ownership
have a material effect on an exchange’s why? What are the potential conflicts and voting limits. The Commission
ability to post or make available for concerns that such Specified Entities requests comment on whether the
trading security-based swaps. may pose? How are conflicts concerns proposed rules related to divesture of
Nevertheless, the Commission requests posed by such Specified Entities ownership and voting limits are
comment on whether the proposed different from those posed by SB SEF appropriate. Should the Commission
limits in this rulemaking could affect a participants or SBS exchange members explicitly require in the proposed rules
national securities exchange’s ability or who are not also Specified Entities? In specific ways to divest ownership and
decision to post or make available for this regard, the Commission notes that voting interest of SB SEF participants
trading security-based swaps. Also, the definition of ‘‘related person’’ would and SBS exchange members who violate
given that national securities exchanges encompass any such entity that is the ownership and voting limits? Is the
currently have limits on ownership and affiliated with such a SB SEF proposed rule pertaining to obtaining
voting by members, would codifying the participant or SBS exchange member, information on ownership and voting
proposed limits help to further mitigate although it may not itself be a SB SEF interest of SB SEFs, SBS exchanges, and
the types of conflicts of interest that participant or SBS exchange member. SBS exchange facilities appropriate?
underlie the Dodd-Frank Act for SBS In addition, national securities Should the Commission require that
exchanges? Would there be any effect on exchanges generally limit ownership trading venues collect information
the willingness of entities to register to and voting by non-members, as well as pertaining to certain ownership or
become a national securities exchange members.159 Specifically, exchanges voting thresholds?
and trade security-based swaps? What generally limit each non-member to no
would be the implication, if any, on an more than 40% ownership of the B. Governance Requirements
exchange that chose to trade security- exchange. The limit on ownership by The Commission is proposing
based swaps through a facility that is a non-members of an exchange is substantive requirements with respect to
separate legal entity? More generally, for designed in part to provide the the governance of SB SEFs, SBS
SB SEFs and SBS exchanges or SBS Commission and the exchange with the exchanges, and SBS exchange facilities
exchange facilities, should ownership proper tools (such as access to books that are designed to address the conflict
and voting be limited to the same and records) necessary to carry out the of interest concerns identified above,
threshold or should they be different? If Commission’s and the exchange’s including the concern that dealer-
the Commission should take a different respective regulatory oversight owners could unduly influence the
approach for ownership and voting, responsibilities, as well as to mitigate governance and operation of a SB SEF
what should that approach be? more general conflict concerns between or SBS exchange. These governance
As described above, Section 765 owners’ commercial interests and the provisions, as discussed below, should
enumerates Specified Entities that the exchange’s regulatory obligations. The help mitigate conflicts of interest as
Commission should consider in its Commission requests comment on directed by Section 765 of the Dodd-
rulemaking. The Commission whether it should impose, as part of this Frank Act.
understands that, depending on who rulemaking, similar limits on ownership
may be permitted to directly effect and voting. Such an ownership limit 1. Board
transactions on a SB SEF (or is a SBS would apply to the Specified Entities, to The Commission proposes that the
exchange member), limits on ownership the extent they are not subject to the Board of a SB SEF, SBS exchange, or
and voting that apply only to SB SEF proposed ownership limit described SBS exchange facility be composed of a
participants or SBS exchange members above. In addition to the requirements majority of independent directors.160
could be either over-inclusive or under- of Section 765, the Dodd-Frank Act The presence of a majority of
inclusive or both, with respect to the more generally requires a SB SEF to independent directors on the Board
Specified Entities. For example, establish and enforce rules to minimize should reduce the ability of owner-
restricting control of a SB SEF based on conflicts of interest in its decision- directors of a SB SEF, SBS exchange, or
an entity’s direct participation on the SB making process and establish a process SBS exchange facility to improperly
SEF could capture a person who is not for resolving the conflicts of interest. influence the operation of such entity to
one of the Specified Entities or, What are the types of conflicts that a their own advantage and to the
conversely, fail to take into person who is not a SB SEF participant detriment of other users or potential
consideration a Specified Entity. or SBS exchange member may pose? users of the facility or exchange. A
Accordingly, the Commission requests The Commission also requests majority independent director
comment on whether the scope of the comment on whether its formulation for requirement should help foster a greater
calculating the 20% threshold is degree of independent decision-making
158 A member has in the past been permitted on appropriate. Specifically, the consistent with the objectives of the
a pilot basis to own more than 20% of a facility of Commission requests comment on all Dodd-Frank Act and the Exchange Act
an exchange subject to certain terms and prongs of the definition of ‘‘related and should reduce the ability of owners
conditions. See Securities Exchange Act Release person,’’ including whether the
Nos. 59281 (January 22, 2009), 74 FR 5014 (January that are participants or members to
28, 2009) (order approving on a pilot basis 50% definition is over-inclusive or under- control key decisions regarding the
ownership of the New York Block Exchange, a inclusive. What other method could the operation of the SB SEF or SBS
trading facility of NYSE, by BIDS ATS, a member Commission use to reach the interest of exchange and thereby potentially limit
of NYSE). This pilot has since been extended for an any person with whom a SB SEF
additional year and will expire on January 22, 2011
unless further extended or permanently approved. participant or SBS exchange member 160 See proposed Rule 702(d)(1) under Regulation
See Securities Exchange Act Release No. 61409 MC. See also supra note 102 and accompanying text
(January 22, 2010), 75 FR 4889 (January 29, 2010). 159 See supra Section III.B. for the proposed definition ‘‘independent director.’’
access to, or limit the products made clearing agency be composed of 35% more difficult for the Commission to
available for trading on, the SB SEF or independent directors. The Commission assure that the SB SEF’s governance
SBS exchange, which could adversely proposes this 35% independence structure continues to meet the
affect the trading of security-based alternative to address potential concerns proposed requirements over time.
swaps in regulated markets. Further, the that requiring a majority independent The Commission welcomes
definition of independent director is Board for security-based swap clearing commenters’ insights to inform its
designed to assure that the independent agencies would affect the Board’s ability understanding of the governance of
director would not have a direct to effectively perform risk management trading venues for security-based swaps.
economic stake in the SB SEF or SBS functions. Security-based swap clearing As discussed above, a majority
exchange, or other relationship that agencies perform a critical function in independent Board may not effectively
would call into question the impartiality mitigating financial risk for security- address all conflicts. The Commission
of the director, and thus would not be based swaps market participants. therefore seeks comment on all aspects
subject to the conflicts of interest Although critical to promoting price of its proposal for a majority
identified above. transparency and therefore market independent Board. Should the
SB SEFs and SBS exchanges are efficiency, as noted above, the Commission adopt a less prescriptive
intended to serve important roles in Commission does not believe that the approach to mitigating conflicts of
providing centralized, transparent operation of SB SEFs, SBS exchanges, interest in the governance of SB SEFs
trading of security-based swaps and, and SBS exchange facilities would pose and SBS exchanges? Are there other
under Section 763(c) of the Dodd-Frank the same level of systemic risk as approaches that would improve
Act or existing Section 6 of the security-based swap clearing agencies governance and mitigate conflicts of
Exchange Act, as applicable, will have because they do not assume the risk of interest? For example, would State laws
a number of responsibilities.161 managing open positions or of governing the fiduciary duty owed by
Requiring a majority independent Board guaranteeing the settlement of corporate board members help to
should help assure that SB SEFs and transactions. Thus, the Commission is mitigate conflicts of interest or, as noted
SBS exchanges would operate in an not making the same proposal with above, would such laws potentially
impartial manner with respect to these respect to SB SEFs, SBS exchanges, and aggravate the types of conflicts of
(and other) mandated duties. Moreover, SBS exchange facilities. interest that the Commission is trying to
requiring a majority independent Board Although a majority independent address? Should the Commission
for SB SEFs and SBS exchanges would Board may address conflicts of interest consider any additional requirements
be commensurate with the manner in concerns that underlie Section 765 of related to fiduciary duties to either
which national securities exchanges the Dodd-Frank Act, it may not enhance mitigation of conflicts or
generally are governed today 162 and effectively eliminate all conflicts. The address deficiencies?
comports with the listing rules of presence of independent directors may Further, the Commission requests
exchanges, which are approved by the be an effective mechanism to address comment on whether requiring the
Commission.163 certain types of conflicts in certain types Board of a SB SEF, SBS exchange, or
One of the alternatives the of institutions but not necessarily in all SBS exchange facility to be composed of
Commission proposes for security-based instances nor for all institutions. The a majority of independent directors
swap clearing agencies is to require the Commission, however, does not believe would improve the governance of the
Board of any security-based swap that the characteristics of SB SEFs and SB SEF, SBS exchange, or SBS exchange
SBS exchanges, and the types of facility, as applicable, and mitigate
161 For SB SEFs, these responsibilities include
conflicts that may be inherent with conflicts of interest that could arise. The
establishing and enforcing rules with respect to the respect to such entities, pose a set of Commission specifically requests
terms and conditions of the security-based swaps
traded or processed on or through the facility and circumstances that are incompatible comment on whether there are other
any limitation on access to the facility; trading with an effective governance via a Board structures that could help
procedures to be used in entering and executing majority independent Board. mitigate conflicts of interest. If having a
orders traded on SB SEFs; and monitoring trading Taking into account these and other majority independent Board is not
in SB SEFs to prevent manipulation, price
distortion, and disruptions of the settlement process concerns, the Commission has necessary to mitigate conflicts, but some
through surveillance, compliance and disciplinary considered a less prescriptive lesser percentage of independent
practices and procedures. See Section 763(c) of the governance rule to address conflicts of directors would help address such
Dodd-Frank Act, Public Law 111–203, Section interest for venues that trade security- concerns, what percentage of Board
763(c).
162 See supra Section III.B. Currently, the based swaps. However, especially members should be required to be
governance structure of a facility of an exchange because SB SEFs are not SROs and thus independent? What are the benefits and
that is a separate legal entity from the exchange and their rules are not subject to costs of requiring Boards of SB SEFs,
that is not a wholly-owned subsidiary of the Commission approval pursuant to SBS exchanges, and SBS exchange
exchange is not subject to any specific board or
committee compositional requirements. Given the Section 19 of the Exchange Act,164 a facilities to be composed of a majority
nature of the conflict concerns for the trading of principles-based approach to of independent directors? Would a
security-based swaps and the structure of the governance may not give the majority independent Board help to
security-based swaps market—namely, the Commission sufficient ability to address mitigate conflicts of interest if the
dominance by a small group of dealers and the
concern with respect to undue influence in the potential conflicts in the operation of SB ownership of a SB SEF, SBS exchange,
operation of the SB SEF or SBS exchange—the SEFs. Although the Commission, or SBS exchange facility is concentrated
Commission believes that it is necessary and through its authority to approve in a small group of owners (e.g., five
appropriate to impose the same board and applications to register as a SB SEF, may owners) rather than a larger group (e.g.,
committee compositional requirements on a facility
of an exchange if that facility posts or makes be able to ascertain that a SB SEF at the greater than ten owners)? Would a
available for trading security-based swaps. time of its registration has a governance majority independent Board help to
163 See Securities Exchange Act Release No. structure that sufficiently would mitigate conflicts of interest that could
48745 (November 4, 2003), 68 FR 64154 (November mitigate conflicts of interest, a less arise between the commercial interests
12, 2003) (order approving File Nos. SR–NYSE–
2002–33, SR–NASD–2002–77, SR–NASD–2002–80,
prescriptive approach could make it of a SB SEF, SBS exchange, or SBS
SR–NASD–2002–138, SR–NASD–2002–139, and exchange facility or the owners of the
SR–NASD–2002–141). 164 15 U.S.C. 78s. SB SEF, SBS exchange or SBS exchange
facility and the regulatory requests comment on whether this controls a SB SEF, SBS exchange, or
responsibilities of the SB SEF or SBS approach is appropriate or whether the SBS exchange facility.
exchange? Are there experience or Commission should take a less 2. Regulatory Oversight Committee
efficiency issues if a majority of the prescriptive approach. The Commission
Board must be composed of also notes that the proposed rule In addition to a majority independent
independent directors? Are there precludes a director from being deemed Board, the Commission proposes that a
remedies for overcoming any such independent if he or she has received SB SEF or SBS exchange establish a
experience or efficiency issues? 165 from the SB SEF, SBS exchange, or SBS ROC that is composed solely of
The Commission also notes that exchange facility within the past three independent directors to oversee the SB
currently, for national securities SEF’s obligations under Section 763(c)
years payments that reasonably could
exchanges, at a minimum, the number of the Dodd-Frank Act or the SBS
affect his or her independent judgment
of non-industry directors should equal exchange’s regulatory oversight
or decision-making, excluding
or exceed the number of industry responsibilities under Section 6 of the
remunerations for Board or Board Exchange Act, respectively.172 This
directors.166 The Commission requests committee services. The Commission
comment on whether requiring a requirement also would apply to a
requests comment on whether it is national securities exchange that posts
majority independent Board could appropriate to exclude compensation for
further mitigate conflicts for SBS or makes available for trading security-
Board or Board committee service from based swaps through a facility of the
exchanges or whether the current disqualifying a director as an
standards exchanges have in place exchange.173 The ROC would oversee
independent director. Are there the regulatory program on behalf of the
would sufficiently address the conflict circumstances or levels of compensation
concerns with respect to exchanges that Board. Specifically, the Commission
that should disqualify a candidate from expects that a ROC, among other things,
would post or make available for trading
being deemed independent? The would monitor a SB SEF’s or SBS
security-based swaps. Further, the
Commission also requests comment on exchange’s regulatory program for
Commission requests comment as to
whether, instead of independence sufficiency, effectiveness, and
whether the requirement for Board
requirements, it should require that the independence; oversee all facets of the
composition should be different for SB
number of ‘‘non-industry’’ directors regulatory program; review the size and
SEFs and SBS exchanges and, if so, why
and how? equal or exceed the number of allocation of the regulatory budget and
The Commission also requests ‘‘industry’’ directors, as such terms are resources; and review regulatory
comment on the proposed definitions of generally defined by the exchanges.169 proposals and advise the Board as to
‘‘independent director’’ and ‘‘material Are there other types of affiliations that whether and how such changes may
relationship.’’ 167 Are the definitions of the Commission should be concerned affect regulation. The proposed rule also
‘‘independent director’’ and ‘‘material about that are not addressed by the would require that any recommendation
relationship’’ appropriate? If not, how proposed definitions of ‘‘independent of the ROC that is not adopted or
should they be defined? The proposed director’’ or ‘‘material relationship’’? implemented by the Board be reported
rule provides circumstances that would The Commission is not proposing that promptly to the Commission.174
The proposed provisions relating to
preclude a finding that a director is the Board composition requirement
the ROC should help limit the ability of
independent.168 The Commission apply to parent companies of a SB SEF,
owners of the SB SEF and SBS exchange
SBS exchange, or SBS exchange
165 The SRO Governance Proposing Release to unduly influence the operation of
facility.170 In other words, the these entities, and thus would further
proposed that the board of a national securities
exchange or national securities association be
Commission is not proposing to require the objectives of good governance and
composed of a majority of independent directors. a holding company that wholly owns, or mitigation of conflicts of interest that
See SRO Governance Proposing Release, supra note entities that control, a SB SEF, SBS underlie Section 765 of the Dodd-Frank
59. A number of commenters, particularly national exchange, or SBS exchange facility to
securities exchanges, favored this proposal. See, Act. A ROC is intended to have an
e.g., PSX Comment Letter, supra note 156; Letter have a majority independent Board.171 important role in assuring that a SB SEF
from Anthony K. Stankiewicz, Esq., Vice President, The Commission preliminarily believes or SBS exchange carries out its
Legal and Governance, BSE, to Jonathan G. Katz, that the composition of the Board of a
Secretary, Commission, dated March 8, 2005
obligations in an even-handed and
(supporting the majority independent board
parent that wholly owns or controls a effective manner and that its oversight
requirement but objecting to the definition of SB SEF, SBS exchange, or SBS exchange functions are adequately funded.
independence) (‘‘BSE Comment Letter’’); Letter from facility does not raise conflicts concerns Although the Commission encourages
Mary Yeager, Assistant Secretary, NYSE, to that require Commission rulemaking.
Jonathan G. Katz, Secretary, Commission, dated
national securities exchanges to have a
March 8, 2005 (‘‘NYSE Comment Letter’’). A few
The Commission, however, requests wholly independent ROC, it has not in
commenters objected to it as being an unnecessary comment on whether the majority
requirement to mandate for all exchanges. See, e.g., independent Board requirement should 172 See Section 763(c) of the Dodd-Frank Act,
ISE Comment Letter, supra note 156; Letter from apply to an entity that owns and Public Law 111–203, Section 763(c), and 15 U.S.C.
William J. Brodsky, Chairman and Chief Executive 78(f). See also proposed Rule 702(e)(1) under
Officer, Chicago Board Options Exchange, Regulation MC.
Incorporated, to Jonathan G. Katz, Secretary, satisfied, would preclude a determination that the 173 Proposed Rule 702(e) under Regulation MC
Commission, dated March 8, 2005 (‘‘CBOE director is independent. does not explicitly include a SBS exchange facility.
Comment Letter’’). The Commission notes, however, 169 See supra note 66.
A facility that posts or makes available for trading
that the SRO Governance Proposing Release related
170 If the parent company of a SB SEF, SBS a security-based swap would do so under the
to national securities exchanges that trade equity exchange or SBS exchange facility was itself a registration of an exchange of which it is a facility.
securities and listed options and registered regulated entity that is subject to the Exchange Act Therefore, the exchange is deemed the statutory
securities associations, and the comments received and rules and regulations thereunder, then it would entity posting or making available for trading the
did not address potential conflicts in other contexts. comply with any requirements that it is subject to security based swap and is responsible for the
166 See supra Section III.B.
in that capacity. regulatory oversight of the facility. Accordingly, the
167 See proposed Rules 700(j) and (l) under 171 The CFTC has proposed to apply a ‘‘public exchange whose facility posts or makes available for
Regulation MC. director’’ requirement to parent companies that trading a security-based swap must itself establish
168 See Section 303A.02 of the NYSE Listed operate DCMs and SEFs. See http://www.cftc.gov/ the requisite ROC.
Company Manual and Nasdaq Rule 5605(a)(2), both ucm/groups/public/@newsroom/documents/file/ 174 See proposed Rule 702(e)(2) under Regulation
of which contain specific circumstances that, if federalregister_governance.pdf. MC.
the past required them to do so.175 As SBS exchange and not a SB SEF can be brought to the Commission’s
mentioned above, however, the conflict participant or SBS exchange member attention?
concerns that Section 765 is intended to may not have access to the same amount 3. Other Board Committees
address are not entirely analogous to or types of information as non-
those posed by national securities independent directors. Therefore, a ROC The Commission is proposing
exchanges. Rather, there is a heightened composed solely of independent compositional and other requirements
concern regarding conflicts of interest directors may need to rely on with respect to various other Board
for trading venues of security-based management or non-independent committees. In this regard, proposed
swaps because a small group of dealers directors for information, with attendant Rule 702(f)(1) under Regulation MC
may exert undue influence to control would require that the nominating
biases of information from such sources.
the level of access to, and the scope of committee of a SB SEF, SBS exchange,
If directors on a ROC, moreover, lack
products traded on such venues. or SBS exchange facility be composed
necessary information or are otherwise
Further, while SB SEFs do not possess solely of independent directors. The
not sufficiently knowledgeable, the proposed requirement for the Board of
the full range of self-regulatory committee’s effectiveness as a whole
obligations that exchanges have, they the SB SEF, SBS exchange, or SBS
may be compromised. Such ROC may exchange facility to be composed of a
nonetheless have a number of regulatory defer to management’s expertise or the
duties that are set forth in the core majority of independent directors could
expertise of non-independent directors be undercut if the nominating
principles for SB SEFs contained in
on the Board. Further, as mentioned committee were dominated by persons
Section 763(c) of the Dodd-Frank Act.176
above, independent directors may have that had an ownership interest in these
Thus, it appears that a need for a wholly
independent ROC may be greater for SB their own biases that could compromise entities, were affiliated with such
SEFs and SBS exchanges than for other the structural protections intended by a owners, or were selected by the owner-
registered national securities wholly independent ROC. Therefore, directors or their affiliates. Further, the
exchanges.177 the Commission seeks comment on the proposed rule would require that any
The Commission also recognizes that, proposal relating to the composition and committee of the Board that is delegated
as mentioned above, an independent duties of the ROC. Would the the authority to act on the Board’s
director, who by definition would be establishment of a fully independent behalf, such as any executive
outside the management of a SB SEF or ROC help mitigate the identified committee, also must be composed of a
conflicts of interest? Are there particular majority of independent directors.178
175 In the SRO Governance Proposing Release, the circumstances under which a ROC This proposed provision extends to
Commission proposed to require SROs to have a should be permitted to have non- Board committees that are authorized to
ROC and to require that all members of such independent directors? If so, please act on behalf of the Board the
committee be independent. See SRO Governance
Proposing Release, supra note 59. Some identify them. compositional requirement proposed for
commenters generally favored the requirement of a Separately, the Commission requests the full Board and is designed to assure
ROC. See, e.g., PSX Comment Letter, supra note
comment on whether it should specify that the SB SEF, SBS exchange or SBS
156; CBOE Comment Letter, supra note 165. exchange facility would not subvert the
However, a number of commenters objected to the in the proposed rule the duties of the
requirement that certain board committees, ROC. If so, what should be the scope of proposed majority Board independence
including the ROC, be composed solely of the ROC’s duties? For example, should standard by delegating the Board’s
independent directors. See, e.g., Phlx Comment duties to a committee that does not have
Letter, supra note 156 (‘‘To impose this requirement a ROC be required to oversee decisions
the same majority independence
on all Standing Committees would potentially as to which entities have access to the
standard.
exclude persons with the most experience and trading facility and under what With respect to a wholly independent
knowledge from serving on these committees.’’); circumstances, or which products are
CBOE Comment Letter, supra note 165; letter from nominating committee, the Commission
Neal Wolkoff, Acting Chief Executive Officer, the made available for trading? Is it recognizes that the proposal may not
American Stock Exchange LLC, to Jonathan G. Katz, appropriate to require that the Board sufficiently mitigate concerns that
Secretary, Commission, dated March 8, 2005 (‘‘[A] submit to the Commission any
number of the exchanges may find it difficult to certain shareholders may be able to
find enough qualified independent directors with
recommendation of the ROC that it does influence or control the director
sufficient expertise to satisfy all of these not adopt or implement? Would this nominating process and thus undermine
committees.’’); letter from the Archipelago requirement help assure good the intent of a majority independent
Exchange, BSE, the Chicago Stock Exchange, ISE, governance that may mitigate conflicts?
the Nasdaq Stock Market, and Phlx, to Jonathan G. Board. As discussed above, an
Katz, Secretary, Commission, dated March 8, 2005
Should such reports be required to be independent director may not truly be
(‘‘[As] a result of the potential loss of flexibility, we submitted promptly to the Commission? independent from the influence of, or
disagree with the mandated requirement for specific Would a different time period be more bias toward, a large shareholder or
committees composed exclusively of directors that appropriate? For instance, should such
meet the [Commission’s] proposed definition of group of shareholders, other non-
independence.’’). The Commission notes, however, reports instead be required to be independent directors, or even from
that the SRO Governance Proposing Release related submitted semi-annually or, for SB management. Consequently, if the
to national securities exchanges that trade equity SEFs, should they be incorporated as nominating committee is composed of
securities and listed options and registered part of the annual report of the Chief
securities associations, and the comments received enough directors who are subject to
did not address potential conflicts in other contexts. Compliance Officer, which is required such influence or bias, the palliative
176 See supra note 54. pursuant to core principle 14 under purpose of requiring a wholly
Section 763(c) of the Dodd-Frank Act?
177 Some exchanges have voluntarily created

