I respectfully concur regarding the Notice of Proposed Rulemaking for Derivatives Clearing Organizations Recovery and Orderly Wind-down Plans; Information for Resolution Planning.  While I generally support and appreciate the diligent efforts on this proposal, I do have several significant concerns regarding the proposal’s breadth and prescriptiveness, as well as foundational questions on accountability and the role of the government in resolution planning.

Strengthening the Financial System through Global Standards

It has been almost 14 years since the G20 met in Pittsburgh to address the financial stability risks that emerged during the 2008 global financial crisis.  One pivotal outcome of that meeting was the agreement to improve the over-the-counter (OTC) derivatives markets by agreeing that all standardized OTC contracts should be exchange-traded and cleared through regulated central counterparties (CCPs) by 2012, aiming to diminish counterparty credit risk and enhance transparency.[1]  This important decision resulted in a stronger and more resilient financial system by aiming to prevent a recurrence of the crisis from inadequate risk management.  At that meeting, the G20 leaders pledged to implement this central clearing mandate in a coordinated and consistent manner across jurisdictions.

In 2012, the Committee on Payments and Market Infrastructures[2] and the International Organization of Securities Commissions (CPMI-IOSCO) established the Principles for Financial Market Infrastructures (PFMIs).[3]  The PFMIs are a set of international standards that provide guidance for the operation and oversight of certain financial market utilities (FMUs), including CCPs (such as CFTC-regulated derivatives clearing organizations (DCOs) or SEC-regulated clearing agencies), trade repositories, payment systems, and central securities depositories (CSDs), that the international community has determined to be an essential component to preserving financial stability in the global financial markets.[4]

U.S. Approach to Implementation of the PFMIs

Pursuant to Title VIII of the Dodd-Frank Act, the U.S. has implemented the PFMIs through multiple regulators overseeing different FMUs, including DCOs, clearing agencies, payment systems, and CSDs.[5]  The Financial Stability Oversight Council (FSOC) designates certain FMUs as systemically important if they pose a risk to the stability of the U.S. financial system (designated FMUs or DFMUs).[6]  To date, the FSOC has designated eight FMUs as systemically important, including two systemically important derivatives clearing organizations (SIDCOs) regulated by the CFTC.[7]

The CFTC, the SEC, and the Federal Reserve have all taken steps to implement Title VIII and the PFMIs, and to promote the stability and efficiency of FMUs subject to their oversight.  All three U.S. regulators have to achieve the same outcomes, because each is implementing the same standards from Title VIII and the PFMIs.  In reviewing each agency’s approach—the Fed’s Regulation HH and the SEC’s recent proposal for recovery and wind-down plans for clearing agencies—it seems that there is an opportunity for greater alignment and consistency across the CFTC, SEC, and the Fed to implementing these same requirements.  I believe the U.S. should take an outcomes-based approach to oversight of DFMUs because we all have to get to the same destination in the end.

CFTC’s 2013 Recovery and Wind-down Rule for SIDCOs and Subpart C DCOs

In 2013, the CFTC determined that the PFMIs were the most relevant international standards for the risk management of SIDCOs, for purposes of meeting its obligations under Title VIII, and began implementing rules fully consistent with the PFMIs.[8]  Specifically, the CFTC promulgated its recovery and wind-down rules for SIDCOs and Subpart C DCOs in 2013.[9]  Since then, we have been fortunate enough to receive valuable guidance from CPMI-IOSCO and the Financial Stability Board regarding resolution frameworks for FMUs, the recovery planning process, and the content of recovery plans.  These guidelines were initially published in 2014 and subsequently updated in 2017 (“CPMI-IOSCO Recovery Guidance”), providing us with invaluable insights.[10]  I support keeping the CFTC’s rules up-to-date and upholding international standards under Title VIII and the PFMIs established by CPMI-IOSCO.

