Governance Requirements for Derivatives Clearing Organizations

As previously announced by U.S. Commodity Futures Trading Commission (CFTC) (please see EventID 21565 in this context for more information), the Commission has now published in the Federal Register its final rule as regards enhanced governance requirements of Derivative Clearing Organizations (DCOs). The aim of the new rule is to improve risk management processes of DCOs, including the identification and handling of risks, so as to reduce the likelihood of failures and costs resulting from such. Furthermore, the new rule shall give market participants „a voice in DCO risk management matters“ which shall ensure that risks are adequately addressed and minimized.
The following paragraph presents a more detailed description of the key requirements of DCOs that are implemented by the new rule:
(1) Creation of a „risk management committee (RMC) by a DCO: The final rule requires the establishment of an RMC whose key responsibility will be to oversee matters that could significantly impact a DCO’s risk profile. In this context, the Board of Directors of a DCO will have to consult with and consider input from these committees on various aspects, such as changes to margin models, default procedures, risk monitoring practices, participation requirements, and the clearing of new products. The Derivatives Clearing Organization should have written policies outlining the consultation process, requiring documentation of the Board’s consideration and response to the committee’s input, and keeping minutes of each committee meeting. The risk management committee should consist of at least two clearing member representatives and, if applicable, two customer representatives. The membership in an RMC must be „regularly“ rotated.
Furthermore, a DCO must establish policies that empower members of RMCs to offer well-informed risk-based insights on all issues brought before the committee by the Advisory Working Groups (RWGs) – please see part (2) below for a detailed description of the new RWGs, their composition, and function. Moreover, a DCO shall ensure that the committee members fulfill their responsibilities in a way that promotes the safety and efficiency of the derivatives clearing organization and ensures the stability of the broader financial system.
(2) Creation of market participant Risk Advisory Working Groups: As mentioned before, the establishment of RWGs is a means to ensure that a DCO obtains risk-based input from a diverse group of market participants. These groups serve as forums where clearing members and customers of clearing members can participate and provide valuable insights on matters that could significantly impact the risk profile of the DCO. In this context, DCOs are required to do the following:
– The DCO must set up one or more market participant risk advisory working groups. The groups should be structured in a way that allows for a diverse cross-section of participants, including clearing members (such as banks and financial institutions) and customers of clearing members (such as institutional investors, asset managers, and hedge funds) to be represented. The goal is to ensure a broad range of perspectives and experiences to better identify and assess potential risks.
– The DCO should develop and maintain written policies and procedures governing the formation and role of each risk advisory working group. These policies and procedures should outline the purpose, objectives, and responsibilities of the working groups. DCOs must also specify the selection criteria for participants to ensure a fair representation of various market participants.
– The DCO should require each risk advisory working group to document the discussions and outcomes of their meetings thoroughly. At a minimum, the groups should prepare summaries of the topics discussed and the key points raised during each meeting. This documentation should be shared with the risk management committee, which can use it to assess and respond to emerging risks effectively.
– Each market participant risk advisory working group should convene at least two times per year. This regularity ensures that the DCO remains up-to-date with the latest developments and risks in the derivatives market. Depending on the complexity and volatility of the market, more frequent meetings may be considered.
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To conclude, it may be worth noting that generally speaking, the CFTC has in large adopted the rule as it was proposed. One change concerned the type of input provided by the RWG which shall be rather risk-based input as opposed to commercially-driven input, as many respondents found risk-based matters to better reflect the purpose of the new groups.