independent nominating committee
ROCs. See, e.g., Securities Exchange Act Release Are there reasons, consistent with could be compromised. Accordingly,
Nos. 51149 (February 8, 2005), 70 FR 7531 mitigation of conflicts, why SB SEFs
(February 14, 2005) (order approving the Commission requests comment on
demutualization of the Chicago Stock Exchange and SBS exchanges should be treated
(‘‘CHX’’)) (at the time of the demutualization, CHX differently with respect to the proposal 178 See proposed Rule 702(f) under Regulation
proposed to have, and currently has, majority to require a fully independent ROC? Are MC. This proposed provision would not apply to
public directors on its ROC) and 62158 (May 24, the ROC or the nominating committee since the
2010), 75 FR 30082 (May 28, 2010) (order approving
there other ways in which material proposals would require the ROC and the
the demutualization of CBOE) (CBOE’s ROC is information pertaining to the ROC’s nominating committee to be composed solely of
composed solely of non-industry directors). ability to carry out its duties effectively independent directors.
whether it should prescribe or limit the in the selection of the SB SEF’s directors In other words, to the extent that there
manner in which a SB SEF, SBS and the administration of its affairs? 181 is more than one type of group or class
exchange, or SBS exchange facility For example, should the Commission of persons that are participants or
could appoint the nominating require that the nominating committee members in a SB SEF or SBS exchange,
committee. Should the Commission consult with participants in the SB SEFs as applicable, the composition of any
consider an alternative to a or SBS exchanges, as applicable? Or, disciplinary panel should not allow one
compositional requirement for a should the Commission require that the group or class to have representation on
nominating committee, such as allowing participants in the SB SEFs or SBS the disciplinary panel that is out of
a SB SEF, SBS exchange, or SBS exchanges select a certain percentage of proportion as compared to other groups
exchange facility to have a board of directors? If so, should the Commission or classes of persons that are
trustees responsible for nominating also limit the ability of owner participants in the SB SEF or SBS
candidates for the Board? If this were a participants (such as dealers) to exchange. In addition, any panel that is
viable alternative, should there be participate in this process? If that is the responsible for disciplinary decisions,
compositional requirements or other case, should any such limitation depend and any appeals body, must include at
limits imposed on the board of trustees? on whether ownership is concentrated least one independent director.183 These
How should such a board of trustees be in a small number of dealers? Should proposed provisions should help
appointed? Would the alternative of a end users also be given guaranteed mitigate conflicts of interest in the SB
board of trustees to nominate directors rights of participation in the governance SEF’s and SBS exchange’s disciplinary
provide greater assurance that of the SB SEF? process. This requirement also would
independent directors are truly The Commission also seeks comment apply to a national securities exchange
independent not only at the time of on whether the proposed compositional that posts or makes available for trading
their nomination but during their requirements relating to any committee a security-based swap through its
service on the Board as well? that is delegated the authority to act on facility.184
Conversely, the Commission also behalf of the Board are appropriate and The Commission seeks comment on
notes that dealer-owners that are Board whether there are any other areas in the proposal relating to requirements of
members would not be able to serve on which the Commission should propose the disciplinary process, including the
a wholly independent nominating compositional requirements for SB SEF compositional requirements. Should
committee and thus would not have a and SBS exchange committees. For any disciplinary panel also be required
voice in the process of nominating example, the Commission requests to include representatives selected by
candidates for Board seats. This would comment on whether it should require SB SEF participants or SBS exchange
mean that the nominating committee any SB SEF, SBS exchange, or SBS members, as applicable? Would the
would not have access to the dealer- exchange facility committee that proposed provisions help to mitigate the
owners’ potentially valuable insights determines which security-based swaps identified conflicts of interest? Should
with respect to qualified candidates for will trade on the SB SEF or SBS any other persons be precluded from
either independent or non-independent exchange, respectively, be composed of dominating the disciplinary process?
director positions. Accordingly, the majority independent directors, or Are there any additional provisions that
Commission invites commenters to require participation by other groups on should be proposed to mitigate conflicts
suggest the appropriate compositional such committee. Should the ROC be of interest in the disciplinary
requirements for the nominating required to oversee decisions regarding process? 185 The Commission also
committee and explain their views. access to the SB SEF and regarding requests comment on whether the
Should the Commission instead require which security-based swaps are made Commission’s proposal would
a majority independent nominating available to trade on the SB SEF? meaningfully supplement or enhance
committee? Would a majority 4. Disciplinary Process the requirements that SBS exchanges, as
independent nominating committee be national securities exchange, already
consistent with the proposal’s goal to As noted above, the Commission have in place with respect to the
mitigate conflicts for SB SEFs and SBS historically has required that national disciplinary process.
exchanges? 179 securities exchanges’ disciplinary
SB SEFs are not subject to ‘‘fair panels be balanced and include industry VI. Discussion of Exemptive Authority
representation’’ requirements, like member representation.182 Proposed Pursuant to Section 36 of the Exchange
national securities exchanges, which Rule 702(g) under Regulation MC would Act
must assure their members ‘‘fair require that any disciplinary process of The Commission pursuant to Section
representation’’ in the selection of a SB SEF and SBS exchange shall 36 of the Exchange Act may grant an
directors and the administration of the preclude any group or class of persons exemption from any rule or any
exchange’s affairs.180 Should the that is a SB SEF participant or SBS provision of any rule under Regulation
Commission adopt additional exchange member from dominating or MC. Any such exemption could be
compositional requirements to provide exercising disproportionate influence. subject to conditions and could be
SB SEF participants a guaranteed voice revoked by the Commission at any time.
181 As discussed above, Section 763(c) of the
Dodd-Frank Act sets forth 14 core principles that 183 See

179 The SRO Governance Proposing Release
SB SEFs must satisfy, including one relating to proposed Rule 702(h) under Regulation
proposed that certain committees, including the conflicts of interest, and provides the Commission MC.
nominating committee, be composed solely of with rulemaking authority with respect to