In our derivatives markets, DCOs provide central clearing and serve as intermediaries who effectively mitigate risk for hundreds of thousands of transactions every day through the settlement and central clearing of contracts.  A significant portion of settlement and clearing in the derivatives market is carried out by two CFTC-registered DCOs designated as SIDCOs by the FSOC in 2012.[11]  It is no secret that if one of these SIDCOs were to experience a failure or collapse that it could have far-reaching and detrimental effects on the broader financial system.  As “giant warehouses of risk”, SIDCOs play a crucial role in mitigating risks for the entire global financial system.  However, in the event of any DCO’s financial distress or potential failure, effective regulations are necessary to ensure an orderly wind-down and recovery process.  And that is why I believe it is so important that our DCOs are efficiently-regulated and well-managed at every level, and why the CFTC has long had the preeminent regulatory framework for the oversight of CCPs and led many international initiatives to strengthen financial stability.

While the prospect of a DCO collapse may appear to be beyond the realm of possibility, it is crucial for regulators to avoid succumbing to a failure of imagination.  In instances where existing regulations prove inadequate, it is our responsibility through rulemakings to devise contingency plans for such worst-case scenarios.

Striking a Balance in Our Rulemaking—More is Not Always Better

I thank the staff of the Division of Clearing and Risk and the Office of General Counsel for their work on this proposal.  I would also like to particularly thank Bob Wasserman and Eric Schmelzer for their hard work and for the time they spent with my office on this proposal.

Generally, it is important that the CFTC continues to periodically review our regulations to see that they remain fit-for-purpose and to update them as necessary to reflect developments in international standards as well as in our markets.  But as I mentioned earlier, while I support today’s proposed rulemaking, I do have some significant concerns.

Definitions

First, regarding the definitions in this proposal.  I appreciate that we attempt to align our definition for “orderly wind-down” with the definition in Regulation HH, as well as considered the definition in the recent SEC proposal.  I thank the staff for making the revisions that I requested and welcome comments.

Another definition of particular focus to me was “legal risk.”  Given my experience implementing governance, risk, and control frameworks—including legal risk management—I took particular care to evaluate the proposal’s definition of legal risk and worked with the staff to try to ensure that the CFTC’s definition was consistent with both international standards as well as best practices.  I drew upon my own experience with risk governance frameworks for legal risk.  I also looked at other aspects of the CFTC rules where we address legal risk for swap dealers and FCMs, as well as the Basel Committee publications on operational risk (since legal risk is a subset of operational risk), as well as the aforementioned CPMI-IOSCO Recovery Guidance, and the Fed’s definition of legal risk (although that is for banking organizations).  I then suggested, and my language is incorporated into the proposal, that the definition of legal risk includes “losses arising from legal, regulatory, or contractual obligations.”  I encourage commenters to take a look at this proposed definition for legal risk, which builds upon some statements in the Recovery Guidance, and to weigh in if this is an appropriate definition, or if there’s a better or alternate formulation.

Recovery scenarios

Second, I believe it would be helpful to have commenters provide feedback on the likelihood of the stress scenarios and whether each of these scenarios are events or types of risk that should be included in all DCOs’ recovery plans.  I also believe that there should be a materiality threshold in connection with determining the recovery scenarios that need to be addressed.

One example of a materiality threshold is that the applicable recovery scenarios would need to have a “significant likelihood” of being triggered, or to evaluate whether multiple scenarios happening at the same time would pose a material risk to the DCO.  I would like to have commenters weigh in on potential approaches to tailoring the type and number of required recovery scenarios.

Information for resolution planning

Third, turning to resolution planning, I believe that it is important to consider the respective roles and responsibilities of the CFTC as the primary regulator over our DCOs, and the FDIC as the resolution authority under Title II.  Based on my own experience engaging with the FDIC, I understand and support the need for the FDIC to be able to carefully engage in resolution planning to address the financial stability risk posed by SIDCOs.

However, I believe that the accountability for sound financial and risk management should lie squarely with CCPs, including for stress, disruption, and even the unlikely event of resolution. Instead, it seems that our proposal shifts accountability from CCP management to the CFTC as regulator, and the FDIC as the primary responsible party for resolution planning, making it the government’s job, not CCP management’s job, to plan ahead.  I believe this oversteps the appropriate role of government, and even interferes with day-to-day business operations by diverting limited resources from critical risk areas to burdensome document production.  I will highlight a few examples.

