The SEC has proposed rules intended to mitigate conflicts of interest for security-based swap clearing agencies, security-based swap execution facilities, and national securities exchanges that post security-based swaps or make them available for trading. Section 765 of the Dodd-Frank Act lays out requirements designed to mitigate conflicts of interests at clearing agencies that clear security-based swaps, at security-based swap execution facilities, or SEFs, and at national securities exchanges that post or make available for trading security-based swaps. To accomplish this, the section provides that the SEC may adopt rules that include numerical limits on control of, or voting rights with respect to, such clearing agencies, execution facilities and exchanges.

The over-the-counter derivatives market has a relatively high concentration of market activity among a limited number of dealers that earn significant revenues from the currently opaque over-the-counter market. SEC staff have identified three primary areas where it believes a conflict of interest could adversely affect the central clearing of security-based swaps:

  • First, participants could seek to limit access to the security-based swap clearing agency by other participants in order to maintain a competitive advantage.
  • Second, participants could seek to limit the scope of products eligible for clearing at the security-based swap clearing agency, particularly if there is an economic incentive to keep the product traded in the over-the-counter market.
  • Third, participants could seek to lower the risk management controls of a security-based swap clearing agency in order to reduce their collateral requirements.

The proposed rules, known as Proposed Regulation MC, require security-based swap clearing agencies, security-based SEFs and security-based swap exchanges to adopt ownership and voting limitations as well as certain governance requirements. Key elements of the proposal include requiring, with respect to security-based swap clearing agencies, one of the following two alternatives:

First Alternative

  • Restrict an individual clearing agency participant from beneficially owning or voting more than 20 percent of any voting interest in the security-based swap clearing agency.
  • Restrict clearing agency participants from beneficially owning or voting more than 40 percent of any voting interest in the security-based swap clearing agency in the aggregate with any other clearing agency participants.
  • The board of directors and any committee that has authority to act on behalf of the board be composed of 35 percent of independent directors.
  • The nominating committee be composed of a majority of independent directors.

Second Alternative

  • Restrict an individual clearing agency participant from beneficially owning or voting more than 5 percent of any voting interest in the security-based swap clearing agency.
  • The board of directors and any committee that has authority to act on behalf of the board be composed of a majority of independent directors.
  • The nominating committee be composed solely of independent directors.

Other key elements of the proposal include:

  • Security-based SEFs and security-based swap exchanges restrict participants or members, as applicable, from owning or holding more than 20 percent of any voting interest of such entity.
  • The board of directors of a security-based SEF or security-based swap exchange, any executive committee of the board of a security-based SEF or security-based swap exchange, and any board committee exercising powers of the board of a security-based SEF or security-based swap exchange be composed of a majority of independent directors.
  • The nominating committee of a security-based SEF or security-based swap exchange consists solely of independent directors.
  • The board of directors of a security-based SEF or security-based swap exchange establish a regulatory oversight committee consisting solely of independent directors to oversee the security-based SEF’s or security-based swap exchange’s regulatory program, and any recommendation of a regulatory oversight committee that is not adopted by the board of a security-based SEF or security-based swaps exchange be reported promptly to the Commission.
  • The disciplinary panels of a security-based swap clearing agency, security-based SEF or security-based swap exchange be compositionally balanced and include one person who would qualify as an independent director.