184 See supra note 173. Similar to the requirement
independent directors. See SRO Governance implementation of these core principles. As the pertaining to the ROC, the exchange, not the
Proposing Release, supra note 59. Some Commission has not yet proposed rules regarding facility, bears the responsibility of disciplining its
commenters favored this requirement. See, e.g., PSX the requirements and operation of a SB SEF, members. See Section 6 of the Exchange Act.
Comment Letter, supra note 156. A number of including the scope of trading on and which Consequently, proposed Rule 702(h) does not
commenters, particularly national securities entities would be allowed to directly access a SB explicitly mention SBS exchange facility. However,
exchanges, objected to the requirement that certain SEF, the Commission may determine that it is more a national securities exchange that posts or makes
board committees be composed solely of appropriate to propose participant representation available for trading a security-based swap through
independent directors. See supra note 175. requirements, if any, in its broader rulemaking its facility must also comply with the requirements
180 See Section 6(b)(3) of the Exchange Act, 15 relating to SB SEFs. of proposed Rule 702(h) under Regulation MC.
U.S.C. 78f(b)(3). 182 See supra Section III.B. 185 See supra note 181.
Generally, the Commission would proposing that provisions of Regulation mandating ownership and voting
consider granting an exemption where MC as applicable to SB SEFs would limitations for security-based swap
the exemption is necessary or become effective sixty (60) days after clearing agencies, SB SEFs, SBS
appropriate in the public interest and July 15, 2011. All other provisions of the exchanges, and SBS exchange facilities
consistent with the protection of rules under Regulation MC would and on whether there are other means
investors. For example, the SBS become effective sixty (60) days after the to achieve the statutory mandate of
exchange, SB SEF, or security-based final rules are published in the Federal Section 765 of the Dodd-Frank Act.
swap clearing agency might be unable, Register. The Commission is proposing
on a temporary basis and for reasons The Commission recognizes that governance requirements for security-
beyond its control, to comply with one existing entities may need a transitional based swap clearing agencies, SB SEFs,
of the rules under Regulation MC. The period to implement any final rules. SBS exchanges, and SBS exchange
Commission could also grant an Accordingly, the Commission is facilities that are designed to mitigate
exemption where the SBS exchange, SB proposing to permit the phase-in conflicts of interest. The Commission
SEF, or security-based swap clearing implementation of the rules under requests comment on whether the
agency demonstrated that it established Regulation MC over two (2) years or two governance requirements, by
alternative means to effectively mitigate regularly-scheduled Board elections. themselves, would be enough to
conflicts of interest as contemplated The phase-in implementation would mitigate conflicts.
under Regulation MC and that it would apply to existing exchanges, clearing The Commission requests comment
otherwise be unable to comply with the agencies, or other institutions that apply on the two alternative proposals for
requirements under Regulation MC, to register as a SBS exchange, SB SEF, security-based swap clearing agencies.
including as a start-up SB SEF, SBS or security-based swap clearing agency. Are there other alternatives that would
exchange, or security-based swap However, the Commission expects that more effectively mitigate conflicts of
clearing agency. The Commission in its entities that are newly created in order interest? Should security-based swap
sole discretion would determine to establish a SBS exchange, SB SEF, or clearing agencies be permitted to choose
whether to grant or deny a request for security-based swap clearing agency between alternatives at all? The
an exemption. In addition, the would fully comply with the final rules. Commission may determine to adopt
Commission could revoke an exemption The Commission requests comment only one of the proposed alternatives as
at any time, including if the SBS on (i) the timing of effectiveness for the a final rule. If only one alternative were
exchange, SB SEF, or security-based final rules, and (ii) the length and to be adopted as a final rule, which one
swap clearing agency could no longer applicability of the implementation should it be? Should any of the
demonstrate that such exemption is period. provisions of the proposed alternatives
necessary or appropriate in the public be revised? The Commission may
VIII. General Request for Comments
interest, or is consistent with the combine aspects of each proposed
protection of investors. The Commission seeks comment on alternative rule (with or without
The Commission requests comment the proposed rules that are intended to modifications) and adopt them as a
on all aspects of the exemptive mitigate conflicts of interest with single final rule. If that approach is
authority. Would such exemptive respect to security-based swap clearing taken, which aspects of each alternative
authority be useful to facilitate the agencies, SB SEFs, SBS exchanges, and should be combined? For example,
purposes of Section 765? If so, in what SBS exchange facilities, on any should the voting interest restrictions in
circumstances should the Commission additional or different provisions that Rule 701(a) be combined with the
grant exemptions? Should exemptions would mitigate conflicts of interest for governance restrictions in Rule 701(b) to
only be granted in limited these entities, and on any other matters create a stronger rule to mitigate
circumstances? Should the Commission that might have an implication on the conflicts of interest at security-based
potentially consider granting proposals. The Commission particularly swap clearing agencies? As compared to
exemptions from all rules under requests comment from the point of each other, how is each alternative
Regulation MC or are exemptions only view of entities that plan to register as likely to affect access and risk
warranted for specific rules or specific security-based swap clearing agencies or management at security-based swap
entities? For example, should SB SEFs and from national securities clearing agencies? How will each
exemptions only be available with exchanges that plan to become SBS alternative affect and be affected by
respect to the voting interest restrictions exchanges or create SBS exchange developments in the market, including
applicable to security-based swap facilities; entities operating platforms the prospect of future competition?
clearing agencies? What specific factors that currently trade or clear security- The Commission also requests
should the Commission consider in based swaps; broker-dealers, financial comment on the impact on competition
determining whether to grant an institutions, major security-based swap the two alternative proposals might
exemption? Are there cases where participants, and other persons that have. The Voting Interest Focus
exemptions may not be appropriate and trade security-based swaps; and end- Alternative and the Governance Focus
should not be considered? users generally. Alternative are designed to address the
The Commission invites commenters unique conflict of interest issues at
VII. Effective and Compliance Date to address whether the proposed rules security-based swap clearing agencies.
The Commission is required to adopt are appropriately tailored to achieve the The Commission requests comment on
rules under Section 765 within 180 days goal of mitigating conflicts of interest in whether imposing voting interest and
of enactment of Title VII. However, the ownership and governance of governance limitations could have the
certain of the rules the Commission is security-based swap clearing agencies, unintended consequence of deterring
proposing today would apply to SB SB SEFs, SBS exchanges, and SBS new, competitive security-based swap
SEFs, which will be the subject of new exchange facilities, including with clearing agencies at a time when central
definitional rules that are required respect to the administration of these clearing for security-based swaps is still
under the Dodd-Frank Act to be entities’ regulatory activities. The developing. A security-based swap
completed by July 15, 2011. Commission also requests comment on clearing agency that currently clears
Accordingly, the Commission is the necessity and appropriateness of security-based swaps but would not
meet the proposed voting interest limits clear swaps, swap execution facilities in Section 765 of the Dodd-Frank Act
would need to revise its ownership and boards of trade designated as a regarding mitigation of conflicts of
structure. There could be costs and contract markets that post swaps or interest.
delays as the security-based swap make swaps available for trading as
IX. Paperwork Reduction Act
clearing agency seeks to find one or required under Section 726 of the Dodd-
more additional owners to satisfy the Frank Act. Understanding that the The proposed rules contain
proposed limits, with a possible Commission and the CFTC regulate ‘‘collection of information’’ requirements
diminution in the value of the original different products and markets and, as within the meaning of the Paperwork
owner(s)’ investment. such, appropriately may be proposing Reduction Act of 1995 (‘‘PRA’’).187 The
The Commission is sensitive to alternative regulatory requirements, the titles for these collections are Rule 701
arguments against imposing ownership Commission requests comments on the of Regulation MC, both in the Voting
and voting limits for security-based impact of any differences between the Interest Focus Alternative and the
swap clearing agencies, some of which Commission and CFTC approaches to Governance Focus Alternative, and Rule
were articulated at the Conflicts the mitigation of conflicts of interest. 702 of Regulation MC.
Roundtable. However, it also Specifically, would the regulatory The Commission has submitted the
understands that the OTC derivatives approaches under the Commission’s information to the Office of
market is highly concentrated and proposed rulemaking pursuant to Management and Budget (‘‘OMB’’) for
dealer dominated. As a result, voting Section 765 of the Dodd-Frank Act and review in accordance with 44 U.S.C.
interest and governance restrictions may the CFTC’s proposed rulemaking 3507 and 5 CFR 1320.11.
be necessary at security-based swap pursuant to Section 726 of the Dodd-
clearing agencies where they have not Frank Act result in duplicative or A. Summary of Collection of
been necessary at other securities inconsistent efforts on the part of market Information
clearing agencies. Access to central participants subject to both regulatory 1. Security-Based Swap Clearing
clearing services will be crucial for most regimes or result in gaps between those Agencies
firms that will actively trade in security- regimes? If so, in what ways do
based swaps that are required to be commenters believe that such Proposed alternative Rule 701(a)(2)
cleared. Although the proposed duplication, inconsistencies, or gaps under Regulation MC would require
restrictions may have the effect of should be minimized? Do commenters security-based swap clearing agencies to
creating barriers to potential security- believe the approaches proposed by the have rules that would: (1) Provide for an
based swap clearing agencies (and thus Commission and the CFTC to mitigate effective mechanism to divest any
market participants could have fewer conflicts of interest are comparable? If participant of any interest owned in
clearing agencies to choose from) the not, why? Do commenters believe there excess of the proposed 20% ownership
incentives of independent directors will are approaches that would make the limit; (2) not give effect to the portion
likely promote increased access to mitigation of conflicts of interest more of any voting interest held by one
central clearing for market participants. comparable? If so, what? Do participant in excess of the proposed
In contrast, although ownership and commenters believe that it would be 20% voting limit; (3) not give effect to
voting limits may more directly affect appropriate for the Commission to adopt the portion of any voting interest among
the ability of SB SEFs and SBS an approach proposed by the CFTC that all security-based swap clearing agency
exchanges to start up, the lack of market differs from the Commission’s proposal? participants owned in the aggregate in
characteristics to promote competing Is so, which one? The Commission excess of the proposed 40% ownership
trading venues for security-based swaps requests commenters to provide data, to limit; and (4) provide an effective
may emphasize the greater need for the extent possible, supporting any such mechanism for the security-based swap
ownership and voting limits. If the suggested approaches. clearing agency to obtain information
market characteristics for security-based In addition, the Commission seeks relating to the voting interests in such
swaps naturally promote dealer comment regarding any potential entity. Alternative Rule 701(b)(2) under
domination without robust competing implication of the proposals on users of Regulation MC would require security-
trading venues, there is more need to any security-based swap clearing based swap clearing agencies to have
mitigate the types of concerns that agencies, SB SEFs, and SBS exchanges, rules that would: (1) Provide for an
underlie Section 765, such as by other market participants, and the effective mechanism to divest any
imposing ownership and voting public generally. The Commission seeks participant of any interest owned in
limits.186 comment on the proposals as a whole, excess of the proposed 5% ownership
The CFTC is adopting rules to including their interaction with the limit; (2) not give effect to the portion
mitigate conflicts of interest for other provisions of the Dodd-Frank Act. of any voting interest held by one
derivatives clearing organizations that The Commission seeks comment on participant in excess of the proposed
whether the proposals would help 5% voting limit; and (3) provide an
186 In the equities market a small group of broker- achieve the broader goals of increasing effective mechanism for the security-
dealers or single-dealer proprietary firms can and transparency and accountability in the based swap clearing agency to obtain
do own alternative trading systems (‘‘ATSs’’) and information relating to the voting
thus it can be argued that SB SEFs and SBS
OTC derivatives market.
exchanges should be permitted to operate similarly. Commenters should, when possible, interests in such entity. Each security-
See Securities Exchange Act Release No. 60997 provide the Commission with empirical based swap clearing agency must
(November 13, 2009), 74 FR 61208 (November 23, data to support their views. Commenters comply with one of the alternatives.
2009) (as of November 2009, there were suggesting alternative approaches Establishing such rules would result in
approximately 73 ATSs that are subject to
Regulation ATS). However, ATSs exist in the
should provide comprehensive a paperwork burden for a security-based
context of a marketplace with robust competition proposals, including any conditions or swap clearing agency. In addition, if the
among numerous trading venues. Therefore, ATSs limitations that they believe should security-based swap clearing agency
that are owned by one broker-dealer or a small apply, the reasons for their suggested was to request to receive ownership and
group of broker-dealers, by virtue of their
ownership structure alone, generally do not present
approaches, and their analysis regarding voting information from participants
a concern that they could lessen price competition why their suggested approaches would
or market efficiency. satisfy the statutory mandate contained 187 44 U.S.C. 3501 et seq.
pursuant to Rule 701(a) or (b), the the security-based swap clearing agency, conceivably be one or two more in the
request would be a collection of and enable the security-based swap future,192 the Commission preliminarily
information. clearing agency to take necessary action estimates that four to six clearing
if the voting interests by a participant or agencies may seek to clear security-
2. SB SEFs, SBS Exchanges, and SBS
group of participants in the security- based swaps and be subject to the
Exchange Facilities
based swap clearing agency exceed information collection requirements in
Proposed Rule 702(c) under those allowed under proposed Rule proposed Rule 701(a) or (b). The
Regulation MC would require SB SEFs, 701(a) or (b). Commission is using the higher estimate
SBS exchanges, and SBS exchange of six for the PRA analysis.
facilities to have rules that would: (1) 2. SB SEFs, SBS Exchanges, and SBS
Provide for an effective mechanism to Exchange Facilities 2. SB SEFs, SBS Exchanges, and SBS
divest any participant or member, as The purpose of the collection of Exchange Facilities
applicable, of any interest owned in information in proposed Rule 702(c) The collection of information
excess of the proposed 20% ownership under Regulation MC is to enable a SB associated with the proposed Rule
limit; (2) not to give effect to the portion SEF, SBS exchange, or SBS exchange 702(c) under Regulation MC would
of any voting interest help by one or facility to monitor voting interests with apply to SB SEFs, SBS exchanges, and
more participants or members, as respect to such entity, and enable the SB SBS exchange facilities. In the Dodd-
applicable, in excess of the proposed SEF, SBS exchange, or SBS exchange Frank Act, Congress defined for the first
20% voting limit; and (3) provide an facility, as applicable, to take necessary time a SB SEF and mandated the
effective mechanism for the SB SEF, action if the ownership or voting rights registration of these new facilities.193
SBS exchange or SBS exchange facility by a participant or member or group of Based on conversations with the CFTC
to obtain information relating to participants or members, as applicable, and industry sources, the Commission
ownership and voting interests in such exceed those allowed under proposed preliminarily believes that
entity. Establishing such rules would Rule 702(b). approximately 10–20 entities could seek
result in a paperwork burden for a SB The purpose of the collection of to become SB SEFs and thus be subject
SEF, SBS exchange, or SBS exchange information in proposed Rule 702(e) to the collection of information
facility, as applicable. In addition, if a under Regulation MC is to provide the requirement of proposed Rule 702(c).
SB SEF, SBS exchange, or SBS exchange Commission with information regarding The Commission is using the higher
facility were to request to receive the instances in which the SB SEF or estimate of 20 SB SEFs for this PRA
ownership and voting information from SBS exchange does not adopt or analysis. In addition, there are currently
participants or members pursuant to implement a recommendation of the 15 national securities exchanges that
Rule 702(c) that would be a collection ROC, which would help the could be subject to the collection of
of information. Commission in its oversight of SB SEFs information requirement of Rule
Proposed Rule 702(e) under and SBS exchanges. The information 702(c).194 To provide an estimate that is
Regulation MC would require SB SEFs collection also should promote sound not under-inclusive, the Commission
and SBS exchanges to establish a ROC regulatory policies and foster the preliminarily estimates that all 15 of the
that is composed solely of independent effectiveness of the ROC by putting the currently registered national securities
directors,188 to oversee the SB SEF’s and SB SEF or SBS exchange on notice that exchanges could become SBS exchanges
SBS exchange’s obligations under the Commission must be apprised or could create a separate legal entity
Section 763(c) of the Dodd-Frank Act promptly of any recommendation that is that would be a facility of the exchange
and Section 6 of the Exchange Act, made by the ROC that is not adopted or to trade security-based swaps.
respectively.189 The proposed rule implemented. The collection of information
would require that any recommendation associated with the proposed Rule
of the ROC that is not adopted or C. Respondents
702(e) under Regulation MC would
implemented by the SB SEF’s or SBS 1. Security-Based Swap Clearing apply to SB SEFs and SBS exchanges.
exchange’s Board be reported promptly Agencies Based on the estimates noted above, to
to the Commission. provide an estimate that is not under-
The collection of information
B. Proposed Use of Information associated with the proposed Rule inclusive, the Commission preliminarily
701(a) and (b) under Regulation MC believes that 20 SB SEFs and 15 SBS
1. Security-Based Swap Clearing exchanges or SBS exchange facilities
would apply to security-based swap
Agencies would be subject to the collection of
clearing agencies. Currently, four
The purpose of the collection of clearing agencies are authorized to clear information requirement of Rule 702(e).
information in proposed Rule 701(a) or credit default swaps, including security-
192 The Commission does not expect there to be
(b) under Regulation MC is to enable a based swaps,190 pursuant to temporary a large number of clearing agencies that clear
security-based swap clearing agency to conditional exemptions under Section security-based swaps, based on the significant level
monitor voting interests with respect to 36 of the Exchange Act.191 The of capital and other financial resources necessary
obligation to centrally clear security- for the formation of a clearing agency.
188 Proposed Rule 702(e) under Regulation MC 193 See Sections 763(a) and 763(c) of the Dodd-
based swap transactions is a new
does not explicitly include SBS exchange facilities Frank Act, Public Law 111–203, Section 763(a) and
because the exchange whose facility posts or makes requirement under Title VII of the (c).
Dodd-Frank Act. Based on the fact that
available for trading a security-based swap must 194 The 15 national securities exchanges are:
itself establish the requisite ROC. See supra note there are currently four clearing BATS Exchange, Inc.; BATS Y–Exchange, Inc.;
173. agencies authorized to clear security- Chicago Board Options Exchange, Incorporated;
189 See Section 763(c) of the Dodd-Frank Act, Chicago Stock Exchange, Inc.; C2 Options
Public Law 111–203, Section 763(c). Specifically,
based swaps and that there could Exchange, Incorporated, EDGA Exchange, Inc.,
the ROC would oversee the SBS exchange’s and SB EDGX Exchange, Inc., International Securities
190 Of the four clearing agencies granted
SEF’s regulatory program on behalf of the Board Exchange, LLC; The NASDAQ Stock Market LLC;
and the Board would be required to delegate temporary exemptions from registration, only three NASDAQ OMX BX, Inc.; NASDAQ OMX PHLX,
sufficient authority, dedicate sufficient resources, have cleared products that are classified as security- Inc.; National Stock Exchange Inc.; New York Stock
and allow sufficient time for the ROC to fulfill its based swaps under Title VII of the Dodd-Frank Act. Exchange LLC; NYSE Amex LLC; and NYSE Arca,
mandate. 191 15 U.S.C. 78mm. Inc.
D. Total Annual Reporting and information related to the voting 2. SB SEFs, SBS Exchanges, and SBS
Recordkeeping Burdens interests held by participants on a Exchange Facilities
quarterly basis. This would provide the Proposed Rule 702(c) would require
1. Security-Based Swap Clearing
security-based swap clearing agency SB SEFs, SBS exchanges, and SBS
Agencies
with sufficiently current information exchange facilities to have rules that
Proposed Rule 701(a) would require regarding participants’ voting interests would provide for an effective
security-based swap clearing agencies to in the security-based swap clearing mechanism to divest any participant or
have rules that would: (1) Provide for an agency and allows the security-based member, as applicable, of any interest
effective mechanism to divest any swap clearing agency to review the owned in excess of the proposed 20%
participant of any interest owned in information at a single point in time. ownership limit; that would not give
excess of the proposed 20% ownership Accordingly, the Commission effect to the portion of any voting
limit; (2) not give effect to the portion preliminarily estimates that each interest held by one or more
of any voting interest held by one security-based swap clearing agency participants or members, as applicable,
participant in excess of the proposed would request information in excess of the proposed 20% voting
20% voting limit; (3) not give effect to approximately 4 times per year from limit; and that would provide an
the portion of any voting interest among approximately 14 participants. effective mechanism for the SB SEF,
all security-based swap clearing agency The Commission also estimates that SBS exchange, or SBS exchange facility
participants owned in the aggregate in the preparation and sending of each of to obtain information relating to
excess of the proposed 40% ownership the 4 requests for information would ownership and voting interests in such
limit; and (4) provide an effective require approximately 4 hours and entity. Establishing such rules or
mechanism for the security-based swap reviewing the responses to each of the policies and procedures, as applicable,
clearing agency to obtain information 4 requests for information would require would result in a paperwork burden for
relating to the voting interests in such 10 hours. This would result in a total a SB SEF, SBS exchange, or SBS
entity. Proposed Rule 701(b) would annual reporting and recordkeeping exchange facility, as applicable. The
require security-based swap clearing burden of 56 hours ((4 requests × 4 Commission preliminarily believes that
agencies to have rules that would: (1) hours) + (4 requests × 10 hours)) for
Provide for an effective mechanism to there would be a one-time paperwork
each security-based swap clearing burden of 15 hours per entity associated
divest any participant of any interest agency, and a total annual burden for all
owned in excess of the proposed 5% with the drafting and implementation of
security-based swap clearing agencies of any such rules by the SB SEF, SBS
ownership limit; (2) not give effect to 336 hours (56 hours × 6 clearing
the portion of any voting interest held exchange, or SBS exchange facility, as
agencies). The Commission applicable, for a total of 525 hours (15
by one participant in excess of the preliminarily estimates that each
proposed 5% voting limit; and (3) hours × 35 respondents).
participant would require 1 hour to The number of responses per year that
provide an effective mechanism for the prepare and send the security-based
security-based swap clearing agency to would be generated by requests by a SB
swap clearing agency its response to the SEF, SBS exchange, or SBS exchange
obtain information relating to the voting request, for a total annual reporting and
interests in such entity. Each security- facility, as applicable, for ownership or
recordkeeping burden for each voting information from participants or
based swap clearing agency must participant of each security-based swap
comply with one of the alternatives. members that are owners of securities
clearing agency of 4 hours (4 requests × entitled to vote or otherwise have a
Establishing such rules would result 1 hour) and a total annual burden for all
in a paperwork burden for a security- voting interest in the SB SEF, SBS
participants in all 6 security-based swap exchange, or SBS exchange facility
based swap clearing agency. The clearing agencies of 336 hours (14
Commission preliminarily believes that would depend upon the number of
participants × 4 hours × 6 security-based owners of voting securities that are
there would be a one-time paperwork swap clearing agencies) thereby
burden of 15 hours per entity associated participants or members. Assuming that
resulting in a total estimated annual all classes of securities entitled to vote
with the drafting and implementation of
burden for all security-based swap are owned or otherwise controlled by
any such rules by the security-based
clearing agencies and participants of participants or members, the minimum
swap clearing agency for a total of 90
672 hours (336 hours for all participants number per SB SEF, SBS exchange, or
hours (15 hours × 6 respondents).
Any collection of information by a + 336 hours for all security-based swap SBS exchange facility would be 5. Based
security-based swap clearing agency clearing agencies). The Commission on the Commission’s understanding of
from a participant that has a voting requests comment on these estimates. the ownership structures and voting
The Commission estimates that the rights of existing entities that may
interest in the security-based swap
total paperwork burden resulting from register as SB SEFs, and its
clearing agency would differ depending
the proposals relating to security-based understanding of the ownership
upon the number of shareholders or
swap clearing agencies is 762 hours for structures and voting rights of existing
other owners of voting interests that are
an initial paperwork burden and 672 national securities exchanges, the
participants in the security-based swap
hours thereafter.195 Commission preliminarily estimates
clearing agency. Accordingly, the
number of responses per year that 195 The aggregate initial paperwork burden is
that each SB SEF, SBS exchange, or SBS
would be generated by proposed Rule calculated as follows: 90 hours (one time paperwork exchange facility on average would
request information from approximately
701(a) or (b) under Regulation MC burden for security-based swap clearing agencies to
would vary by security-based swap establish rules to divest any ownership interest in 20 participants or members, as
excess of the limit and not to give effect to any applicable. The Commission believes
clearing agency. At this point, however, portion of the voting interests in excess of the limit)
currently only the largest fourteen + 336 hours (annual burden for security-based swap that it would be reasonable for a SB
dealer firms are participants that clear clearing agencies to prepare and send requests for
security-based swaps at such clearing voting information) + 336 hours (annual burden for 762 hours (total paperwork burden resulting from
participants of security-based swap clearing the proposals relating to security-based swap
agencies. The Commission believes that agencies to prepare and send responses to requests clearing agencies) ¥ 90 hours (one-time paperwork
it would be reasonable for security- for voting information) = 762 hours. After the initial burden for security-based swap clearing agencies) =
based swap clearing agencies to collect year, the paperwork burden is calculated as follows: 672 hours.
SEF, SBS exchange, or SBS exchange would meet at least once per month and effective date of Title VII; however,
facility to collect information on would decide each time that it meets security-based swap clearing agencies
ownership and voting rights on a not to adopt a ROC recommendation. may be required to retain records and
quarterly basis. Accordingly, the Therefore, the Commission estimates information collected pursuant to
Commission preliminarily estimates that the total reporting burden under the proposed Rules 701(a) or (b) similar to
that each SB SEF, SBS exchange, or SBS proposed Rule 702(e) for all SB SEFs the current recordkeeping requirements
exchange facility would request and SBS exchanges combined would be in Rule 17a–1.
information approximately 4 times per 420 hours.196
year from approximately 20 participants The Commission estimates that the 2. SB SEFs, SBS Exchanges, and SBS
or members. total paperwork burden resulting from Exchange Facilities
The Commission estimates that the the proposals relating to SB SEFs, SBS Although recordkeeping and retention
preparation and sending of each of the exchanges or SBS exchange facilities is requirements have not yet been
4 requests for information would require 5,705 for an initial paperwork burden established for SB SEFs under new
approximately 4 hours, and reviewing and 5,180 thereafter.197 Exchange Act provisions added by the
the responses to each of the 4 requests Dodd-Frank Act, the Commission is
E. Retention Period of Recordkeeping
for information would require 10 hours. authorized to adopt such rules.200 In
Requirements
This would result in a total annual addition, the recordkeeping and
reporting and recordkeeping burden of 1. Security-Based Swap Clearing reporting core principle applicable to
56 hours ((4 requests × 4 hours) + (4 Agencies SB SEFs, as set forth in Section 763(c)
requests × 10 hours)) for each SB SEF, Security-based swap clearing agencies of the Dodd-Frank Act, requires a SB
SBS exchange, or SBS exchange facility, will be required to be registered with SEF to maintain records of all activities
as applicable, and a total annual burden the Commission following the effective relating to the business of the facility,
for all SB SEFs, SBS exchanges, and date of Title VII of the Dodd-Frank including a complete audit trail, in a
SBS exchange facilities of 1,960 hours Act.198 Accordingly, once registered form and manner acceptable to the
(56 hours × 35 respondents). The with the Commission, security-based Commission for a period of five
Commission preliminarily estimates swap clearing agencies would be years.201 Therefore, for purposes of this
that each participant or member would required to retain any collection of PRA, the Commission assumes that a SB
require 1 hour to prepare and send the information pursuant to proposed Rules SEF would be required to retain any
response to the request, for a total 701(a) or (b) under Regulation MC as collection of information pursuant to
annual reporting and recordkeeping applicable, in accordance with, and for proposed Rules 702(c) and 702(e) under
burden for each participant or member the periods specified in Rule 17a–1 Regulation MC, as applicable, for a
of 4 hours (4 requests × 1 hour) and a under the Exchange Act.199 Retention period of not less than five years.
total annual burden for all participants and recordkeeping requirements have Should the Commission propose rules
or members of 2,800 hours (700 not been established for security-based to implement the recordkeeping and
participants or members × 4 hours). The swap clearing agencies before the reporting core principle for SB SEFs, it
Commission requests comment on these would include any collection of
estimates. 196 (20 (estimated number of SB SEFs subject to information burden with respect to any
The Commission preliminarily the collection of information under the proposed proposed recordkeeping and retention
believes that the collection of Rule 702(e)) + 15 (estimated number of SBS
rules for SB SEFs in such rulemaking.
information burden imposed by exchanges subject to the collection of information
under the proposed Rule 702(e))) × 12 (estimated All registered national securities
proposed Rule 702(e) under Regulation number of notices prepared annually by each SB exchanges must currently comply with
MC would be minimal. The Commission SEF pursuant to the proposed Rule 702(e)) × 1 hour the recordkeeping and reporting
estimates that a representative of the (estimate of total time to complete, review, and requirements in Rule 17a–1 under the
Board of a SB SEF or SBS exchange prepare required notice) = 420 hours.
197 The aggregate initial paperwork burden is Exchange Act.202 Therefore, SBS
would spend no more than one hour to calculated as follows: 525 hours (one-time exchanges would be required to retain
complete the required notice to the paperwork burden for SB SEFs, SBS exchanges and any collection of information pursuant
Commission. This figure includes the SBS exchange facilities to establish rules to divest to proposed Rules 702(c) and 702(e), as
time to prepare, review, and any ownership interest in excess of, and to not give
effect to any portion of voting interests in excess of, applicable, in accordance with, and for
electronically submit such notice to the the proposed 20% limit) + 1,960 hours (annual the periods specified in, Rule 17a–1
Commission. The Commission expects burden for SB SEFs, SBS exchanges and SBS under the Exchange Act.
to establish an electronic mailbox for exchange facilities to prepare and send requests for
these notices and would identify the ownership and voting information) + 2,800 hours F. Collection of Information Is
address if the Commission were to (annual burden for participants to prepare and send Mandatory
responses to requests for ownership and voting
adopt this specific proposal. Although information) + 420 hours (annual burden for SB 1. Security-Based Swap Clearing
the Commission preliminarily believes SEFs and SBS exchanges to prepare and submit Agencies
that the Board of a SB SEF or SBS notices pursuant to proposed Rule 702(e)(2)) =
exchange often would adopt or 5,705 hours. After the initial year, the paperwork The collection of information under
burden is calculated as follows: 5,705 hours (total proposed alternative Rules 701(a) and
implement the recommendations of its paperwork burden resulting from the proposals
ROC, the Commission preliminarily relating to SB SEFs, SBS exchanges and SBS (b) under Regulation MC would be
believes that the Board of a SB SEF or exchange facilities)—525 hours (one-time
paperwork burdens for SB SEFs, SBS exchanges 200 As discussed above, Section 763(c) of the
SBS exchange could occasionally decide

