Derivatives clearing organizations (DCOs) play a significant role in our markets by providing essential clearing and settlement market infrastructure. They are important market intermediaries that create trust in stability by taking on counterparty risk and standing in as financial guarantors in the event of a customer or clearing member default. The risks DCOs take on in providing such services include custody, credit, and liquidity risk; other general business, operational, and legal risks; as well as the risk of its clearing members. Such risks not only threaten the a DCOs continuity of operations, but also a DCOs clearing members resulting in a broader threat to the greater financial system.

During periods of persistent stress, DCOs provide services that are crucial for continuity in the financial markets they serve. Given the significance of DCOs in our markets, any liquidity or solvency crisis event at a DCO couple result in a meltdown with far reaching consequences throughout the entire financial system. Recovery and wind-down plans are critical to prevent losses across our market and any knock-on effects or spill over into other markets. It is essential DCOs have recovery and orderly wind-down plans to prevent significant market disruption and limit widespread risk to our financial system.

I support the Commission’s consideration of the proposed regulations on recovery and orderly wind-down plans for DCOs. The rules proposed address the longstanding need to for all DCOs to have wind-down plans rather than only those deemed systemically important in the aftermath of the 2008 Financial Crisis. We have observed the need to ensure the integrity of not only the largest DCOs, but all DCOs. In addition, the proposal provides for an important update to Commission regulations for DCOs including codification of staff guidance 16-61 and incorporation of international guidance on recovery and resolution planning issued since 2013.[1] The implementation of these proposed regulations would operate to support the strength and continuity of all DCOs as instructed by the reforms established in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).[2].

The history and development of §39.39 recovery and wind-down regulations

I. Legislative and Regulatory History

In 2010, Dodd-Frank established a framework for over-the-counter derivatives, including swaps,[3] that form the basis for the Commission’s authority to promulgate rules for DCOs. Title VII of Dodd-Frank sets out eighteen core principles for DCOs (DCO Core Principles) with which DCOs must comply in order to register and maintain registration with the Commission.[1] The DCO Core Principles “serve to reduce risk, increase transparency, and promote market integrity within the financial system.”[5] In conjunction with section 8a(5) of the Commodity Exchange Act (CEA), Title VII grants the Commission authority to promulgate regulation as necessary to implement and enforce the DCO Core Principles.[6] In 2011, the Commission adopted regulations to implement Title VII of Dodd-Frank.[7] These regulations created regulatory standards for compliance with DCO Core Principles.[8] Among the many regulations adopted, the Commission made amendments to Part 39 which included DCO Core Principle D – Risk Management.[9] Core Principle D requires DCOs have policies and procedures in place that ensure the DCO will be able to manage the risks associated with discharging its responsibilities.[10]

Title VIII of Dodd-Frank introduced a collaborative, multi-agency framework for regulating systemically important financial market utilities (FMUs) providing payment, clearing, and settlement activities.[11] Specifically, section 804 of Dodd-Frank provides the Financial Stability Oversight Council (FSOC) with the authority to designate certain FMUs as systemically important.[12] This includes the ability to designate DCOs as systemically important (SIDCOs). In 2012, FSOC designated two CFTC-registered DCOs as SIDCOs.[13]

In addition to establishing a multi-agency regulatory framework, Title VIII created standards for SIDCOs for risk mitigation.[14] The objectives and principles for risk management at SIDCOs are (1) Promote risk management; (2) promote safety and soundness; (3) reduce systemic risks; and (4) support the stability of the broader financial system.[15] The risks which DCOs face not only threaten the viability and strength of a DCOs operations, but also threaten clearing members of DCOs and the broader financial system. Such risks include credit and liquidity risk by both the DCO itself and its clearing members as well as other general business, operational, custody, investment, and legal risks.[16] All of these risks could result in financial failures of DCOs. Disorderly failure[17] of DCOs –in particular SIDCOs– would likely cause significant disruption to our financial markets.[18] This systemic risk results in a necessity for DCOs to have viable plans for recovery and orderly wind-down during times of significant stress or in the event of failure.

