I have frequently written about Clearing Agencies and their critical importance to the operation of the United States capital markets. See “Tightening the Reins: SEC Approves Proposed Rule Change to Clearing Agencies Investment Policy,” issued April 29, 2021; “’Margin, I Have to Have More Margin’: The National Securities Clearing Corporation Proposes to Increase the Minimum Required Fund Deposit,” issued May 27, 2021; “Fixing FICC: Agency Proposes Rule Changes to Encourage More Repo Clearing,” issued June 8, 2021; and “Valuing the Risk: FICC Proposes Rule Change to Protect Against Repo Volatility,” issued on October 17, 2022. As stated in the U.S. Department of the Treasury Report “A Financial System that Creates Economic Opportunity: Capital Markets” (October 2017) states:
Because of the level and concentration of financial transactions handled by [financial market utilities] and their interconnectedness to the rest of the financial system [financial market utilities, such as clearing agencies] represent a significant systemic risk to the U.S. financial system. Much of this systemic risk is the result of inherent interdependencies, either directly through operational, contractual, or affiliation linkages or indirectly through payment, clearing, and settlement processes.
That Report also notes that clearing agencies “date back to the late 19th century when they were used to net payments in commodities future markets. In the United States, the New York Stock Exchange …established a clearing house in 1892.” As discussed at some length in my “Tightening the Reins” Blog cited above, the modern clearing agencies began to be established in the 1970’s, primarily to handle the material growth in the volume of securities trading which had caused the so-called “back office” crisis in processing the paperwork evidencing transactions.
Clearing agencies have evolved over the last almost 50 years primarily in response to changing market conditions, especially those related to and caused by the material advances in trading technology. Each of the clearing agencies has, from time to time, proposed rule amendments and even wholesale revisions, to maintain competitive market positions; respond to member concerns; and adapt to changes in market regulations and in the market conditions themselves. Each of my Blogs cited above involves proposals for changes, notionally improvements, by one or more clearing agencies. As clearing agencies must register with, and are regulated by, the U.S. Securities and Exchange Commission (“SEC”), clearing agency rules and rule changes must be approved by the SEC before they may take effect. Accordingly, rule change proposals are set forth in formal and often lengthy written presentations to the Commission and discuss the reason for a proposed change and its impact on both agency members and the investing public. By and large, the history of these clearing agencies has been one of enlightened self-government by private bodies, subject at all times to continuing governmental oversight.
Now, on Aug. 8, 2022, comes the SEC with a 172-page set of governance rules that would impose mandatory structures and policies on every clearing agency. Specifically, the SEC proposal would directly set the governance standards for clearing agency boards and committees, including having independent directors and requiring representation for each “stakeholder” category (the public, large agency members, small agency members, agency owners, etc.). These requirements would apply to the board of directors, the nominating committee (which the agency would have to have), and a prescribed risk management committee. In addition, the agency would be required to have specified policies and procedures on dealing with both actual and potential conflicts of interest. In the words of the Commission’s August 8 Press Release:
If adopted, the proposed rules would increase the transparency of the decision-making process on clearing agency boards and committees and improve the alignment of incentives between clearing agency participants and owners. In particular, the proposed rule would reduce conflicts of interest, increase the role of independent directors in board decision-making processes, and help promote fair representation of owners and participants in the selection of directors.
It is noteworthy that the Press Release concedes that the SEC “previously proposed but did not adopt rules regarding clearing agency governance in two separate releases between 2010 and 2011. Unsaid by the Press Release, but emphasized in an August 8 Statement by Commissioner Hester Peirce, the SEC in 2016, in finalizing rules (required under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010) for clearing agencies dealing in securities-based swap transactions, the SEC “expressly rejected the suggestion from several commenters that it impose a director independence requirement …[and] concluded that it was unnecessary to … specify the requirements for the composition of clearing agency boards.” Commissioner Peirce terms “ominous” that the SEC rules proposal refers to the changes as “facilitating” a clearing agency board’s “consideration and management of diverse stakeholder interests.” She goes on to note that the proposed rules would “send boards running off in multiple directions, rather than keeping them singularly focused on the clearing agency’s well-being.” Commissioner Mark Uyeda expresses similar concerns in his August 8 Statement, meaning that the rules proposal was issued after a 3-2 vote at the SEC.
SEC Chair Gary Gensler is quoted in the Press Release as saying:
[The proposed rules] would enhance governance standards for all registered clearing …[agencies], particularly with regards to conflicts of interest. …[T]hese rules would help to build more transparent and reliable …[agencies]…[which] would in turn help ensure our markets are more resilient, protecting investors and building trust in our markets.
One early (on Aug. 9, 2022) commenter on the proposal noted that “The Commission seems to continually be imposing new rules,” suggestive that such activity may be an aspect of self-justification rather than a careful regulatory response to a condition raising significant risks in the capital markets. In any event, it is surely fair to characterize the proposal as a Commission effort to micromanage the clearing agencies. This view is consistent with points made forcefully by both dissenting Commissioners that the proposed rules: may limit competition, increase market concentration, and fail to take into account legitimate differences among the various clearing agencies, in addition to (as Commissioner Peirce stated) taking “an overly prescriptive, regulator-knows best approach …[to governance and conflicts] that risks diluting the duties of directors to the clearing agency and depriving clearing agencies of the flexibility and expertise needed…[for] effective governance.” In many ways this SEC proposal evokes memories of the August 19, 2019, action of the Business Roundtable to revise in a fundamental and oft criticized way its Statement on the Purpose of a Corporation. No longer are directors to focus on profits for the corporation and its shareholders; rather, they are to give “appropriate attention” to a panoply of stakeholders, from employees, to customers, to community members and the public generally, and to the shareholders.
There is a comment period of the longer of 60 days after the proposed rules are published on the SEC website OR 30 days following publication in the Federal Register.
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