and SBS exchange facilities) = 5,180 hours. Dodd-Frank Act sets forth 14 core principles that
not to adopt such recommendations. 198 New Exchange Act Section 17A(g) provides SB SEFs must satisfy, including one relating to
Although the Commission expects that that it shall be unlawful for a clearing agency, recordkeeping and reporting, and provides the
this would be an infrequent occurrence, unless registered with the Commission, directly or Commission with rulemaking authority with
the Commission preliminarily estimates indirectly to make use of the mails or any means respect to implementation of these core principles.
or instrumentality of interstate commerce to See Section 763(c) of the Dodd-Frank Act, Public
that a Board could decide not to adopt Law 111–203, Section 763(c).
perform the functions of a clearing agency with
a ROC recommendation up to 12 times respect to a security-based swap. 15 U.S.C. 78q– 201 See Section 763(c) of the Dodd-Frank Act,
per year. This estimate assumes that the 1(g). Public Law 111–203, Section 763(c).
Board of a SB SEF or SBS exchange 199 17 CFR 240.17a–1. 202 17 CFR 240.17a–1.
mandatory. The collection of provisions of 5 U.S.C. 522, the exchange. The proposed rules, however,
information under proposed Rules collection of information pursuant to are also likely to impose costs on
701(a) and (b) would be required from the proposed Rules 702(c) and (e) would security-based swap clearing agencies,
participants in a security-based swap not be confidential and would be SB SEFs, and SBS exchanges. The
clearing agency upon request from the publicly available. Commission is sensitive to the costs and
security-based swap clearing agency. benefits that would result from the
H. Request for Comment
The collection of information would proposed rules and has identified
allow the security-based swap clearing Pursuant to 44 U.S.C. 3505(c)(2)(B), certain costs and benefits of these
agency and the Commission to the Commission solicits comment to: proposals, as described below.
determine whether the requirements in 1. Evaluate whether the proposed
collection of information is necessary A. Background
proposed Rules 701(a) and (b) regarding
limitations on voting interests are met. for the performance of the functions of The proposed governance and
the agency, including whether the ownership and voting rules are intended
2. SB SEFs, SBS Exchanges, and SBS information shall have practical utility; to reduce conflicts of interest in
Exchange Facilities 2. Evaluate the accuracy of the security-based swap clearing agencies,
The collection of information under agency’s estimate of the burden of the SB SEFs, and SBS exchanges.
proposed Rule 702(c) under Regulation proposed collection of information; Ownership and voting limitations and
MC would be mandatory. The collection 3. Enhance the quality, utility, and other governance rules are designed to
of information would allow the SB SEF, clarity of the information to be limit the influence of any single market
SBS exchange, or SBS exchange facility collected; and participant or a group of participants in
as applicable, and the Commission to 4. Minimize the burden of collection the operation of security-based swap
determine whether the requirements in of information on those who are to clearing agencies, SB SEFs, and SBS
proposed Rule 702(c) regarding respond, including through the use of exchanges and thus reduce the risk that
limitations on ownership and voting automated collection techniques or conflicts of interest would negatively
rights are met and enable the SB SEF, other forms of information technology. affect the operation of these entities and
Persons wishing to submit comments the security-based swaps market.203
SBS exchange, or SBS exchange facility,
on the collection of information
as applicable, to take necessary action if However, since the OTC swaps
requirements should direct them to the
the ownership or voting rights by a marketplace regulated under Title VII
following persons: (1) Desk Officer for
participant or group of participants likely would change significantly after
the Securities and Exchange
exceed those allowed under proposed the effective date of the Dodd-Frank Act
Commission, Office of Information and
Rule 702(b). and the Commission’s rules
Regulatory Affairs, OMB, Room 3208,
The collection of information under promulgated thereunder, it is difficult to
New Executive Office Building,
proposed Rule 702(e) under Regulation quantify the costs and benefits that the
Washington, DC 20503; and (2)
MC would be mandatory and permit the proposed rules may create. These issues
Secretary, Securities and Exchange
Commission to collect accurate are discussed more fully below.
Commission, Station Place, 100 F Street,
information about the regulatory
NE., Washington, DC 20549–1090 with B. Security-Based Swap Clearing
program of SB SEFs and SBS exchanges.
reference to File No. S7–27–10. OMB is Agencies
Specifically, the collection of
required to make a decision concerning The Commission has granted
information would allow the
the collection of information between 30 exemptions from Section 17A of the
Commission to stay informed about the
and 60 days after publication, so a Exchange Act to five entities to act as
recommendations of the ROC that are
comment to OMB is best assured of clearing agencies for security-based
not followed by the SB SEF or SBS
having its full effect if OMB receives it swaps.204 The first cleared CDS
exchange and the SB SEF’s or SBS
within 30 days of publication. The transaction pursuant to the exemptive
exchange’s reasons for not adopting
Commission has submitted the orders was cleared on March 9, 2009.
such recommendations.
proposed collection of information to Security-based swap clearing is,
G. Responses to Collection of OMB for approval. Requests for the therefore, in an emergent stage and
Information Will Not Be Kept materials submitted to OMB by the empirical evidence on how the security-
Confidential Commission with regard to this based swaps market will develop
collection of information should be in following the effective date of the Dodd-
1. Security-Based Swap Clearing
writing, refer to File No. S7–27–10, and Frank Act and rules thereunder is
Agencies
be submitted to the Securities and scarce. However, the number of
Other than information for which a Exchange Commission, Office of security-based swap clearing agencies
security-based swap clearing agency Investor Education and Advocacy, may converge in the long run to a very
requests confidential treatment and Station Place, 100 F Street, NE., small number or even a single security-
which may be withheld from the public Washington, DC 20549–0213. based swap clearing agency.205 This is
in accordance with the provisions of 5
U.S.C. 522, the collection of information X. Cost-Benefit Analysis
203 The Commission pursuant to Section 36 of the
pursuant to the proposed Rules 701(a) Congress has required the Exchange Act may grant an exemption from any
and (b) would not be confidential and Commission to implement rules under rule or any provision of any rule under Regulation
MC. Any such exemption could be subject to
would be publicly available. Section 765 of the Dodd-Frank Act to

conditions and could be revoked by the
mitigate conflicts of interest in the Commission at any time. See supra Section VI for
2. SB SEFs, SBS Exchanges, and SBS security-based swaps market. The a discussion of the Commission’s exemptive
Exchange Facilities proposed rules under Regulation MC are authority under Section 36 of the Exchange Act.
Other than information for which a designed to enhance, through mitigation 204 See CDS Clearing Exemption Orders, supra
SB SEF, SBS exchange or SBS exchange of conflicts of interest, the benefits of note 17.
205 See, e.g., Darrell Duffie and Haoxiang Zhu,
facility requests confidential treatment having security-based swaps cleared ‘‘Does a Central Clearing Counterparty Reduce
and which may be withheld from the through a security-based swap clearing Counterparty Risk?’’ Stanford University Working
public in accordance with the agency and traded on a SB SEF or SBS Paper, March 2010; Craig Pirrong, 2009, ‘‘The
because of the potential for efficiency Another potential benefit of the clearing agency. However, non-
gains through convergence given that imposition of a limitation on voting participant shareholders may not face
central clearing of securities is interests is the chance that a broader the same potential of downside risk as
characterized by large fixed costs and group of participants would have the clearing agency participants. For
benefits to participants associated with ability to reduce their risk exposure as example, non-participant shareholders
consolidating portfolios. Alternatively, greater levels of central clearing is do not bear certain costs associated with
competitive forces may result in use of encouraged if the risks at the clearing increased risk since the clearing agency
a larger number of security-based swap agency are managed appropriately. losses are shared by the clearing agency
clearing agencies, particularly if the Clearing agencies decrease systemic risk participants. To the extent that non-
security-based swap clearing agencies by mutualizing losses 207 and netting participant shareholders use their
specialize in clearing particular types of otherwise bilateral obligations. There control to maximize revenues of the
security-based swaps or if they clear may, however, at times be a trade-off clearing agency without full
security-based swaps only in certain between a clearing agency’s risk consideration of the total clearing
jurisdictions.206 management and its participation agency risks, the potential cost is that
standards. It likely would be beneficial suboptimal clearing agency
1. Costs and Benefits Related to
if the voting restrictions proposed by participation standards will be
Ownership Restrictions in Security-
Rules 701(a) and (b) under Regulation developed. All directors have a
Based Swap Clearing Agencies
MC in each of the Voting Interest Focus fiduciary duty to the security-based
Restrictions on the voting interests Alternative and the Governance Focus swap clearing agency and its
held by clearing participants may affect Alternative lead to increased market shareholders, however, they also have a
the number of potential clearing participation. Conversely though, to the duty to oversee the security-based swap
participants and may also affect the extent that such market participation clearing agency’s compliance with the
level of their participation in clearing goes beyond prudent levels, it may requirements in the Exchange Act and
security-based swaps. The 20% create more systemic risk at the the rules and regulations thereunder. In
individual voting limitation on security- security-based swap clearing agency. certain circumstances, independent
based swap clearing agencies and the For example, lessening capital directors could give greater emphasis to
40% aggregate voting limitation on requirements to increase participation profit-maximizing initiatives and fail to
security-based swap clearing agencies, beyond a prudent level may increase the give sufficient consideration to the
under the proposed Voting Interest overall risk of clearing operations, while related risk management issues.
Focus Alternative, and the 5% increasing capital requirements for Another potential cost of ownership
individual voting limitation under the clearing members without an adequate and voting limitations, notwithstanding
Governance Focus Alternative, are basis may needlessly exclude some the fact that the market structure may
intended to keep participants from smaller dealers or other firms from converge in the long-run to a single
exercising undue influence over the participation and thereby create market security-based swap clearing agency, is
security-based swap clearing agency and inefficiencies.208 the potential effect on competition
to lessen the likelihood of anti- Non-participant shareholders may among alternative security-based swap
competitive behavior. One particular also have an incentive to permit more clearing agency venues. Under the
concern is that without a limitation on clearing agency participation than Voting Interest Focus Alternative, a 20%
voting interests, large dealers may clearing agency participant shareholders individual participant voting limit and
control a security-based swap clearing would. Non-participant shareholders a 40% aggregate participant voting limit
agency and set standards—such as a benefit from increased membership to restricts the ability of any single dealer
heightened capital threshold for the extent that additional revenues are or small group of dealers to own a
participation or a requirement that generated and therefore have an security-based swap clearing agency,
participants have execution incentive to promote increased use of but it may also reduce the potential
capabilities—to limit participation by central clearing both in terms of number number of investors that would be
non-owner dealers or brokers and of participants and the scope of willing to devote resources to form a
increase or protect their market share products cleared. This could potentially security-based swap clearing agency.
and potentially influence market prices. reduce systemic risk by making more This potentially diminishes the
Hence, a potential benefit of voting OTC products eligible for central likelihood for a long-term market
limitations may be the preservation of clearing. In addition, non-shareholder structure with multiple clearing
non-owner dealers’ access to central participants have an incentive to agencies. Conversely, the Governance
clearing and promotion of competition promote appropriate risk management Focus Alternative would not impose an
that results in lower costs to market because a financial loss to the clearing aggregate cap and would allow the
participants. The proposed limitations agency would devalue their investment. voting interests in a security-based swap
in both the Voting Interest Focus For example, security-based swap clearing agency to be owned entirely by
Alternative and the Governance Focus clearing agencies may put their own participants. This would facilitate the
Alternative are designed to achieve this capital or surplus funds at risk in the formation of security-based swap
result. event of a default. In addition, clearing clearing agencies by potential users and
agencies face reputational risk promote greater competition among
Economics of Clearing in Derivatives Markets:
associated with a member default that security-based swap clearing agencies.
Netting, Asymmetric Information, and the Sharing In addition, if a participant is subject

