The SEC's proposed rules on CCPs: tough new requirements or just business as usual?

Last week the SEC issued a 400 page proposed rule-making for CCP operations in the US – this is the US translation of CPSS-IOSCO’s Principles for Financial Market Infrastructure from April 2012. This whopper contains much of the usual standard issue stuff on transparency and reporting, which is cumbersome but maintains the rules of the game. But how about their proposals on collateral and liquidity?

These are big rules meant to cover a wide range of market infrastructure. The SEC says that the rules capture covered clearing agencies. These include: “registered clearing agencies that (i) have been designated as systemically important by the Financial Stability Oversight Council (“FSOC”) and for which the Commission is the supervisory agency, pursuant to the Clearing Supervision Act (“designated clearing agencies”), (ii) provide central counterparty (“CCP”) services for security-based swaps or are involved in activities the Commission determines to have a more complex risk profile, where in either case the Commodity Futures Trading Commission (“CFTC”) is not the supervisory agency for such clearing agency as defined in Section 803(8) of the Clearing Supervision Act, or (iii) are otherwise determined to be covered clearing agencies by the Commission.” This is pretty much a catch-all but exempts CME and ICE from some of its requirements since these CCPs are already covered by the CFTC.

Legal Risk. The SEC is codifying existing practices but also requiring reporting on legal risk matters, including if a CCPs decision to void trades in the face of a clearing member’s insolvency is reversed, what happens then? “For example, where a covered clearing agency’s procedures addressing a participant default and establishing a security interest in collateral lack clarity or there is significant uncertainty regarding enforceability, there is a risk the clearing agency may face claims to void, stay or reverse its actions, which could be made by a bankruptcy trustee or other type of receiver in an insolvency of a participant, undermining the clearing agency’s ability to safeguard securities and funds.” This is tough stuff to figure out clearly and could result in additional laws or legal opinions on what-if default scenarios.

Conforming model validation. Here’s a curveball: the SEC proposes that a clearing firm must evaluate its risk model every year. That’s fine, but “A conforming model validation would also require that the model validation be performed by a qualified person who is free from influence from the persons responsible for the development or operation of the models or policies being validated so that credit risk models can be candidly assessed.” Given the black box nature of these models, this may raise some alarms at the covered firms.

Collateral and margin. Nothing special or new here in our read.

Qualifying Liquid Resources. The SEC is introducing a new idea of what qualifies as a liquid asset at a clearing firm: Cash; assets that are readily available and convertible into cash through prearranged funding arrangements; assets that can be pledged at a Central Bank. This may put some strain on corporate bonds and equities unless the CCP has a prearranged line of credit or repo arrangement to move those assets out the door.

Our review suggests that there is some new teeth in the SEC’s proposals and that there will be many substantial details to first understand, then iron out. There’s a lot more to chew on here and lawyers will be busy.

The full SEC proposed rules are here.

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