Our proposal requires that SIDCOs produce voluminous information and documentation directly to the CFTC on an ex ante basis, so that the CFTC can then, in turn, review the information and documentation and then produce it to the FDIC to maintain.  This raises several concerns.

From one perspective, I am concerned that we are shifting accountability and responsibility from the management of the SIDCOs where it should be, to the CFTC.  One example is the proposal’s requirements with respect to producing legal contracts for internal and external service providers, so that the CFTC and the FDIC can identify which contracts or agreements for services are not resolution resilient.  It does not make sense to me why the burden-shifting is first on the CFTC and the FDIC.  It is critical that the management of the SIDCOs identify and mitigate their legal risks, and in the first instance, review their own legal contracts and make their own determination.

I am not familiar with any other circumstance, for any other regulator, in which that type of legal documentation is comprehensively produced to the regulator on an ongoing basis to maintain.  I believe that it is more common for regulated entities to be required to maintain an inventory of such legal documentation in addition to recordkeeping and retention requirements, and to mitigate the legal risks associated with those legal contracts or contractual obligations.  Then, the regulator would periodically inspect or examine the framework for legal risk management and any specific regulatory requirements associated with the specific type of legal documentation, including the review of a sample or multiple samples of those legal contracts as appropriate.  I would like to hear from commenters if this approach, which is standard practice for inspections and examinations, would make sense here.

Another example of this burden-shifting from business management to the regulators is with respect to producing copies of licenses and licensing agreements to the CFTC so that the CFTC can then produce them to the FDIC.  I am not aware of any other regulator that keeps its own document repository of business licenses and licensing agreements for regulated entities.

Regarding information about clearing members that is requested for resolution planning, I do wonder if the CFTC already has this information because we directly regulate clearing members such as futures commission merchants (FCMs) and swap dealers.  I would like to ensure that we are collecting any information from SIDCOs in the most efficient way possible, in order to make the best use of the CFTC’s limited resources and to limit the administrative burden.  And, it goes without saying that I hope the CFTC will request only information that is truly necessary, and is not information that the CFTC already collects, in order to minimize duplication.

And more generally, because the SEC and the Fed are the other regulators with primary jurisdiction over their respective DFMUs, I would like to know if the SEC and the Fed will be taking the same approach as the CFTC to the production of information for resolution planning to the FDIC.  Again, there should be alignment across all three agencies if we are all subject to the same Dodd-Frank statutory requirements.

Orderly wind-down plans

Fourth, moving to orderly wind-down plans, there are a number of detailed technical requirements set forth in the proposal.  I will address a few of particular concern.

Ancillary service providers.  The proposal includes a requirement to identify ancillary service providers in connection with critical operations and services provided by and to DCOs.  To be clear, this requirement is referring to fourth parties, which is the next frontier after third party risk management.  I encourage commenters to address whether this requirement is an appropriate way to approach the risk from fourth parties, or if it the proposal is overbroad.

Annual testing.  Regarding annual testing of tools for wind-down plans, I wonder if there is a more appropriate frequency for testing that would make sense for smaller DCOs that present a more limited risk profile.  I believe that testing frequency should be risk-based, and I appreciate that the staff added this question into the proposal at my request.  I also noted that it is possible that more than one tool can be used concurrently, and the staff have added a question regarding listing the order in which DCOs would use tools for wind-down plans.

Wind-down scenarios.  On a technical point regarding wind-down scenarios, the proposal includes a requirement to assess the associated risks to non-defaulting clearing members and their customers and linked FMIs.  I appreciate that the staff made some adjustments to that language in order to reflect my concern that because there are clearing members that are not FCMs that clear on an agency basis for their customers, that the proposal more accurately contemplates different types of clearing members and clearing models or market structure.