of Default Risks Through a Central Counterparty,’’ would likely negatively affect the value
to restrictions regarding the amount of
Working paper, University of Houston. of shareholders’ shares. This aligns the
206 The central clearing of security-based swaps is voting interest it may own in a security-
interests of shareholders with
still developing and the Commission has not made based swap clearing agency, then it may
appropriate risk management of a
any determinations about the number of security- forgo a potential investment
based swap clearing agencies that may be used by opportunity, unless it is willing to
207 See, e.g., Ice Trust Overview, p. 7 (available
market participants. However, it is important that
emerging security-based swap clearing agencies at https://www.theice.com/publicdocs/clear_us/ invest in non-voting shares of the
have the opportunity to compete with existing ICE_Trust_Overview.pdf). security-based swap clearing agency.
security-based swap clearing agencies. 208 See supra Section II.A.2.a. The effect of these restrictions is
different with respect to individual and security-based swap clearing markets, in which the dealers have a
participants under the Governance agencies collectively.211 significant financial stake.212 Products
Focus Alternative, which limits any one Under the Voting Interest Focus that are eligible for clearing that are not
participant’s voting interest in a Alternative, proposed Rule 701(a) in cleared do not have the price
security-based swap clearing agency to Regulation MC would require the transparency or investor accessibility
5%, than it is under the Voting Interest security-based swap clearing agency to that they would otherwise have,
Focus Alternative, which limits any one have rules requiring a participant to increasing market participant costs paid
participant’s voting interests to 20% and divest voting interest greater than the by investors. As a result, there are
has an aggregate voting interest limit of 20% threshold and rules reasonably potential incentives for security-based
40%. In the case of an ownership designed not to give effect to a voting swap clearing agency participants to
position in excess of regulator’s interest of a participant greater than the coordinate in ways that voting
restrictions, the owner would have to 20% threshold or voting interests of restrictions cannot address.
divest a portion of its voting shares in participants considered in the aggregate Representation by independent
order to meet the regulatory with any other participants greater than directors would provide views and
requirement. The potential foregone the 40% threshold. This proposed rule influence that by design are not subject
benefits include profits generated from would impose a cost on the security- to these conflicts.
clearing activities that are distributed to based swap clearing agency to initiate Proposed Rule 701(b)(3) in Regulation
owners as well as any private ownership the divestiture or not give effect to the MC of the Governance Focus Alternative
benefits from directing the clearing voting rights that surpass the stated would require that a majority of
operations, which include activities threshold. Particularly in the case of the directors must be independent. As a
discussed above with respect to aggregate participant voting limitation, result, participants could not directly
conflicts of interest. While it is difficult the security-based swap clearing agency control the Board regardless of their
to assess the value of these investment would have to develop standards voting interests. To further the goal of
opportunities, the 2010 six-month data regarding how to allocate the voting majority independence on the Board,
from consolidated reports of condition interest for which it will give effect if proposed Rule 701(b)(4) under
and income from the Federal Financial the aggregate voting interest is above the Regulation MC in the Governance Focus
Institutions Examinations Council of the 40 percent threshold. Alternative would require a security-
largest security-based swap clearing Similarly, under the Governance based swap clearing agency to establish
agency provides a snapshot of the Focus Alternative, proposed Rule 701(b) a nominating committee composed
magnitude of current profits being in Regulation MC would impose a cost solely of independent directors. Since
generated.209 on the security-based swap clearing many of the Board decisions come from
Moreover, as previously discussed in agency to require the divestiture or not committees and conflicts may be
the PRA section, proposed Rules 701(a) give effect to the voting rights that prevalent or even more pronounced in
and (b) under Regulation MC would surpass the stated threshold of 5 these situations, proposed Rule
require a security-based swap clearing percent. However, because there is not 701(b)(5) under Regulation MC in the
agency to have an effective mechanism a proposed limit on participants’ Governance Focus Alternative would
to obtain information relating to voting aggregate voting interests under the require that if any committee, including
interests in the security-based swap Governance Focus Alternative, the but not limited to a risk committee, has
clearing agency by any participant in security-based swap clearing agency authority to act on behalf of the Board,
the security-based swap clearing agency. would not have to adopt rules for that committee must also be composed
It was estimated that these obligations allocating voting interests in the case of of a majority of independent directors.
would result in a total annual burden a divestiture. This would help prevent important
for all security-based swap clearing 2. Costs and Benefits Related to decisions from escaping the view of a
agencies of 336 hours plus a total Independence Requirements for majority of independent directors. To
annual reporting and recordkeeping Security-Based Swap Clearing Agencies the extent that independent directors
burden for all participants of 336 hours. reduce the likelihood that one group of
It was also estimated that there would Potential conflicts of interest also participants coordinate decision-making
be a 90 hour one-time paperwork exist between participants of a security- in such a way that is detrimental to the
burden for security-based swap clearing based swap clearing agency and the security-based swap clearing agency as
agencies to establish rules to divest any public interest. Even when the influence a whole, it would serve to benefit the
ownership interest in excess of the limit of any single dealer is limited through security-based swap clearing agency and
and not to give effect to any portion of voting restrictions, economic incentives the market generally.
the voting interests in excess of the could align several dealer participants The Voting Interest Focus Alternative
limit. Assuming an hourly cost of $291 in a way that may be costly to investors. would require 35%, rather than a
for a compliance attorney 210 to meet For instance, in order for a product to majority, of the Board be composed of
these requirements, this would result in be required to trade through an SB SEF independent directors. While director
an overall estimated initial annual cost or SBS exchange, it must be deemed independence is widely believed to be
of $221,742 and an annual cost eligible for clearing at a clearing agency. a catalyst for improved governance,
thereafter of $195,552 for participants A dealer-controlled security-based swap there is no conclusive empirical
clearing agency may have an incentive evidence to support the view that a
209 ICE Trust’s profits for the first six months of to limit the products deemed eligible for majority of independent directors
2010 were $1,325,000, which would represent an clearing because then such a product benefits shareholder profits.213 It also is
annual profit of $2,650,000. FFIEC Central Data
Repository’s Public Data Distribution, https://
would remain viable in the OTC often argued that the presence of inside
cdr.ffiec.gov/public/Default.aspx.
210 The hourly rate for the compliance attorney is 211 Overall initial annual cost for participants and 212 See, generally, Darrell Duffie, ‘‘How Should
from SIFMA’s Management & Professional Earnings clearing agencies information requirements = (336 We Regulate Derivatives Markets?’’ Pew Financial
in the Securities Industry 2009, modified by the hours + 336 hours + 90 hours) × $291 = $221,742. Reform Project, Briefing Paper #5, 2009.
Commission’s staff to account for an 1,800-hour Overall subsequent annual cost for participants and 213 However, the Commission recognizes that the
work-year and multiplied by 5.35 to account for clearing agencies information requirements = (336 industry widely accepts a majority of independent
bonuses, firm size, employee benefits and overhead. hours + 336 hours) × $291 = $195,552. directors as ‘‘best practices.’’ See supra note 122.
affiliated board members is important in qualifications, of the persons serving on governing security-based swaps, which
facilitating the flow of material the Board. Independent directors that could slow Board processes at least
information to independent directors so take the time to understand the initially. These costs would be greater
that they may come to informed operations and programs of a security- under the Governance Focus
decisions.214 This may be especially based swap clearing agency and to ask Alternative, which requires a higher
important for a security-based swap probing questions of management are percentage of independent directors on
clearing agency because it provides more likely to be effective independent the Board and on the committees.
highly specialized and technical directors. However, independent The proposed governance
services. The imposition of a Board directors would unlikely be able to requirements could impose other costs
structure that precludes the likely acquire the specific risk management on security-based swap clearing
owners of a security-based swap expertise related to clearance and agencies. A security-based swap
clearing agency—dealers—from gaining settlement if they do not have relevant clearing agency may incur costs as a
a majority may have a negative effect on experience prior to serving on the result of the requirement to include
the operations of the security-based Board. In addition, because independent 35% or a majority of independent
swap clearing agency if independent directors would not be employed by or directors on its Board and a similar or
directors do not have commensurate participants in the security-based swap heightened requirement with respect to
qualifications or skills as participant clearing agency, they may often need to committees authorized to act on behalf
directors. There could be significant rely on management or other directors of the Board. Any such costs are likely
costs associated with educating to keep fully informed. There could be to be incurred in connection with
independent directors about the costs to the security-based swap clearing conducting a search for independent
clearance and settlement process and agency if one or more independent directors with the necessary
the complex risk management issues directors is ineffectual because he or she qualifications and expertise to serve on
that must be considered by the Board. did not fully understand the operations the Board of a security-based swap
This could slow the Board or committee or risk management procedures of the clearing agency. The actual cost for each
processes, at least initially. Clearing and security-based swap clearing agency. security-based swap clearing agency
settlement is a highly specialized area Thus, imperfect decisions by may vary based on the current
and it may be difficult to find independent directors could result in governance arrangements and practices
independent directors with relevant costs to the security-based swap clearing of the security-based swap clearing
experience. As a result, independent agency. This may potentially be more agencies. In addition, if a security-based
directors may defer to industry directors likely where the majority of the Board swap clearing agency is required to
or to the officials of the clearing agency, is required to be independent. On the conduct a search for independent
who have more knowledge and other hand, independent directors who directors, the costs incurred by the
experience, thereby undermining the have relevant expertise, are engaged in security-based swap clearing agency
benefits of requiring independence. carrying out their director duties, and may vary based on whether it has the
In the context of wholly independent who grasp the issues confronting the resources to conduct its own search or
committees, such as a nominating security-based swap clearing agency has to retain an outside consultant. The
committee, the independent directors could be very beneficial to the security- Commission preliminarily estimates
may become reliant on executive based swap clearing agency because that those security-based swap clearing
directors and other employees of the they could bring an outside perspective agencies that must rely on a recruitment
security-based swap clearing agency to specialist to secure an independent
and fresh insights and ideas to the
inform their decision-making due to director could incur a cost of
security-based swap clearing agency.
their lack of expertise in clearing and approximately $68,000 per director.215
settlement. If management fails to keep The proposed governance
the directors on wholly independent requirements under both the Voting C. SB SEFs and SBS Exchanges
committees fully informed, the Interest Focus Alternative and the Currently, there are no trading venues
independent directors on such Governance Focus Alternative could that are registered with the Commission
committees fail to seek sufficient impose other costs on security-based as SB SEFs, and no national securities
information from management to make swap clearing agencies. An entity that exchanges that currently post or make
informed decisions, or management fails plans to register as a security-based available for trading security-based
to give independent directors adequate swap clearing agency may need to revise swaps. Based on the Dodd-Frank Act’s
resources to make effective decisions, the composition of its Board if the Board definition, a SB SEF could include a
there could be costs to the security- currently is not composed of 35% or a trading platform with participating
based swap clearing agency. On the majority of independent directors. dealers.216 SB SEFs are conceptually
other hand, if management fully Moreover, security-based swap clearing
apprises the directors on wholly agencies may have to restructure their 215 The Commission is basing this estimate on a
independent committees of necessary nominating committees as well as other recent study noting that the retainer fee for outside
information and the independent committees that are authorized to act for directors is on average $67,624. See http://
the Board. In this regard, security-based www.hewittassociates.com/
directors have sufficient resources and _MetaBasicCMAssetCache_/Assets/Articles/2010/
are fully engaged with respect to their swap clearing agencies could face 2010_Outside_Director_Compensation.pdf. The
duties, there would be benefits to the difficulties locating qualified Commission believes that this amount could serve
security-based swap clearing agency. individuals to serve as independent as a proxy for the amount of any fee to be charged
directors, particularly because security- by a recruitment firm that would conduct a national
In addition, the effectiveness of the search for an independent director.
Board can depend on the personalities based swaps trading is complex and the 216 Section 763(c) of the Dodd-Frank Act sets
and personal traits, as well as the pool of qualified candidates may be forth 14 core principles that SB SEFs must satisfy
limited. There also may be costs in and provides the Commission with rulemaking
214 See M. Harris and A. Raviv, 2007, ‘‘A Theory
educating independent directors to authority with respect to implementation of these
of Board Control and Size,’’ The Journal of Finance; core principles. The Commission expects to address
R. Adams and D. Fererria, 2008, ‘‘A Theory of
become familiar with the manner in the issue of what is a SB SEF in a separate
Friendly Boards,’’ The Journal of Finance, vol. 62(1) which these security-based swaps are rulemaking under Section 763(c) of the Dodd-Frank
pp. 217–250. traded and the new regulatory structure Continued
similar to alternative trading systems often emerge.217 Hence, SB SEFs, SBS $291 for a compliance attorney,219 these
and national securities exchanges in the exchanges, and SBS exchange facilities requirements would result in an overall
equity and options markets and that are controlled by a single dealer annual cost per SB SEF, SBS exchange
designated contract markets in the may not necessarily result in unfair or SBS exchange facility of $4,365, or
futures markets in that they will provide trading practices if market participants $152,775 in the aggregate for all SB
a centralized trading facility for the have alternative comparable venues to SEFs, SBS exchanges, and SBS
trading of security-based swaps. To the execute the same security-based swaps exchange facilities.220
extent that SB SEFs would organize and and those venues are able to compete As previously discussed in the PRA
form in a similar manner to these effectively with single dealer platforms. section, proposed Rule 702(c) would
structures, the Commission Allowing SB SEFs, SBS exchanges and require SB SEFs, SBS exchanges, or SBS
preliminarily anticipates that SB SEFs SBS exchange facilities that are exchange facilities, as applicable, to
and SBS exchanges would be controlled by a single dealer may in fact have an effective mechanism to obtain
significantly more competitive than increase the level of competition, which information relating to ownership and
security-based swap clearing agencies. would benefit investors. A 20% voting interest in the SB SEF, SBS
In particular, barriers to entry in terms restriction on ownership of voting exchange, or SBS exchange facility, by
of capital are likely to be lower, and securities could require a dealer to any participant or member of the SB
many existing dealers, national partner with either other dealers or a SEF, SBS exchange or SBS exchange
securities exchanges and other entities non-dealer majority owner, or to hold a facility.221 It was estimated that these
of various sizes currently have non-voting ownership interest, which obligations would result in a total
electronic trading capabilities that could could reduce incentives to start up a annual burden for all SB SEFs, SBS
allow them to enter this market readily. new venue, potentially limiting exchanges, and SBS exchange facilities
innovative alternatives to security-based of 1,960 hours. It was also estimated
1. Costs and Benefits Related to swap execution and security-based that there would be a total annual
Ownership Requirements of SB SEFs swap products.218 reporting and recordkeeping burden for
and SBS Exchanges The Commission anticipates that the all participants or members of 2,800
The 20% ownership and voting limits proposed ownership and voting hours. Assuming an hourly cost of $291
contained in proposed Rule 702(b) limitations may impose costs on SB for a compliance attorney 222 to meet
under Regulation MC would prohibit SEFs, SBS exchanges and SBS exchange these requirements, this would result in
any SB SEF participant or SBS exchange facilities. Entities planning to register as an overall annual cost of $1,385,160 for
SB SEFs and SBS exchanges would have participants or members and SB SEFs,
member or small group thereof from
to ensure that they are in compliance SBS exchanges, and SBS exchange
owning or otherwise controlling any
with the proposed ownership and facilities collectively.223 To the extent
class of voting securities or other
voting limitations and thus would need that certain participants or members
interests of a SB SEF, SBS exchange or
to spend time and incur costs to design may be required to file ownership or
SBS exchange facility, as applicable.
or modify their ownership structure and voting information with a domestic or
The intent of this requirement, as with
internal processes, as well as take the international government authority
security-based swap clearing agencies,
necessary steps to draft or amend their pursuant to securities laws, and such
is to limit the influence of any single
governing documents and rules to information is made available to the SB
dealer or a small group of dealers in a
comply with such ownership and voting SEF, SBS exchange, or SBS exchange
single SB SEF, SBS exchange or SBS limitations. Designing or modifying facility, this cost would be reduced.
exchange facility and thus reduce the internal processes and drafting or Proposed Rule 702(c) under
likelihood that smaller non-owner revising governing documents and rules Regulation MC also would require a SB
dealers would be unfavorably treated would impose costs on SB SEFs, SBS SEF, SBS exchange or SBS exchange
and the ability of dealer-owners to exchanges and SBS exchange facilities. facility to have rules to divest a
influence market prices of security- The Commission estimates that it would participant or member of an ownership
based swaps. It is hard to predict, take a compliance attorney interest that violates the proposed
however, what entities will be SB SEFs approximately 15 hours to revise the ownership limits, and to not give effect
or SBS exchanges or whether there will relevant governing documents and to to a voting interest of a participant or
be any market power from owning or file them with the appropriate member that violates the proposed
controlling a SB SEF or SBS exchange authorities. Assuming an hourly cost of voting limits. As previously discussed
as discussed above. If the concern, as in the PRA section, this requirement is
with central clearing, is that a single SB 217 For example, there are currently 15 registered estimated to result in an initial
SEF or SBS exchange emerges as the national securities exchanges with varying paperwork burden for all SB SEFs, SBS
dominant trading platform, then platforms and business models that compete for
exchanges, or SBS exchange facilities of
ownership and voting restrictions may clients and order flow in the equities and/or options
markets. 525 hours. Assuming an hourly cost of
be an important consideration. For 218 As noted above, Section 763(c) of the Dodd- $291 for a compliance attorney 224 to
example, the NYSE was the dominant Frank Act sets forth 14 core principles that SB SEFs meet these requirements, this would
exchange for trading equity securities must satisfy, including one relating to conflicts of
for a long period, and even today U.S. interest, and provides the Commission with 219 See supra note 210.
rulemaking authority with respect to
futures markets are characterized by a implementation of these core principles. The
220 Overall annual cost per SB SEF, SBS
dominant exchange connected to a exchange, or SBS exchange facility = 15 hours ×
Commission may determine that it is appropriate to