Title VIII also directs the Commission to consider prudential requirements and international standards when promulgating risk management regulations that govern operations relating to payment, clearing, and settlement activities for SIDCOs.[19] In 2013, the Commission considered international standards relevant to risk management of SIDCOs as required under section 805(a)(2)(A). [20] At that time, the Commission determined the most relevant international standards were the Principles for Financial Market Infrastructure (PFMIs) established by the Bank of International Settlements’ (BIS) and the International Organization of Securities Commissions (IOSCO).[21] The PFMIs are a “unified set of international risk management standards for central counterparties” (CCPs) that facilitate clearing and settlement.[22] They set out a list of 24 principles that seek to address the numerous risks faced by CCPs.[23]

Later in 2013, the Commission implemented Part 39 regulations that set out broad rules for recovery, wind-down, and resolution planning for SIDCOs and Subpart C DCOs.[24][25] In adopting these wind-down and recovery regulations, the Commission considered PFMI Principles 3 and 15.[26] PFMI Principle 3 calls for a framework for the comprehensive management of risks including legal, credit, liquidity, business, and operational risks.[27] PFMI Principle 15 covers general business risk and calls for a CCPs to identify, monitor, and manage general business risk.[28] The Commission determined that although there is no DCO Core Principle that directly calls for DCOs to establish recovery and wind-down plans, DCO Core Principles B (financial resources), D (risk management), G (default rules and procedures), and I (system safeguards) as well as PFMI Principles 3 and 15 collectively support the need for DCOs to create policies and procedures that identify scenarios that may prevent a SIDCO or Subpart C DCO “from providing critical operations and services as a going concern and would assess the effectiveness of a full range of options for recovery and wind-down.”[29] In light of this determination, the Commission adopted Regulation 39.39 which requires SIDCOs and Subpart C DCOs “to maintain viable plans for recovery and orderly wind-down.”[30]

II. CFTC Letter 16-61 and International Standards

At that time, the Commission adopted Regulation 39.39, there was no specific international guidance on wind-down and recovery planning. In 2014, the Committee on Payments and Market Infrastructures (CPMI) with IOSCO issued guidance for FMIs and governing authorities on development of recovery plans (2014 CPMI-IOSCO Recovery Guidance). [31] The guidance considered and interpreted key principles relevant to recovery planning including PFMI Principles 3 and 15.[32] Further, the report provided guidance on the recovery planning process, contents of recovery plans, and recovery tools to be used by FMIs.[33]

In 2016, in light of 2014 CPMI-IOSCO Recovery Guidance, the staff of the Commission’s Division of Clearing and Risk (DCR) issued Letter 16-61 to provide additional details on the subjects and analyses that SIDCOs and Subpart C DCOs should include in their wind-down plans.[34] The letter provided a list of subjects DCR believed SIDCOs and Subpart C DCOs should analyze and include in their recovery and wind-down plans including such as inclusion of particular tools to be used in recovery and wind-down.[35] Specifically, the guidance provided a list of specific scenarios to be evaluated and set out a framework for how to identify, monitor for, and analyze the scenario and include such information in recovery plans.[36] Further, the guidance suggested a framework for how identify, implement, and analyze recovery tools in such scenarios and how to incorporate it into Recovery plans.[37] Finally, the guidance also provided a framework for including processes for wind-down options in the event of a failure or inability to successfully implement a recovery plan.[38]

In 2017, CPMI and IOSCO issued further guidance that updated the 2014 CPMI-IOSCO Recovery Guidance.[39] The guidance sought to clarify, among other things, how to implement recovery plans, replenish financial resources, and transparency in recovery tools.[40] Also in 2017, the Financial Standards Board issued guidance of CCP resolution planning that provided recommendations for resolution authorities about continuity of critical functions and implementation of crisis management groups, and development of resolution plans. [41] Most recently in August 2022, CPMI and IOSCO published a discussion paper on CCP practices to address non-default loses which includes a discussion of annual testing and review of a CCP’s recovery plan.[42]

Recovery and Orderly Wind-Down Planning

Recovery planning is essential to DCO risk management in that provides a mechanism to consider risk scenarios and their potential scope of impact, as well as evaluate specific tools, steps, and contingency plans. Recovery plans provide actionable steps that have been deeply considered and well thought out for those exigent and extreme circumstances that may threaten the viability of DCOs. An anticipated scenario with a thoughtful corresponding recovery plan provides for a DCO to have an efficient and effective recovery “such that it can continue to provide its critical services” even while its viability may be threatened.[43] Additionally, recovery plans provides stability, certainty, and clarity for a DCO’s clearing members and clients in tumultuous situations and can reduce the potential for panic and contagion. The reduction of stress and uncertainty as a result of advance recovery planning results in optimized, efficient, and effective recovery actions. Recovery planning is globally recognized as essential for all FMIs in a post 2008 Financial Crisis world. As stated by CMPI-IOSCO in 2014:

‘Recovery’ concerns the ability of an FMI to recover from a threat to its viability and financial strength so that it can continue to provide its critical services without requiring the use of resolution powers by authorities. Recovery therefore takes place in the shadow of resolution.[44]

When recovery is not a viable option or where the execution of a recovery plan is ineffective, it is critical to financial stability for FMIs to have orderly resolution plans. Title II of Dodd-Frank established the Orderly Liquidation Authority, an alternative framework and process to bankruptcy to efficiently and expeditiously wind-down financial institutions.[45] Title II establishes the FDIC as the receiver for failing financial institutions designated as systematically important like SIDCOs.[46] Effective wind-down plans provide the benefit of well-considered strategic planning for wind-down in advance of any viability threatening event that can be shared with the FDIC in an instance of insolvency. Wind-down plans facilitate efficient transition of SIDCO into FDIC receivership. The key objectives for the orderly wind-down is to facilitate financial system stability by minimizing the fallout of financial instability and ultimately minimize systemic risk.

Amendments to Part 39

Today, the Commission –in consultation with the FDIC, Federal Reserve, and SEC– takes the next step in recovery and wind-down planning for DCOs by proposing amendments that encompasses all DCOs and provides clarity and specificity on the quality of such plans. We recognize that the failure of any DCO, not just those deemed significantly important, might result in significant market disruption. As such, the proposed regulations seek to provide important clarity and consistency for not only SIDCOs and Subpart C DCOs, but all DCOs. This NPRM codifies and expands upon DCR’s 16-61 Letter and incorporates international guidance on recovery and resolution planning issued since 2013. The DCR staff has thoughtfully crafted proposed rules which will guide SIDCOs, Subpart C DCOs, and all other DCOs in updating or crafting wind-down plans and in some instances, recovery plans.

Currently, Regulation 39.39 only applies to SIDCOs and Subpart C DCOs. It requires these DCOs “to maintain viable plans for recovery and orderly wind-down.”[47] The regulation specifies that in developing such plans, SIDCOs and Subpart C DCOs must identify scenarios which may prevent the DCO from meeting its obligations, providing its critical operations and services, and assess options for recovery and wind-down.[48] The wind-down plan must include procedures to timely notify the Commission when a recovery plan is initiated or a wind-down plan is pending as well as procedures for providing both the Commission and FDIC with necessary information for resolution planning.[49] Section 39 also requires the plans be supported with financial resources sufficient to implement such plans.[50] SIDCOs and Subpart C DCOS must also maintain viable plans for raising additional financial resources, including capital, which must be approved by the DCO’s board of directors and regularly updated.[51] For non-SIDCOs and non-Subpart C DCOs, no regulation currently requires them create and maintain recovery or wind-down plans.[52]

To alight part 39 with CFTC Letter No. 16-61 and international standards, the Commission proposes to require all DCOs create, maintain, and submit to the Commission plans for orderly wind-down substantially similar to those currently required for SIDCOs and Subpart C DCOs.[53] Additionally, the Commission proposes to amend section 39.39 for SIDCOs and Subpart C DCOs to include eight specific sections in their wind-down and recovery plans:

1. Identify and describe critical operations and services, interconnections and interdependencies, and agreements and plans to address the risks associated with each.[54]
2. Conduct a six-part analysis for each recovery scenario, including for commonly applicable scenarios like settlement or custodian bank failure and scenarios resulting from investment risk, poor business results, fraud, legal liabilities, and losses resulting from interconnectedness and interdependencies.[55]
3. Discuss criteria that may trigger consideration or implementation of the recovery plan, describes a plan for monitoring events that are likely trigger the recovery plan, and includes a description of information-sharing and escalation processes with the DCO’s senior management and board.[56]
4. Describe recovery tools, the order in which they will be used, the time frame for use of each tool, governance and approvals to execute the tools, necessary steps to implement the tools, whether a tool is mandatory or voluntary, and an assessment of the risks associated with each tool.[57]
5. Identify and describe scenarios that would prevent the DCO from meeting its obligations and tools that may be used in the orderly wind-down.[58]
6. Determine the agreements, arrangements, and licenses that are subject to change or termination as a result of activation of a recovery or wind-down plan and describe actions the DCO will take to ensure continuity of operations and services during recovery and wind-down despite alteration or termination.[59]
7. Include a requirement for an annual review and formal approval by the board of directors and describe the governance structure that defines the responsibilities of board members, senior executives, and business units. Must also include description of the decision-making process.[60]