For example, there are clearing members of a DCO that are swap dealers and do self-clearing of their principal trading activities.  Without clarification, the rule text could have been construed to encompass all of the clients, counterparties, and customers of a swap dealer that is a clearing member, even if unrelated to the swap dealer’s self-clearing of swap dealing activity—such as the retail banking customers of a commercial bank, where the federally-chartered banking entity subject to regulation by the Office of the Comptroller of the Currency, is also registered with the CFTC as a swap dealer.  I believe it would be overreaching for a DCO to be required to assess the associated risks of a DCO wind-down scenario to the retail banking customers of that legal entity.

Scope and lack of tailoring.  I believe the proposal takes a one-size-fits-all approach to DCO wind-down plans by requiring all DCOs, regardless of size or risk profile, to adhere to the same extensive requirements.  As one example, I imagine that for fully-collateralized DCOs which present a lesser risk profile, the cost of the legal and consulting fees to draft such wind-down plans could easily exceed their total annual operating budget, and a much simpler or straightforward plan would be sufficient.  Accordingly, I believe the Commission should consider whether to allow risk-based tailoring of wind-down plans, and I appreciate that the staff has included a question in the proposal to reflect my concern.

Implementation of plans

Finally, regarding implementation period, I am concerned that the mere six months for implementation that is permitted in the proposal is not sufficient for the incredibly thorough and detailed plans that the proposal requires.  I appreciate that the staff has added a question on the appropriate amount of time to implement these new requirements for DCO recovery and orderly wind-down plans.

Conclusion

The world has come a long way since the 2008 global financial crisis to address systemic risk and financial stability in connection with FMIs such as CCPs, and I commend the leadership of the CFTC’s efforts, alongside the G20, Financial Stability Board, IOSCO, the Bank for International Settlements (BIS) CPMI, and both U.S. and non-U.S. authorities.  Though much work has been done, I believe in the adage that one’s work is never done.  That is why I support, and continue to support, the Commission and staff in periodically reviewing and updating our rules to reflect developments in international standards as well as in markets.

I have several significant concerns regarding the proposal’s breadth and prescriptiveness, as well as foundational questions on accountability and the role of the government in resolution planning.

Further, I believe there could be important benefits to enhancing the clarity of this proposal.  The sheer length of the proposed rule itself makes it challenging to discern and address specific issues effectively.  I believe that a more direct and concise rule would be prudent, and I look forward to receiving public comment.

[1] See Leaders’ Statement: The Pittsburgh Summit (2009), available at https://www.oecd.org/g20/summits/pittsburgh/G20-Pittsburgh-Leaders-Declaration.pdf

[2] The Committee on Payments and Market Infrastructures was renamed the Committee on Payment and Settlement Systems.  See History of the CPMI, Bank for International Settlements, available at https://www.bis.org/cpmi/history.htm.

[3] See Principles for Financial Market Infrastructures, Bank for International Settlements, available at https://www.bis.org/cpmi/info_pfmi.htm.

[4] Id.

[5] See Designated Financial Market Utilities, Board of Governors of the Federal Reserve System, available at www.federalreserve.gov/paymentsystems/designated_fmu_about.htm. 

[6] Id.

[7] The Federal agency that has primary jurisdiction over one of the eight designated FMUs is indicated in parentheses:

• The Clearing House Payments Company, L.L.C. (Federal Reserve);
• CLS Bank International (Federal Reserve);
• Chicago Mercantile Exchange, Inc. (CFTC);
• The Depository Trust Company (Securities and Exchange Commission (SEC));
• Fixed Income Clearing Corporation (SEC);
• ICE Clear Credit L.L.C. (CFTC);
• National Securities Clearing Corporation (SEC); and
• The Options Clearing Corporation (SEC).

See id.

[8] See Derivatives Clearing Organizations and International Standards, 78 FR 72475, 72478 (Dec. 2, 2013) and Derivatives Clearing Organizations General Provisions and Core Principles, 85 FR 4800, 4822 (Jan. 27, 2020).

[9] Id.

[10] See CPMI-IOSCO, Recovery of financial market infrastructures (Oct. 15, 2014), available at https://www.bis.org/cpmi/publ/d121.pdf and CPMI-IOSCO, Resilience of central counterparties: further guidance on the PFMI (July 5, 2017), available at https://www.bis.org/cpmi/publ/d163.htm.

[11] See note 7, supra.