$291 = $4,365; aggregate annual cost for all SB
single clearing agency. propose additional rules to mitigate conflicts of
SEFs, SBS exchanges, and SBS exchange facilities
interest with respect to SB SEFs, including
However, evidence from the current incorporating ownership and/or voting limits and = $4,365 × 35 = $152,775.
cash equity and options markets shows other requirements with respect to ownership of a
221 See supra Section IX.
that several trading platforms with SB SEF by persons other than SB SEF participants.
223 Overall annual cost for participants or
different business models and clienteles The Commission also may consider proposals such
as providing for the fair representation of SB SEF members and SB SEFs, SBS exchanges and SBS
participants in the selection of the SB SEF’s exchange facilities = (1,960 hours + 2,800 hours) ×
Act. See Section 763(c) of the Dodd-Frank Act, directors and the administration of its affairs as part $291 = $1,385,160.
Public Law 111–203, Section 763(c). of its broader rulemaking relating to SB SEFs. 224 See supra note 210.
result in an initial cost of $152,775 for limitations. Based on these factors, the independent and not likely to be unduly
all SB SEFs, SBS exchanges, and SBS Commission preliminarily believes that influenced by an owner of the SB SEF,
exchange facilities.225 the aggregate costs imposed by the SBS exchange or SBS exchange facility
This proposed rule also would impose ownership and voting limitations on who is possibly a SB SEF participant-
costs on SB SEFs, SBS exchanges, or entities initially seeking to register as SB dealer or SBS exchange member or
SBS exchange facilities to initiate the SEFs, SBS exchanges or SBS exchange affiliate thereof. In addition, the
divestiture or not give effect to the facilities would not be significant. requirement in proposed Rule 702(g)
voting rights that surpass the stated under Regulation MC that any
threshold. For example, a SB SEF, SBS 2. Costs and Benefits Related to
Independence Requirements in SB SEFs committee that would have the
exchange, or SBS exchange facility authority to act on behalf of the Board
could incur costs involved with and SBS Exchanges
be composed of a majority of
redeeming shares held in excess of the Proposed Rule 702(d) under independent directors is designed to
proposed limits if such entity chooses to Regulation MC would require the prevent important decisions from
provide in its rules that any such excess Boards of SB SEFs and SBS exchanges escaping the view of a majority of
shares would be purchased by the or SBS exchange facilities to be independent directors. Many Board
entity. A SB SEF, SBS exchange, or SBS composed of at least a majority of decisions come from committees and
exchange facility also could adopt rules independent directors to mitigate conflicts may be similarly prevalent or
to limit voting by any participant or conflicts of interest and help ensure that even more pronounced in these
member that owns more than 20% of the entity does not advance the interests situations.
outstanding interests. Thus, a SB SEF, of its owners, some of which may be Proposed Rule 702(e) under
SBS exchange, or SBS exchange facility dealer-participants or their affiliates. By Regulation MC also would require the
also could incur costs associated with mandating a structure that would Board of any SB SEF and SBS exchange
monitoring votes cast at any shareholder require a majority of Board members to to establish a ROC consisting solely of
meeting to determine that no SB SEF be independent, the governance of SB independent directors to oversee the
participant or SBS exchange member SEFs, SBS exchanges and SBS exchange entity’s regulatory obligations.226 The
and its related persons subject to the facilities should be less susceptible to Commission preliminarily believes that
voting limits exceeds those limits. promoting the self-interests of such this requirement should be effective in
The Commission recognizes that participants. The majority independent managing the conflicts of interest
entities that are currently in existence directors should help foster a greater
inherent in the Board’s oversight of
and plan to become SB SEFs, SBS degree of independent decision-making
whether a SB SEF or SBS exchange
exchanges or SBS exchange facilities consistent with the objectives of the
satisfies its regulatory obligations. The
could incur costs if they do not meet the Dodd-Frank Act and the Exchange Act.
proposed provision relating to the
proposed ownership and voting Further, a Board whose independent
establishment of an independent ROC
limitations. For example, if a single or directors constitute at least a majority of
should help promote greater
small group of market participants that the Board should help ensure that the
accountability on the part of SB SEFs
would be direct participant(s) in a SB views of independent directors are
and SBS exchanges with respect to the
SEF plans to register a platform as a SB taken into account and should help
obligations placed on them by the
SEF, it or they potentially would need strengthen the hand of independent
directors when dealing with Exchange Act, including as amended by
to secure additional owners to meet the
management. In the Commission’s the Dodd-Frank Act, and strengthen
20% limitation on ownership of voting
preliminary view, requiring the Boards their ability to meet those obligations. A
securities of a SB SEF. This could
of SB SEFs, SBS exchanges and SBS ROC composed solely of independent
impose costs on an entity that has a
exchange facilities to have a majority of directors should result in a greater
single owner-participant or a small
independent directors should help degree of objective decision-making
number of owner-participants and that
reduce the possibility of damaging with respect to the SB SEF’s or SBS
plans to register a platform as a SB SEF,
conflicts of interest that otherwise might exchange’s regulatory obligations.
from the costs of finding other owners
arise when persons who do not meet the Vigilant and informed oversight by a
or the sharing of potential profits with
definition of independent director at the strong, effective and independent ROC
a larger group of owners. As noted
SB SEF, SBS exchange or SBS exchange may increase investor confidence in the
above, currently there are no trading
facility are involved in key decisions, operation of SB SEFs and SBS
venues that are registered with the
such as which products will be made exchanges, and the security-based
Commission as SB SEFs. Based on
available for trading and the access swaps market generally. National
initial discussions with market
levels of potential market participants. securities exchanges that currently have
participants that have indicated an
To the extent that independent directors a ROC composed of independent
interest in registering as a SB SEF, the
would reduce the likelihood that one directors have noted the benefits of such
Commission preliminarily believes that
group of participants could coordinate a governance mechanism.227 In
few entities that may register as a SB
SEF currently have ownership decision-making in such a way that 226 Proposed Rule 702(e) under Regulation MC
structures that would conflict with the would be detrimental to the SB SEF, does not explicitly include SBS exchange facilities
proposed ownership and voting SBS exchange or SBS exchange facility because the exchange whose facility posts or makes
limitations for SB SEFs. In addition, as as a whole, this would be a benefit. available for trading a security-based swap must
discussed above, national securities In addition, proposed Rule 702(f) itself establish the requisite ROC. See supra note
under Regulation MC would require that 173.
exchanges that may potentially register 227 See CBOE Comment Letter, supra note 165
as SBS exchanges or create a facility that the nominating committee of a SB SEF, (‘‘CBOE also implemented other changes that are
will be a SBS exchange facility should SBS exchange or SBS exchange facility similar to the proposals contained in the Release,
already be in compliance with the be composed solely of independent for example establishing a Regulatory Oversight
directors. This proposed requirement Committee, composed solely of public directors
proposed ownership and voting * * *. As a result, CBOE believes that its existing
should foster a process for nominating governance structure and practices serve not only
225 This initial cost is estimated as follows: 15 independent directors that would help to protect investors and the public interest and
hours × 35 respondents × $291 per hour = $152,775. to assure that such directors are Continued
addition, requiring the Board to report important role of independent can undertake the search on their own
promptly to the Commission any directors.229 but would incur some expenditures,
recommendation of the ROC that the The proposed governance such as placing advertisements in
Board does not implement should requirements could impose costs on SB national media; to a higher cost for
provide the Commission with SEFs, SBS exchanges and SBS exchange those entities that must secure the
information on a timely basis regarding facilities. Entities planning to register as services of a recruitment firm that
the Board’s decision not to take certain SB SEFs and SBS exchanges may need specializes in the placement of
actions. to draft or amend their governing independent directors. The Commission
The governance proposals for SB documents and design or modify their preliminarily estimates that those SB
SEFs, SBS exchanges and SBS exchange governance processes to comply with SEFs, SBS exchanges or SBS exchange
facilities would complement the the proposed governance requirements, facilities that must rely on a recruitment
proposed ownership and voting limits which would impose costs on SB SEFs, specialist to secure an independent
for these entities. Five or more dealer- SBS exchanges and SBS exchange director could incur a cost of
participants or members could still own facilities. The Commission estimates approximately $68,000 per director.231
100% of the voting securities of a SB that it would take a compliance attorney The Commission preliminarily
SEF, SBS exchange or SBS exchange approximately 15 hours to revise the estimates that 10–20 entities could seek
facility, as applicable, under the relevant governing documents and to to register as SB SEFs and notes that
proposed voting and ownership limits. file them with the appropriate there are 15 national securities
In addition, even when the influence of authorities, for a total estimated cost per exchanges; however, the number of
any single dealer is limited through SB SEF, SBS exchange or SBS exchange Board members could vary widely
ownership and voting restrictions, facility of $4,365, or $152,775 in the among SB SEFs, SBS exchanges and
economic incentives can align several aggregate for all SB SEFs or SBS SBS exchange facilities. Therefore, the
dealer participants in a way that may be exchanges, and SBS exchange Commission provides an estimate of a
costly to investors. As a result, there are facilities.230 maximum recruitment cost of $68,000
potential incentives for SB SEF An entity that plans to register as a SB per independent director.232
participant-dealers and SBS exchange SEF or a SBS exchange may need to The imposition of a Board structure
member-dealers to coordinate in ways revise the composition of its Board (or that precludes the likely participants in
that ownership and voting restrictions that of its SBS exchange facility, in the SB SEFs, SBS exchanges or SBS
could not address. Requiring case of an exchange that posts or makes exchange facilities—dealers—from
independence on the Board and certain available for trading security-based gaining a majority or having
key Board committees should further swaps through a facility with a separate representation on certain Board
reduce the ability of the participant- governance structure), if the Board committees may have a negative effect
owners of the SB SEF or member- currently is not composed of a majority on the operations of the SB SEF, SBS
owners of the SBS exchange or SBS of independent directors. SB SEFs and exchange or SBS exchange facility if
exchange facility to unduly influence SBS exchanges or SBS exchange independent directors do not have
decision-making at the Board level in a facilities also would need to establish commensurate qualifications or skills as
way that advances their interests. wholly independent nominating affiliated directors or do not engage
Representation by independent committees, and SB SEFs and SBS actively in their Board or committee
directors would provide views and exchanges would need to establish duties. There could be costs in
influence that by design are not subject educating independent directors to
wholly independent ROCs. In this
to these conflicts. become familiar with the manner in
regard, SB SEFs, SBS exchanges and
As noted in the discussion relating to which security-based swaps are traded
security-based swap clearing agencies, SBS exchange facilities could face
difficulties in locating qualified and in the new regulatory structure that
while director independence is widely would govern them, which could slow
believed to be a catalyst for improved individuals to serve as independent
directors, particularly because security- Board or committee processes at least
governance and the Commission initially. In addition, independent
recognizes that the industry widely based swaps trading is complex and
some potential candidates may decline directors may yield to industry directors
accepts a majority of independent who have more knowledge and
directors as ‘‘best practices,’’ 228 there is to serve as a director if they believe that
they lack sufficient expertise. experience, thereby undermining the
no conclusive empirical evidence to benefits of requiring independence. In
support the view that a majority of The Commission preliminarily
believes that the cost of securing the context of wholly independent
independent directors benefits committees, such as a nominating
shareholder profits. However, the Model independent directors to serve on the
Business Corporation Act recognizes the Board of the SB SEF, SBS exchange or
231 The Commission is basing this estimate on a
SBS exchange facility could range from
recent study noting that the retainer fee for outside
assure the integrity of CBOE’s regulatory activities, a relatively low cost for those entities directors is on average $67,624. See http://
but also to enhance the ability of CBOE to develop that have the contacts and resources to www.hewittassociates.com/
and implement sound business strategies’’); NYSE be able to search for one or more _MetaBasicCMAssetCache_/Assets/Articles/2010/
Comment Letter, supra note 165 (‘‘As an important independent directors on their own; to 2010_Outside_Director_Compensation.pdf. The
part of the reform process of 2003, the NYSE Commission believes that this amount could serve
formalized the effective functional separation of a moderate cost for those entities that as a proxy for the amount of any fee to be charged
regulatory programs from the competitive business by a recruitment firm that would conduct a national
functions, under a Chief Regulatory Officer (‘‘CRO’’) 229 MODEL BUS. CORP. ACT § 8.01(c) (4th ed. search for an independent director.
reporting to a Regulatory Oversight Committee 2008). 232 As discussed above, since 2004 when the
(‘‘ROC’’) of the Board of Directors consisting of all 230 Assuming an hourly cost of $291 for a Commission proposed rules to promote the fair
independent directors * * *. We agree with the compliance attorney, the overall annual cost per SB administration and governance of, and to impose
Commission that this structure, with a separate SEF, SBS exchange or SBS exchange facility and ownership and voting limitations on, national
regulatory executive reporting to an empowered, aggregate cost for all SB SEFs, SBS exchanges, and securities exchanges, a number of exchanges have
qualified and independent board, amply funded SBS exchange facilities was calculated as follows: adopted governance structures which meet many of
and professionally staffed, assures the integrity of per entity annual cost = 15 hours × $291 = $4,365; the requirements of proposed Rule 702. Thus, the
the regulatory process.’’) aggregate annual cost = $4,365 × 35 = $152,775. See costs for complying with the proposed governance
228 See supra note 122. supra note 210. rules would be decreased for some SBS exchanges.
committee or ROC, the independent SB SEF, SBS exchange or SBS exchange Exchange Act 236 requires the
directors may become reliant on facility because they could bring fresh Commission, when adopting rules
executive officers and other employees insights and ideas to these entities. under the Exchange Act, to consider the
of the SB SEF or SBS exchange to Finally, under the proposed Rule effect such rules would have on
inform their decision-making due to 702(e)(2) under Regulation MC, SB SEFs competition. Section 23(a)(2) of the
their lack of expertise in the industry. If and SBS exchanges would need to Exchange Act also prohibits the
management fails to keep the directors report promptly to the Commission any Commission from adopting any rule that
on wholly independent committees recommendation of the ROC that the would impose a burden on competition
fully-informed, if the independent Board does not adopt or implement, not necessary or appropriate in
directors on such committees fail to which would result in costs to SB SEFs furtherance of the purposes of the
seek sufficient information from and SBS exchanges. As discussed above, Exchange Act.
management to make informed the Commission preliminarily estimates Security-based swaps are currently
decisions or if management fails to give that the annual information collection executed and traded in the OTC market,
independent directors adequate burden for each SB SEF or SBS with five large commercial banks
resources to make effective decisions, exchange under this provision of the representing 97% of the total U.S.
there could be costs to the SB SEF, SBS proposed rules would be 12 hours.233 banking industry national amounts
exchange or SBS exchange facility. On Accordingly, the Commission’s staff outstanding of derivatives.237 The gross
the other hand, if management fully estimates that it would cost each SB SEF notional amount of CDS as of the end
apprises the directors on wholly or SBS exchange $3,492 annually to of 2009 was approximately $30
independent committees of necessary comply with this provision of the trillion.238
information and the independent proposed rules.234 As discussed above, the Commission
directors have sufficient resources and has granted exemptions to five entities
are fully engaged with respect to their D. Request for Comments to act as security-based swap clearing
duties, there would be benefits to the SB The Commission requests that agencies for CDS.239 Four of the
SEF, SBS exchange or SBS exchange commenters provide views and exemptions are currently active. SB
facility. supporting information regarding the SEFs and SBS exchanges are expected to
costs and benefits associated with the register to trade security-based swaps in
In addition, the effectiveness of
proposals. The Commission seeks connection with the implementation of
majority independent Boards can
estimates of these costs and benefits, as rules under Title VII of the Dodd-Frank
depend on the personalities and
well as any costs and benefits not Act.
personal traits, as well as the As discussed above, the intent of the
qualifications, of the persons serving on already identified. The Commission also
ownership and voting limitations and
the Board. Independent directors that requests comment regarding the relative
governance proposed rules is to mitigate
take the time to understand the costs and benefits of pursuing
potential conflicts of interests of market
operations and programs of a SB SEF, alternative regulatory approaches that
participants in the clearing and trading
SBS exchange or SBS exchange facility are consistent with Section 765 of the
of security-based swaps. These
and to ask probing questions of Dodd-Frank Act. In addition, the
proposed rules may have a significant
management are more likely to be Commission requests comment on
effect on the level of competition within
effective independent directors. whether other provisions of the Dodd-
the marketplace.
However, because independent Frank Act for which Commission The voting restrictions on security-
directors would not be employed by the rulemaking is required are likely to have based swap clearing agencies that limit
SB SEF, SBS exchange, or SBS exchange an effect on the costs and benefits of the the influence of any single participant
facility or be participants or members of proposed rules. or group of participants could increase
such entity, they often may need to rely XI. Consideration of Burden on the level of competition at the
on management or other directors to Competition, and Promotion of participant level if they preserve access
keep them fully informed. There could Efficiency, Competition, and Capital to central clearing and trading by other
be costs to the SB SEF, SBS exchange, Formation participants. Without these voting
or SBS exchange facility if one or more restrictions, it may be possible for a
independent directors is ineffectual Section 3(f) of the Exchange Act 235 dominant participant owner to use its
because he or she did not fully requires the Commission, whenever it voting interest to set rules, fees, or
understand the operations of the SB SEF engages in rulemaking and is required to capital requirements that engender an
or SBS exchange, either because the consider or determine whether an action uncompetitive environment. For
independent directors did not take the is necessary or appropriate in the public instance, a heightened capital threshold
necessary initiative or management interest, to consider, in addition to the for participation might prevent some
failed to keep the independent directors protection of investors, whether the firms from qualifying as participants
fully apprised of information that would action would promote efficiency, and thus deny them access to clearing.
lead to their effective decision-making. competition, and capital formation. In However, the proposed voting
Thus, imperfect decisions by addition, Section 23(a)(2) of the limitations among participants may also
independent directors could result in impede competition at the security-
costs to the SB SEF, SBS exchange, or 233 See supra Section IX.D.
based swap clearing agency level, since
SBS exchange facility. On the other 234 12 hours (estimated annual information
hand, independent directors who have collection burden for each SB SEF and SBS
236 15 U.S.C. 78w(a)(2).
exchange) × $291 (hourly cost for a compliance
expertise in areas that could be helpful attorney) = $3,492. The hourly rate for the 237 See Office of the Comptroller of the Currency,
to the SB SEF, SBS exchange or SBS compliance attorney is from SIFMA’s Management Quarterly Report on Bank Trading and Derivatives
exchange facility, who are engaged in & Professional Earnings in the Securities Industry Activities, First Quarter 2010.
carrying out their director duties, and 2009, modified by the Commission’s staff to 238 Data available at http://www.isda.org/
account for an 1,800-hour work-year and multiplied statistics/pdf/ISDA-Market-Survey-results1987-