Describe procedures for testing of viability plans and tools. The description must describe the types of testing and the procedures for updating the plans in light of findings from test results. The testing must be conducted with participation of clearing members.[61]

The other proposed amendments for Part 39 include updates to definitions to apply generally to all DCOs, establishing a fixed deadline to develop and file recovery and wind-down plans, requiring DCOs to provide certain information directly to the Commission to be shared with the FDIC[62] as well as information upon request, and updating the Subpart C election forms.

Conclusion

The need for orderly recovery is particularly important to me as I think back to my time as working in finance and then as an academic during the 2008 Financial Crisis. Prior to Dodd-Frank, there was no means of orderly resolution which proved tremendously harmful to our economy in a period of severe turmoil. The effort undertaken by DCR to create parallelism with international standards are important as our understanding of recovery and resolution has evolved since 2010. I believe the proposed rules, as currently drafted, would effectively facilitate transparency as well as provide a foundation for quick, efficient, and effective action in instances of market instability and risk to DCOs operations. Greater transparency and thoughtfully developed risk plans will result in increased confidence in our derivatives markets.

While I support the proposal, I look forward to carefully considering the comments we receive to determine the best path forward to protect our markets through the stability of DCOs. I am hopeful the comments submitted in response to the proposal will answer some of the explicit questions set out in the release text as well as support the drafting of final rules that create clarity for DCOs and our markets.

I want to thank the staff of the Division of Clearing and Risk –Robert Wasserman, Megan Wallace, and Eric Schmelzer– for their diligent and thoughtful work on these proposed regulations.

[1] Commodity Futures Trading Commission, Notice of Proposed Rulemaking on Derivatives Clearing Organizations Recovery and Orderly Wind-down Plans; Information for Resolution Planning, p. 5-6 (Jun. 7, 2023), available at https://www.cftc.gov/media/8711/votingdraft060723_17CFRPart39b/download (hereinafter “NPRM on DCO Recovery and Orderly Wind-down Plans”)

[2] Dodd-Frank Wall Street Reform and Consumer Protection Act, No. 111-203, 124 Stat. 1376 (2010).

[3] Derivatives Clearing Organizations and International Standards, 78 Fed. Reg. 72,475, 72,476 (Dec. 12, 2013) (codified in 17 C.F.R. §39) (hereinafter “2013 DCOs Rule Release”).

[4] 7 U.S.C. §7a-1(c)(2).

[5] NPRM on DCO Recovery and Orderly Wind-down Plans, p. 4.

[6] 7 U.S.C. §7a-1(c)(2)(A)(i); 7 U.S.C. §12a(5).

[7] Derivatives Clearing Organizations General Provisions and Core Principles, 76 Fed. Reg. 69,333 (November 8, 2011)(codified in 17 C.F.R.§§ 1, 21, 29, and 140)(hereinafter “2011 DCOs Core Principles Release”).

[8] 2011 DCOs Core Principles Release at 69,335.

[9] Id. at 69,362.

[10] 7 U.S.C. §7a-1(c)(2)(D).

[11] Section 805 of the Dodd-Frank Act, 12 U.S.C. §5464.

[12] Section 804 of the Dodd-Frank Act, 12 U.S.C. §5463.

[13] 2013 DCOs Final Rule Release at 72,477.

[14] Enhanced Risk Management Standards for Systemically Important Derivatives Clearing Organizations, 78 FR 49,663, 49,665 (August 15, 2023)(codified in 17 C.F.R. §39)(hereinafter “2013 SIDCOs Final Rule Release”).

