Title VIII provides a new framework for assessing the systemic risk associated with financial institutions and financial market utilities involved in clearing activities for financial transactions. The Title grants authority to the Board of Governors of the Federal Reserve System (Board of Governors), U.S. Commodities Futures Trading Commission (CFTC), Securities & Exchange Commission (SEC), and Federal Deposit Insurance Corporation (FDIC) to work together to promulgate rules and standards of operation, enforce those rules, and generally help manage the systemic risk of these clearing entities and other financial market utilities.
When a financial transaction occurs, financial market utilities (FMUs) are responsible for finalizing the transaction by clearing transactions and settling the exchange of payment and securities between financial institutions. Efficient clearing processes are necessary to ensure that at the end of each trading day, all transactions are accounted for and netted to determine the standing of all parties in the market. The financial downturn in 2008 exposed inefficiencies in the clearing process for major financial institutions that could destabilize the economy. Therefore, Title VIII was implemented to mitigate systemic risk by establishing standards for efficient clearing processes, giving the Board of Governors more supervisory authority, and strengthening systemically important FMUs and other institutions that perform clearing activities. See 12 U.S.C. § 5461 (Dodd-Frank Act § 802).
This Title applies to any financial market utilities (FMUs) and other financial institutions that engage in clearing activities that the FSOC designates as “systematically important.” See 12 U.S.C. § 5462 (Dodd-Frank Act § 803). In applying that designation, the FSOC considers the aggregate value of the cleared transactions, the aggregate exposure of the market to that FMU, the relationship that the FMU has with other financial institutions, the potential effect on the market if that FMU failed, and any other appropriate factors. See id.
Supervisory and Rulemaking Authority
Title VIII provides for a multi-agency rulemaking and supervising system involving the FSOC, Board of Governors, FDIC, CFTC and SEC. See 12 U.S.C. § 5464 (Dodd-Frank Act §§ 805, 803(8)). The Board of Governors, with consultation and participation from the CFTC and FDIC, has the power to prescribe the standards that all covered FMUs must meet. See id. (Dodd-Frank Act § 805). Although the Title is careful not to expand the authority of the Board of Governors beyond what is authorized in the Commodities Exchange Act or the Securities Exchange Act, it does establish that rules promulgated by the Board of Governors will supersede any less stringent rules. See 12 U.S.C. § 5470 (Dodd-Frank Act § 811).
These standards can control risk management procedures, margin and collateral requirements, participant default policies, timely completion of clearing and settlement activities, and capital requirements. See 12 U.S.C. § 5464 (Dodd-Frank Act § 805). In addition to giving the Board of Governors and other supervisory agencies rulemaking power, Title VIII also authorizes those same organizations to conduct examinations of FMU operations and to exercise enforcement powers to compel compliance with new rules and standards. See 12 U.S.C. § 5466, 12 U.S.C. § 5467 (Dodd-Frank Act §§ 807, 808). Finally, Title VIII grants the Board of Governors the power to make any rules necessary to properly carry out their duties, a broad grant of rulemaking authority. See 12 U.S.C. § 5471 (Dodd-Frank Act § 812).
To help enhance the operations of the FMUs, Title VIII allows banking institutions to open banking accounts for designated FMUs. See 12 U.S.C. § 5465 (Dodd-Frank Act § 806). However, the same section severely curtails the power of those banks to extend loans to the FMUs. See id. Additionally, the Board of Governors has the ability to exempt or modify the requirements for capital reserves that would apply under § 19 of the Federal Reserve Act. See id.; 12 U.S.C. § 461.
As a part of the investigations of FMUs, the Board of Governors and other agencies have the power to collect reports, records and other information. See 12 U.S.C. § 5468 (Dodd-Frank Act § 809). Before an organization is designated as a covered FMU, agencies can demand any information necessary to evaluate the FMU’s systemic importance. See id. After designation, the agencies can collect any information regarding the FMUs or other financial institution’s clearing and settlement processes, or information used to assess compliance with the rules promulgated under the Title. See id. However, agencies must share any important information with their fellow supervisory organizations, and any information disclosed is afforded a special exemption from disclosure under the Freedom of Information Act. See id.; 5 U.S.C. § 552.
The future impact of Title VIII is still unclear. While the Title grants straightforward powers, the implementation of the Title will determine how broad the new powers of the Board of Governors are. For example, the Title does not provide guidance as to what constitutes a “systematically important” financial institution or FMU, or what standards will actually be promulgated for clearing operations.
The recent activity in rulemaking under Title VIII has attempted to address some of these questions. In the Financial Stability Oversight Council’s (FSOC) advance notice of proposed rulemaking in November 2010, they requested information that could be used in developing the specific criteria required to designate financial institutions as “systematically important.” The FSOC announced the rule regarding designation of FMUs on March 17, 2011. The CFTC has also promulgated standards of operation for derivative clearing operations, which would fall under the supervision of the CFTC. In addition, the SEC also proposed a rule regarding the process for review of security-based swaps.