who grasp the issues confronting the SB by 5.35 to account for bonuses, firm size, employee present.xls.
SEF, SBS exchange or SBS exchange benefits and overhead. 239 See CDS Clearing Exemption Orders, supra
facility could be very beneficial to the 235 15 U.S.C. 78c(f). note 17.
there are likely a limited number of facility, or for an existing national rules under Regulation MC on
firms with the expertise, resources and securities exchange to post or make efficiency, competition, and capital
desire to have an ownership interest in available for trading security-based formation. The Commission requests
a security-based swap clearing swaps, will be low. If a SB SEF, SBS that commenters provide views and
agency.240 exchange or SBS exchange facility supporting information regarding any
As previously noted, evidence from would not provide the desired level of such effects. The Commission notes that
the securities markets suggests that access to a market participant, and the such effects are difficult to quantify. The
clearing agencies over the long-run tend start-up costs of setting up a competing Commission seeks comment on possible
to converge to a small number of entities SB SEF, SBS exchange or SBS exchange anti-competitive effects of the proposed
or even a single entity. Clearing facility are low, then this would rules under Regulation MC not already
activities are characterized by high start- encourage the entrance of alternate identified. The Commission also
up costs and low marginal costs such trading venues for market participants requests comment regarding the
that there are large economies of scale. and allow competition to discipline competitive effects of pursuing
For example, all trades executed on the harmful practices by any single SB SEF, alternative regulatory approaches that
eight U.S. based options exchanges are SBS exchange, or SBS exchange facility. are consistent with Section 765 of the
cleared at the Options Clearing However, if ownership restrictions are Dodd-Frank Act. In addition, the
Corporation, and trades executed on the such that dealers must coordinate Commission requests comment on how
U.S. equity markets, composed of ownership among a group, then there the other provisions of the Dodd-Frank
exchanges, alternative trading platforms, may be fewer potential owners Act for which Commission rulemaking
and OTC trading, are cleared at the available, and thus there could be less is required will interact with and
National Securities Clearing incentive to form competing SB SEFs, influence the competitive effects of the
Corporation, a wholly-owned subsidiary SBS exchanges, or SBS exchange proposed rules under Regulation MC.
of the Depository Trust and Clearing facilities. In this case, ownership
Corporation.241 A single security-based limitations would impede XII. Consideration of Impact on the
swap clearing agency may also be more competition.242 Economy
efficient in that it would facilitate the The proposed rules under Regulation
For purposes of the Small Business
fungibility of contracts across multiple MC relating to Board and committee
Regulatory Enforcement Fairness Act of
execution facilities and exchanges. independence may also increase the
1996, or ‘‘SBREFA,’’ 243 the Commission
Whether the differences in the Voting level of participant competition by
making it more difficult for a small must advise the OMB as to whether
Interest Focus Alternative and the proposed Regulation MC and the rules
Governance Focus Alternative would group of dealer-owners to influence a
security-based swap clearing agency, SB proposed thereunder constitute a
result in substantially different effects ‘‘major’’ rule. Under SBREFA, a rule is
on efficiency, capital formation, and SEF or SBS exchange even in light of
the proposed ownership and voting considered ‘‘major’’ where, if adopted, it
competition remains uncertain. results or is likely to result in: (1) An
Preliminarily, the Commission believes restrictions. This is necessary because
economic incentives could align the annual effect on the economy of $100
that the aggregate cap on participant million or more (either in the form of an
voting interests may limit the formation interests of participants against the
interest of the security-based swap increase or a decrease); (2) a major
of new clearing agencies and, increase in costs or prices for consumers
consequently, limit the opportunity for clearing agency, SB SEF or SBS
exchange as a whole irrespective of or individual industries; or (3)
competition among security-based swap significant adverse effect on
clearing agencies. However, the whether those participants are owners.
For example, if the Board of a dealer- competition, investment or innovation.
aggregate cap under the Voting Interest
Focus Alternative may also be more controlled security-based swap clearing The Commission requests comment
effective at mitigating conflicts of agency determines to refuse to clear a on the potential impact of proposed
interest than the rules proposed under proposed security-based swap product, Regulation MC and the rules proposed
the Governance Focus Alternative, and then such a product would not be thereunder on the economy on an
could result in greater access to central required to be traded on a SB SEF or annual basis. Commenters are requested
clearing and a higher volume of SBS exchange and would likely trade to provide empirical data and other
security-based swap products made OTC, reducing price transparency and factual support for their view to the
eligible for clearing. As discussed likely resulting in higher revenue for the extent possible.
previously, central clearing would dealers in the OTC market than if the
product was available through a SB SEF, XIII. Regulatory Flexibility Act
facilitate improved transparency, risk Certification
management, and competition in the SBS exchange or SBS exchange facility.
security-based swaps market. This in Majority independence requirements for Section 603(a) of the Regulatory
turn should have a positive effect on the Board and committees that have the Flexibility Act 244 (‘‘RFA’’) requires the
efficiency, capital formation, and authority to act on behalf of the Board Commission to undertake an initial
are an additional tool to address this regulatory flexibility analysis of the
competition.
The Commission preliminarily potential conflict of interest. Given the proposed rules under Regulation MC on
believes that the start-up costs for a SB size of the security-based swaps market small entities, unless the Commission
SEF, SBS exchange or SBS exchange and its non-competitive tendencies, the certifies that the proposed rules, if
benefits with respect to efficiency and adopted, would not have a significant
240 The Commission pursuant to Section 36 of the competition that ownership, voting, and economic impact on a substantial
Exchange Act may grant an exemption from any director representation requirements number of small entities.245
rule or any provision of any rule under Regulation would provide are likely to be
MC. See supra Section VI. substantial.
241 The central clearing of security-based swaps is 243 Public Law 104–121, Title II, 110 Stat. 857
The Commission requests comment (1996) (codified in various sections of 5 U.S.C., 15
still developing and the Commission has not made
any determinations about the number of security- on the possible effects of the proposed U.S.C. and as a note to 5 U.S.C. 601).
244 5 U.S.C. 603(a).
based swap clearing agencies that may be used by
market participants. 242 See supra note 240. 245 5 U.S.C. 605(b).
A. Security-Based Swap Clearing C. SBS Exchanges PART 242—REGULATIONS M, SHO,

Agencies ATS, AC, NMS, AND MC AND
Proposed Rule 702 under Regulation
CUSTOMER MARGIN REQUIREMENTS
Proposed Rule 701 under Regulation MC would apply to all SBS exchanges.
FOR SECURITY FUTURES
MC would apply to all security-based All of the 15 currently registered
swap clearing agencies. Four entities are national securities exchanges could 1. The authority citation for part 242
currently exempt from registration as a become SBS exchanges, and therefore, is amended by adding authorities for
clearing agency under section 17A of subject to the requirements of Rule Sections 242.700, 242.701 and 242.702
the Exchange Act to provide central 702.251 to read as follows:
clearing services for CDS, a class of For purposes of Commission Authority: 15 U.S.C. 77g, 77q(a), 77s(a),
security-based swaps.246 The rulemaking in connection with the RFA, 78b, 78c, 78f, 78g(c)(2), 78i(a), 78j, 78k–1(c),
Commission believes, based on its a national securities exchange is a small 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 78q–1,
understanding of the market, that likely business if it has been exempted from 78q(a), 78q(h), 78w(a), 78dd–1, 78mm, 80a–
no more than six security-based swap the reporting requirements of Rule 601 23, 80a–29, and 80a–37.
clearing agencies could be subject to the of Regulation NMS 252 (Dissemination of * * * * *
requirements of proposed Rule 701. Transaction Reports and Last Sale Data Section 242.700 is also issued under sec.
with Respect to Transactions in NMS 943, Public Law 111–203, Section 765.
For purposes of Commission Section 242.701 is also issued under sec.
rulemaking in connection with the RFA, Stocks) and is not affiliated with any
943, Public Law 111–203, Section 765.
an issuer or person, other than an person (other than a natural person) that Section 242.702 is also issued under sec.
investment company, is a small is not a ‘‘small business.’’ 253 None of the 943, Public Law 111–203, Sections 763 and
business if its total assets on the last day currently registered national securities 765.
of its most recent fiscal year were $5 exchanges is a small entity. Therefore,
the Commission preliminarily believes 2. The part heading for part 242 is
million or less.247 The Commission revised to read as set forth above.
believes that the entities likely to that none of the SBS exchanges will be
considered small entities. 3. Sections 242.700, 242.701 and
register as security-based swap clearing 242.702 are added to read as follows:
agencies will not be small entities, but D. Certification
rather part of large business entities that § 242.700 Definitions.
have assets in excess of $5 million and For the reasons stated above, the (a) The term affiliate means any
total capital in excess of $500,000.248 Commission certifies that the proposed person that, directly or indirectly,
rules under Regulation MC would not controls, is controlled by, or is under
B. SB SEFs have a significant economic impact on common control with, the person.
a substantial number of small entities. (b) The terms beneficial ownership,
Proposed Rule 702 under Regulation The Commission requests comments
MC would apply to all SB SEFs. In the beneficially owns or any derivative
regarding this certification. The thereof shall have the same meaning,
Dodd-Frank Act, Congress defined for Commission requests that commenters
the first time what activity would with respect to any security or other
describe the nature of any impact on ownership interest, as set forth in
constitute a SB SEF and mandated the small entities, including national
registration of these new facilities. The § 240.13d–3, as if (and whether or not)
securities exchanges, clearing agencies such security or other ownership
Commission preliminarily believes that or other small businesses or small
approximately 10 to 20 SB SEFs could interest were a voting equity security
organizations that may register as SB registered under section 12 of the
be subject to the requirements of SEFs, SBS exchanges or security-based
proposed Rule 702. Exchange Act (15 U.S.C. 78l); provided
swap clearing agencies, and provide that to the extent any person
For purposes of Commission empirical data to support the extent of beneficially owns any security or other
rulemaking in connection with the RFA, the impact. ownership interest solely because such
an issuer or person, other than an XIV. Statutory Basis and Rule Text person is a member of a group within
investment company, is a small the meaning of section 13(d)(3) of the
business if its total assets on the last day Pursuant to the Exchange Act, 15 Exchange Act (15 U.S.C. 78m(d)(3)),
of its most recent fiscal year were $5 U.S.C. 78a et seq., and particularly, such person shall not be deemed to
million or less.249 The Commission Sections 3, 3D, 6, 11A, 17A, 19, and beneficially own such security or other
preliminarily believes that the entities 23(a) thereof, and Section 765 of the ownership interest for purposes of this
likely to register as SB SEFs will not be Dodd-Frank Act, the Commission is section, unless such person has the
considered small entities because most, proposing to adopt Regulation MC power to direct the vote of such security
if not all, of the SB SEFs will be part of under the Exchange Act. or other ownership interest.
large business entities, and that all SB (c) The term Board means the Board
List of Subjects in 17 CFR Part 242
SEFs will have assets in excess of $5 of Directors or Board of Governors of the
million.250 Reporting and recordkeeping security-based swap execution facility
requirements, Securities. or national securities exchange or
246 See CDS Clearing Exemptions, supra note 17. facility thereof that posts or makes
Text of Proposed Rule Amendments
247 17 CFR 230.157. See also 17 CFR 240.0–10(a). available for trading security-based
248 Commission staff based this determination on
For the reasons stated in the swaps, or security-based swap clearing