[15] Section 805 of the Dodd-Frank Act, 12 U.S.C. §5464(b). “As outlined in section 805(c), these standards may address such areas as: “(1) Risk management policies and procedures; (2) margin and collateral requirements; (3) participant or counterparty default policies and procedures; (4) the ability to complete timely clearing and settlement of financial transactions; (5) capital and financial resources requirements for designated [FMUs]; and (6) other areas that are necessary to achieve the objectives and principles in [section 805](b).” 2013 SIDCO Final Rule Release at 49,665 (quoting 12 U.S.C. §5464(C)).

[16] NPRM on DCO Recovery and Orderly Wind-down Plans, p. 5.

[17] While not formally defined in Dodd-Frank, “disorderly failure” typically refers to a significant disruption to a financial institution without a plan for recovery or wind-down that results in the inability of the institution to maintain ongoing viability that cause detrimental impacts to customers, clients, related entities, and the broader financial system.

[18] NPRM on DCO Recovery and Orderly Wind-down Plans, p. 5.

[19] 2013 SIDCO Final Rule Release at 49,665.

[20] See 2013 SIDCO Final Rule Release.

[21] 2013 SIDCO Final Rule Release at 49,666.

[22] Id.

[23] Id.

[24] 2013 DCOs Final Rule Release at 72,494.

[25] In 2013, the Commission also adopted regulations to allow registered DCOs that are not designated as SIDCOs to elect to become subject to the provisions of in Subpart C of part 39 of the Commission’s regulations. Those DCOs that make the election are referred to as Subpart C DCOs. In making this election, Subpart C DCOs voluntarily agree to operate in compliance with and be subject to review for compliance with PFMIs and other heightened standards for SIDCOs. See 2013 DCOs Final Rule Release at 72,479.

[26] 2013 DCOs Final Rule Release at 72,495.

[27] Id. at 72,478.

[28] Id. at 72,495.

[29] Id.

[30] Id.

[31] CPMI-IOSCO, Recovery of financial market infrastructures (Oct. 15, 2014) (hereinafter “2014 CPMI-IOSCO Recovery Guidance”).

[32] 2014 CPMI-IOSCO Recovery Guidance.

[33] 2014 CPMI-IOSCO Recovery Guidance.

[34] CFTC Letter No. 16-61 (July 21, 2016).

[35] Id.

[36] Id. at 5.

[37] Id. at 7.

[38] Id. at 9.

[39] CPMI-IOSCO, Recovery of financial market infrastructures (July 5, 2017) (hereinafter “2017 CPMI-IOSCO Recovery Guidance”).

[40] NPRM on DCO Recovery and Orderly Wind-down Plans, p. 15.

[41] Id. (citing FSB, Guidance on Central Counterparty Resolution and Resolution Planning (July 5, 2017) (hereinafter “2017 FSB Resolution Guidance”)).

[42] Id. at 16 (citing CPMI-IOSCO, A discussion paper on central counterparty practices to address non-default loses (Aug. 4, 2022)).

[43] Id. at 17.

[44] 2014 CPMI-IOSCO Recovery Guidance.

[45] Section 202(b) of the Dodd-Frank Act; 12 U.S.C. 5384(b).

[46] See 12 U.S.C. 5384(b).

[47] 2013 DCOs Final Rule Release at 72,495; 17 C.F.R. §39.39(b).

[48] 17 C.F.R. §39.39(c)(1).

[49] 17 C.F.R. §39.39(c)(2).

[50] 17 C.F.R. §39.39(d).

[51] 17 C.F.R. §39.39(e).

[52] NPRM on DCO Recovery and Orderly Wind-down Plans, p. 13.

[53] Proposed §39.13(k); NPRM on DCO Recovery and Orderly Wind-down Plans, p. 18-19.

[54] Proposed §39.39(c)(1).

[55] Proposed §39.39(c)(2).

[56] Proposed §39.39(c)(3).

[57] Proposed §39.39(c)(4).

[58] Proposed §39.39(c)(5).

[59] Proposed §39.39(c)(6).

[60] Proposed §39.39(c)(7).

[61] Proposed §39.39(c)(8).

[62] This includes information about organization structure, activities, and governance; information about clearing members; arrangements with other clearing entities (including offset and cross-margin arrangements); financial schedules and supporting details (off balance sheet obligations, contingent liabilities, obligations to creditors, shareholders, and affiliates). Proposed §39.39(f)