its review of various public sources of financial
information about the current registered clearing preamble, the Commission is proposing agency, as applicable, or any equivalent
agencies and entities currently exempt from to amend Title 17, Chapter II of the body.
clearing agency registration under Section 17A of Code of the Federal Regulations as (d) The term clearing agency has the
the Exchange Act. follows: same meaning as set forth in section
249 17 CFR 230.157. See also 17 CFR 240.0–10(a).
250 Commission staff based this determination on
3(a)(23) of the Exchange Act (15 U.S.C.
its review of various public sources of financial
251 See supra note 194. 78c(a)(23)).
information about the entities likely to register as 252 17 CFR 242.601. (e) The term control means the
SB SEFs. 253 17 CFR 240.0–10(e). possession, direct or indirect, of the
power to direct or cause the direction of facility or national securities exchange for trading security-based swaps, or a
the management and policies of a or facility thereof that posts or makes participant in the security-based swap
person, whether through the ownership available for trading security-based clearing agency, as applicable, or any
of voting securities, by contract, or swaps, or security-based swap clearing affiliate thereof; or
otherwise. A person is presumed to agency, as applicable, or any affiliate (C) Pension and other forms of
control another person if the person: thereof, or within the past three years deferred compensation for prior
(1) Is a director, general partner or was employed by or otherwise had a services, not contingent on continued
officer exercising executive material relationship with the security- service.
responsibility (or having similar status based swap execution facility or (iv) The director, or an immediate
or functions); national securities exchange or facility family member, is a partner in, or
(2) Directly or indirectly has the right thereof that posts or makes available for controlling shareholder or executive
to vote 25 percent or more of a class of trading security-based swaps, or officer of, any organization to or from
voting securities or has the power to sell security-based swap clearing agency, as which the security-based swap
or direct the sale of 25 percent or more applicable, or any affiliate thereof; execution facility or national securities
of a class of voting securities; or (ii) (A) The director is a security- exchange or facility thereof that posts or
(3) In the case of a partnership, has based swap execution facility makes available for trading security-
the right to receive, upon dissolution, or participant, a member of a national based swaps, or security-based swap
has contributed, 25 percent or more of securities exchange that posts or makes clearing agency, as applicable, or any
the capital. available for trading security-based affiliate thereof made or received
(f) The term director means any swaps, or a participant in the security- payments for property or services in the
member of the Board. based swap clearing agency, as current or any of the past three full
(g) The term Exchange Act means the applicable, or within the past three fiscal years that exceed two percent of
Securities Exchange Act of 1934 (15 years was employed by or affiliated with the recipient’s consolidated gross
U.S.C. 78a et seq.). such participant or member or any revenues for that year, other than the
(h) The term facility has the same affiliate thereof; or following:
meaning as set forth in section 3(a)(2) of (B) The director has an immediate (A) Payments arising solely from
the Exchange Act (15 U.S.C. 78c(a)(2)). family member that is, or within the investments in the securities of the
(i) The term immediate family past three years was, an executive security-based swap execution facility
member means a person’s spouse, officer of a security-based swap or national securities exchange or
parents, children and siblings, whether execution facility participant, a member facility thereof that posts or makes
by blood, marriage or adoption, or of a national securities exchange that available for trading security-based
anyone residing in such person’s home. posts or makes available for trading swaps, or security-based swap clearing
(j) The term independent director security-based swaps, or a participant in agency, as applicable, or affiliate
means: the security-based swap clearing agency, thereof; or
(1) A director who has no material as applicable, or any affiliate thereof; (B) Payments under non-discretionary
relationship with: (iii) The director, or an immediate charitable contribution matching
(i) The security-based swap execution family member, has received during any programs.
facility or national securities exchange twelve month period within the past (v) The director, or an immediate
or facility thereof that posts or makes three years payments that reasonably family member, is, or within the past
available for trading security-based could affect the independent judgment three years was, employed as an
swaps, or security-based swap clearing or decision-making of the director from executive officer of another entity where
agency, as applicable; the security-based swap execution any executive officers of the security-
(ii) Any affiliate of the security-based facility or national securities exchange based swap execution facility or
swap execution facility or national or facility thereof that posts or makes national securities exchange or facility
securities exchange or facility thereof available for trading security-based thereof that posts or makes available for
that posts or makes available for trading swaps, or security-based swap clearing trading security-based swaps, or
security-based swaps, or security-based agency, as applicable, or any affiliate security-based swap clearing agency, as
swap clearing agency, as applicable; thereof or from a security-based swap applicable, serve on that entity’s
(iii) A security-based swap execution execution facility participant, a member compensation committee;
facility participant, a member of a of a national securities exchange that (vi) The director, or an immediate
national securities exchange that posts posts or makes available for trading family member, is a current partner of
or makes available for trading security- security-based swaps, or a participant in the outside auditor of the security-based
based swaps, or a participant in the the security-based swap clearing agency, swap execution facility or national
security-based swap clearing agency, as as applicable, or any affiliate thereof, securities exchange or facility thereof
applicable; or other than the following: that posts or makes available for trading
(iv) Any affiliate of a security-based (A) Compensation for Board or Board security-based swaps, or security-based
swap execution facility participant, a committee services; swap clearing agency, as applicable, or
member of a national securities (B) Compensation to an immediate any affiliate thereof, or was a partner or
exchange that posts or makes available family member who is not an executive employee of the outside auditor of
for trading security-based swaps, or a officer of the security-based swap security-based swap execution facility
participant in the security-based swap execution facility or national securities or national securities exchange or
clearing agency, as applicable. exchange or facility thereof that posts or facility thereof that posts or makes
(2) A director is not an independent makes available for trading security- available for trading security-based
director if any of the following based swaps, or security-based swap swaps, or security-based swap clearing
circumstances exists: clearing agency, as applicable, or any agency, as applicable, or any affiliate
(i) The director, or an immediate affiliate thereof or of a security-based thereof who worked on the audit of the
family member, is employed by or swap execution facility participant, a security-based swap execution facility
otherwise has a material relationship member of a national securities or national securities exchange or
with the security-based swap execution exchange that posts or makes available facility thereof that posts or makes
available for trading security-based occupying a similar status or performing (ii) Any person associated with a
swaps, or security-based swap clearing similar functions); security-based swap execution facility
agency, as applicable, or any affiliate (2) Any person directly or indirectly participant;
thereof, at any time within the past controlling, controlled by, or under (iii) Any immediate family member of
three years; or common control with such security- a security-based swap execution facility
(vii) In the case of a director that is based swap dealer or major security- participant or any immediate family
a member of the audit committee, such based swap participant; or member of the spouse of such person,
director (other than in his or her (3) Any employee of such security- who, in each case, has the same home
capacity as a member of the audit based swap dealer or major security- as the security-based swap execution
committee, the Board, or any other based swap participant. This term does facility participant or who is a director
Board committee), accepts, directly or not include any person associated with or officer of the security-based swap
indirectly, any consulting, advisory, or a participant in a security-based swap execution facility or any of its parents
other compensatory fee from the clearing agency whose functions are or subsidiaries; or
security-based swap execution facility solely clerical or ministerial. (iv) Any immediate family member of
or national securities exchange or (s) The term person associated with a a person associated with a security-
facility thereof that posts or makes security-based swap dealer or major based swap execution facility
available for trading security-based security-based swap participant has the participant or any immediate family
swaps, or security-based swap clearing same meaning as set forth in section member of the spouse of such person,
agency, as applicable, or any affiliate 3(a)(70) of the Exchange Act (15 U.S.C. who, in each case, has the same home
thereof or a security-based swap 78c(a)(70)) or any rules or regulations as the person associated with the
execution facility participant, a member thereunder. security-based swap execution facility
of a national securities exchange that (t) The term person associated with a participant or who is a director or
posts or makes available for trading security-based swap execution facility officer of the security-based swap
security-based swaps, or a participant in participant means any partner, officer, execution facility or any of its parents
the security-based swap clearing agency, director, or branch manager of such or subsidiaries; and
as applicable, or any affiliate thereof, security-based swap execution facility (3) When used with respect to a
other than fixed amounts of pension and participant (or any person occupying a national securities exchange or facility
other forms of deferred compensation similar status or performing similar thereof that posts or makes available for
for prior service, provided such functions), any person directly or trading security-based swaps:
compensation is not contingent in any indirectly controlling, controlled by, or (i) Any affiliate of a member of the
way on continued service. under common control with such national securities exchange that posts
(k) The term major security-based security-based swap execution facility or makes available for trading security-
swap participant has the same meaning participant, or any employee of such based swaps;
as set forth in section 3(a)(65) of the security-based swap execution facility (ii) Any person associated with a
Exchange Act (15 U.S.C. 78c(a)(65)) or participant. member of the national securities
any rules or regulations thereunder. (u) The term related person means:
(1) When used with respect to a exchange that posts or makes available
(l) The term material relationship for trading security-based swaps;
security-based swap clearing agency:
means a relationship, whether (i) Any affiliate of a security-based (iii) Any immediate family member of
compensatory or otherwise, that swap clearing agency participant; a member of the national securities
reasonably could affect the independent (ii) Any person associated with a exchange that posts or makes available
judgment or decision-making of the security-based swap clearing for trading security-based swaps or any
director. participant; immediate family member of the spouse
(m) The term member has the same (iii) Any immediate family member of of such person, who, in each case, has
meaning as set forth in section 3(a)(3) of a security-based swap clearing agency the same home as the member of the
the Exchange Act (15 U.S.C. 78c(a)(30)). participant that is a natural person or national securities exchange that posts
(n) The term national securities any immediate family member of the or makes available for trading security-
exchange means any exchange spouse of such person, who, in each based swaps or who is a director or
registered pursuant to section 6 of the case, has the same home as the security- officer of the national securities
Exchange Act (15 U.S.C. 78f). based swap clearing agency participant exchange or facility thereof that posts or
(o) The term participant when used or who is a director or officer of the makes available for trading security-
with respect to a clearing agency has the security-based swap clearing agency or based swaps, or any of its parents or
same meaning set forth in section any of its parents or subsidiaries; or subsidiaries; or
3(a)(24) of the Exchange Act (15 U.S.C (iv) Any immediate family member of (iv) Any immediate family member of
78c(a)). a person associated with a security- a person associated a member of the
(p) The term person has the same based swap clearing agency participant national securities exchange that posts
meaning as set forth in section 3(a)(9) of that is a natural person or any or makes available for trading security-
the Exchange Act (15 U.S.C. 78c(a)(9)). immediate family member of the spouse based swaps or any immediate family
(q) The term person associated with a of such person, who, in each case, has member of the spouse of such person,
member has the same meaning as set the same home as the person associated who, in each case, has the same home
forth in section 3(a)(21) of the Exchange
with the security-based swap clearing as the person associated with the
Act (15 U.S.C. 78c(a)(21)). agency participant or who is a director national securities exchange that posts
(r) The term person associated with a or officer of the security-based swap or makes available for trading security-
participant in a security-based swap clearing agency or any of its parents or based swaps or who is a director or
clearing agency means: subsidiaries; officer of the national securities
(1) Any partner, officer, director, or (2) When used with respect to a exchange or facility thereof that posts or
branch manager of such security-based security-based swap execution facility: makes available for trading security-
swap dealer or major security-based (i) Any affiliate of a security-based based swaps or any of its parents or
swap participant (or any person swap execution facility participant; subsidiaries.
(v) The term security-based swap has with respect to the voting of, any administer a process for the nomination
the same meaning as set forth in section interest in the security-based swap of individuals to the Board.
3(a)(68) of the Exchange Act (15 U.S.C. clearing agency that exceeds 40 percent (5) Other committees of the Board. A
78c(a)(68)) or any rules or regulations of the voting power of any class of security-based swap clearing agency
thereunder. securities or other ownership interest of may establish such other committees of
(w) The term security-based swap such security-based swap clearing the Board, including a risk committee,
dealer has the same meaning as set forth agency. as it deems appropriate. However, if
in section 3(a)(71) of the Exchange Act (2) Divestiture. (i) The rules of the such committee has the authority to act
(15 U.S.C. 78c(a)(71)) or any rules or security-based swap clearing agency on behalf of the Board, the committee
regulations thereunder. must provide an effective mechanism to must be composed of at least 35 percent
(x) The term security-based swap divest any participant of any voting independent directors.
clearing agency means a clearing agency interest owned in excess of the (6) Disciplinary panels. The
that clears security-based swaps. limitation in paragraph (a)(1) of this disciplinary processes of a security-
(y) The term security-based swap section. based swap clearing agency shall
execution facility has the same meaning (ii) The rules of the security-based preclude any group or class of persons
as set forth in section 3(a)(77) of the swap clearing agency must be that is a participant from dominating or
Exchange Act (15 U.S.C. 78c(a)(77)) or reasonably designed not to give effect to exercising disproportionate influence on
any rules or regulations thereunder. the portion of any voting interest held the disciplinary process. Any
(z) The term security-based swap by one or more participants in excess of disciplinary panel of a security-based
execution facility participant means a the limitations in paragraph (a)(1) of this swap clearing agency shall also include
person permitted to directly effect section. at least one person who would qualify
transactions on the security-based swap (iii) The rules of the security-based as an independent director. If the
execution facility. swap clearing agency must provide an security-based swap clearing agency
effective mechanism for it to obtain provides for a process of an appeal to
§ 242.701 Mitigation of conflicts of interest information relating to voting interests the Board, or to a committee of the
of security-based swap clearing agencies. in the security-based swap clearing Board, then that appellate body also
Each security-based swap clearing agency by any participant in the shall include at least one person who
agency must comply with the provisions security-based swap clearing agency and would qualify as an independent
of either paragraphs (a) or (b) this its related persons. director.
section, and must have the capacity to (3) Board. (i) The Board of each (b)(1) Limits on voting interests. A
carry out the purposes of paragraphs (a) security-based swap clearing agency security-based swap clearing agency
or (b) of this section, respectively. must be composed of at least 35 percent shall not permit any security-based
(a)(1) Limits on voting interest. A independent directors. swap clearing agency participant, either
security-based swap clearing agency (ii) No director may qualify as an alone or together with its related
shall not permit any security-based independent director unless the Board persons, to:
swap clearing agency participant, either affirmatively determines that the (i) Beneficially own, directly or
alone or together with its related director does not have a material indirectly, any interest in the security-
persons, to: relationship with the security-based based swap execution facility that
(i) Beneficially own, directly or swap clearing agency or any affiliate of exceeds 5 percent of any class of
indirectly, any interest in the security- the security-based swap clearing agency, securities, or other ownership interest,
based swap clearing agency that exceeds or a participant in the security-based entitled to vote of such security-based
20 percent of any class of securities, or swap clearing agency, or any affiliate of swap clearing agency; or
other ownership interest, entitled to a participant in the security-based swap (ii) Directly or indirectly vote, cause
vote of such security-based swap clearing agency. the voting of, or give any consent or
clearing agency; (iii) The security-based swap clearing proxy with respect to the voting of, any
(ii) Directly or indirectly vote, cause agency must establish policies and interest in the security-based swap
the voting of, or give any consent or procedures to require each director, on clearing agency that exceeds 5 percent
proxy with respect to the voting of, any his or her own initiative or upon request of the voting power of any class of
interest in the security-based swap of the security-based swap clearing securities or other ownership interest of
clearing agency that exceeds 20 percent agency, to inform the security-based such security-based swap clearing
of the voting power of any class of swap clearing agency of the existence of agency.
securities or other ownership interest of any relationship or interest that may (2) Divestiture. (i) The rules of the
such security-based swap clearing reasonably be considered to bear on security-based swap clearing agency
agency; whether such director is an independent must provide an effective mechanism to
(iii) In the aggregate with any other director. divest any participant of any voting
security-based swap clearing agency (4) Nominating committee. (i) A Board interest owned in excess of the
participants and their related persons, of any security-based swap clearing limitation in paragraph (b)(1) of this
beneficially own, directly or indirectly, agency shall establish a nominating section.
any interest in the security-based swap committee composed of a majority of (ii) The rules of the security-based
clearing agency that exceeds 40 percent independent directors. swap clearing agency must be
of any class of securities, or other (ii) The nominating committee of any reasonably designed not to give effect to
ownership interest, entitled to vote of security-based swap clearing agency the portion of any voting interest held
such security-based swap clearing must identify individuals qualified to by one or more participants in excess of
agency; or become Board members through a the limitations in paragraph (b)(1) of
(iv) In the aggregate with any other consultative process with the this section.
security-based swap clearing agency participants of the security-based swap (iii) The rules of the security-based
participants and their related persons, clearing agency consistent with criteria swap clearing agency must provide an
directly or indirectly vote, cause the approved by the Board and consistent effective mechanism for it to obtain
voting of, or give any consent or proxy with the provisions of this section, and information relating to voting interests
in the security-based swap clearing Board, then that appellate body also available for trading security-based
agency or its holding company by any shall include at least one person who swaps.
participant in the security-based swap would qualify as an independent (c) Divestiture. (1) The rules of a
clearing agency. director. security-based swap execution facility
(3) Board. (i) The Board of each or national securities exchange or
security-based swap clearing agency § 242.702 Mitigation of conflicts of interest facility thereof that posts or makes
must be composed of a majority of of security-based swap execution facilities available for trading security-based
and national securities exchanges that post
independent directors. or make available for trading security-based
swaps must provide an effective
(ii) No director may qualify as an swaps. mechanism to divest any security-based
independent director unless the Board swap execution facility participant or
affirmatively determines that the (a) General. Each security-based swap member, as applicable, of any interest
director does not have a material execution facility and national owned in excess of the ownership
relationship with the security-based securities exchange or facility thereof limitations in paragraphs (b)(1)(i) and
swap clearing agency or any affiliate of that posts or makes available for trading (2)(i) of this section.
the security-based swap clearing agency, security-based swaps must comply with (2) The rules of a security-based swap
or a participant in the security-based the provisions of this section and must execution facility or national securities
swap clearing agency, or any affiliate of have the capacity to carry out the exchange or facility thereof that posts or
a participant in the security-based swap purposes of this section. makes available for trading security-
clearing agency. (b) Limits on ownership and voting. based swaps must be reasonably
(iii) The security-based swap clearing (1) A security-based swap execution designed not to give effect to the portion
agency must establish policies and facility shall not permit any security- of any voting interest held by one or
procedures to require each director, on based swap execution facility more security-based swap execution
his or her own initiative or upon request participant, either alone or together with facility participant or member, as
of the security-based swap clearing its related persons, to: applicable, in excess of the limitations
agency, to inform the security-based (i) Beneficially own, directly or in paragraphs (b)(1)(ii) and (b)(2)(ii) of
swap clearing agency of the existence of indirectly, any interest in the security- this section.
any relationship or interest that may based swap execution facility that (3) The rules of a security-based swap
reasonably be considered to bear on exceeds 20 percent of any class of execution facility or national securities
whether such director is an independent securities, or other ownership interest, exchange or facility thereof that posts or
director. entitled to vote of such security-based makes available for trading security-
(4) Nominating committee. (i) A Board swap execution facility; or based swaps must provide an effective
of any security-based swap clearing (ii) Directly or indirectly vote, cause mechanism for it to obtain information
agency shall establish a nominating the voting of, or give any consent or relating to ownership and voting
committee composed solely of proxy with respect to the voting of, any interests in the security-based swap
independent directors. interest in the security-based swap execution facility or national securities
(ii) The nominating committee of any exchange or facility thereof that posts or
execution facility that exceeds 20
security-based swap clearing agency makes available for trading security-
percent of the voting power of any class
must identify individuals qualified to based swaps by any security-based swap
of securities or other ownership interest
become Board members through a execution facility participant or
of such security-based swap execution
consultative process with the member, as applicable.
facility.
participants of the security-based swap (d) Board. (1) The Board of any
clearing agency consistent with criteria (2) A national securities exchange or security-based swap execution facility
approved by the Board and consistent facility thereof that posts or makes or national securities exchange or
with the provisions of this section, and available for trading security-based facility thereof that posts or makes
administer a process for the nomination swaps shall not permit any member, available for trading security-based
of individuals to the Board. either alone or together with its related swaps must be composed of a majority
(5) Other committees of the Board. A persons, to: of independent directors.
security-based swap clearing agency (i) Beneficially own, directly or (2) No director may qualify as an
may establish such other committees of indirectly, any interest in the national independent director of a security-based
the Board, including a risk committee, securities exchange or facility thereof swap execution facility unless the Board
as it deems appropriate. However, if that posts or makes available for trading affirmatively determines that the
such committee has the authority to act security-based swaps that exceeds 20 director does not have a material
on behalf of the Board, the committee percent of any class of securities, or relationship with the security-based
must be composed of a majority of other ownership interest, entitled to swap execution facility, any affiliate of
independent directors. vote of such national securities the security-based swap execution
(6) Disciplinary panels. The exchange or facility thereof that posts or facility, a security-based swap execution
disciplinary processes of a security- makes available for trading security- facility participant, or any affiliate of a
based swap clearing agency shall based swaps; or security-based swap execution facility
preclude any group or class of persons (ii) Directly or indirectly vote, cause participant.
that is a participant from dominating or the voting of, or give any consent or (3) No director may qualify as an
exercising disproportionate influence on proxy with respect to the voting of, any independent director of a national
the disciplinary process. Any interest in the national securities securities exchange or facility thereof
disciplinary panel of a security-based exchange or facility thereof that posts or that posts or makes available for trading
swap clearing agency shall also include makes available for trading security- security-based swaps unless the Board
at least one person who would qualify based swaps that exceeds 20 percent of affirmatively determines that the
as an independent director. If the the voting power of any class of director does not have a material
security-based swap clearing agency securities or other ownership interest of relationship with the national securities
provides for a process of an appeal to such national securities exchange or exchange or facility thereof, any affiliate
the Board, or to a committee of the facility thereof that posts or makes of the national securities exchange or
facility thereof, a member of the national securities exchange or facility or makes available for trading security-
national securities exchange, or any thereof that posts or makes available for based swaps shall preclude any group or
affiliate of such member. trading security-based swaps must be class of security-based swap execution
(e) Regulatory oversight committee. composed solely of independent facility participants or group or class of
(1) A Board of any security-based swap directors. members of the national securities
execution facility or national securities (2) The nominating committee of a exchange that posts or makes available
exchange that posts or makes available security-based swap execution facility for trading security-based swaps, as
for trading security-based swaps shall or national securities exchange or applicable, from dominating or
establish a regulatory oversight facility thereof that posts or makes exercising disproportionate influence on
committee, composed solely of available for trading security-based the disciplinary process. Any
independent directors, to assist it in swaps must identify individuals disciplinary panel of a security-based
minimizing actual and potential qualified to become directors, consistent swap execution facility or national
conflicts of interest. The regulatory with criteria approved by the Board and securities exchange that posts or makes
oversight committee shall oversee the consistent with the provisions of this available for trading security-based
security-based swap execution facility’s section, and administer a process for the swaps shall also include at least one
obligations under section 3D of the nomination of individuals to the Board. person who would qualify as an
Exchange Act or the national securities (g) Other committees of the Board. A independent director. If the security-
exchange’s obligation under section 6 of security-based swap execution facility based swap execution facility or
the Exchange Act (15 U.S.C. 78f), as or national securities exchange or national securities exchange that posts
applicable, on behalf of the Board. The facility thereof that posts or makes or makes available for trading security-
Board shall delegate sufficient authority, available for trading security-based based swaps provides for a process of an
dedicate sufficient resources, and allow swaps may establish such other appeal to the Board, or to a committee
sufficient time for the regulatory committees of the Board, including an of the Board, then that appellate body
oversight committee to fulfill its executive committee, as it deems also shall include at least one person
mandate. appropriate. However, if such who would qualify as an independent
(2) The Board shall promptly report to committee has the authority to act on director.
the Commission any recommendations behalf of the Board, the committee must Dated: October 14, 2010.
of the Regulatory Oversight Committee be composed of a majority of
By the Commission.
that the Board does not adopt or independent directors.
implement. (h) Disciplinary panels. The Elizabeth M. Murphy,
(f) Nominating committee. (1) The disciplinary processes of a security- Secretary.
nominating committee of a security- based swap execution facility or [FR Doc. 2010–26315 Filed 10–25–10; 8:45 am]
based swap execution facility or national securities exchange that posts BILLING CODE 8011–01–P

Swap Entities - Conflict Mitigation

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Swap Entities - Conflict Mitigation

Uploaded by

Copyright:

Available Formats

Tuesday,

October 26, 2010

21 These clearing agencies include ICE Trust US

December 14, 2009. One method for calculating an

SEFs and SBS exchanges become more

status or performing similar functions); (2) any

at 13156, supra note 59. Regulation MC. MC.

MC. Regulation MC. MC.

members of SB SEFs or SBS exchanges, proposals outlined in this release. In

compositional requirements of the Commission require the Board to report

Commission related to the ability to control an utilities.’’). MC.

of ‘‘director.’’ Regulation MC. Regulation MC.

costs and benefits of requiring the

Regulation MC. 131 See

612194 (December 22, 2009), 74 FR 68883

145 See supra note 98 for the proposed definition

of which contain specific circumstances that, if federalregister_governance.pdf. MC.

177 Some exchanges have voluntarily created

Dodd-Frank Act sets forth 14 core principles that 183 See

nominating committee, be composed solely of with rulemaking authority with respect to

SBS exchange could occasionally decide

would be publicly available. Section 765 of the Dodd-Frank Act to

Netting, Asymmetric Information, and the Sharing In addition, if a participant is subject

Commission may determine that it is appropriate to

account for an 1,800-hour work-year and multiplied statistics/pdf/ISDA-Market-Survey-results1987-

A. Security-Based Swap Clearing C. SBS Exchanges PART 242—REGULATIONS M, SHO,

For the reasons stated in the swaps, or security-based swap clearing

You might also like