[Federal Register Volume 77, Number 149 (Thursday, August 2, 2012)]
[Rules and Regulations]
[Pages 45907-45921]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-18762]


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FEDERAL RESERVE SYSTEM

12 CFR Part 234

[Regulation HH; Docket No. R-1412]
RIN 7100-AD 71


Financial Market Utilities

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is publishing a final rule, Regulation HH, 
Designated Financial Market Utilities. This rule implements provisions 
of sections 805(a) and 806(e) of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank Act'' or ``Act''), including 
risk-management standards for financial market utilities (``FMUs'') 
that are designated as systemically important by the Financial 
Stability Oversight Council (the ``Council'') and standards for 
determining when a designated FMU is required to provide advance notice 
of proposed changes to its rules, procedures, or operations that could 
materially affect the nature or level of risks presented by the 
designated FMU.

DATES: This final rule is effective September 14, 2012.

FOR FURTHER INFORMATION CONTACT: Jennifer A. Lucier, Assistant Director 
(202) 872-7581 or Kathy C. Wang, Senior Financial Services Analyst 
(202) 872-4991, Division of Reserve Bank Operations and Payment 
Systems; Christopher W. Clubb, Senior Counsel (202) 452-3904 or Kara L. 
Handzlik, Senior Attorney (202) 452-3852, Legal Division; for users of 
Telecommunications Device for the Deaf (TDD) only, contact (202) 263-
4869.

SUPPLEMENTARY INFORMATION: 

I. Background

    Title VIII of the Dodd-Frank Act, titled the ``Payment, Clearing, 
and Settlement Supervision Act of 2010,'' was enacted to mitigate 
systemic risk in the financial system and to promote financial 
stability, in part, through enhanced supervision of designated FMUs.\1\ 
Section 803 of the Dodd-Frank

[[Page 45908]]

Act defines an FMU as a person that manages or operates a multilateral 
system for the purpose of transferring, clearing, or settling payments, 
securities, or other financial transactions among financial 
institutions or between financial institutions and the person. The 
basic risks that FMUs must manage include credit risk, liquidity risk, 
settlement risk, operational risk, and legal risk. These risks arise 
between financial institutions and FMUs as they settle payments and 
other financial transactions. In order to maintain financial stability, 
FMUs must be well-designed and operated in a safe and sound manner. If 
a systemically important FMU fails to measure, monitor, and manage its 
risks effectively, it could pose significant risk to its participants 
and the financial system more broadly.
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    \1\ The Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376, was 
signed into law on July 21, 2010.
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    Under section 805(a)(1) of the Dodd-Frank Act, the Board is 
required to promulgate risk-management standards governing the 
operations related to the payment, clearing, and settlement (``PCS'') 
activities of certain FMUs that are designated as systemically 
important by the Council. Section 805(a)(1) of the Act also requires 
the Board to take into consideration relevant international standards 
and existing prudential requirements in prescribing the regulations. 
For a designated FMU that is a derivatives clearing organization 
(``DCO'') registered under section 5b of the Commodity Exchange Act or 
a clearing agency registered under section 17A of the Securities 
Exchange Act of 1934 (collectively, ``designated clearing entities''), 
the Commodity Futures Trading Commission (``CFTC'') or the Securities 
and Exchange Commission (``SEC''), respectively, are granted authority 
to prescribe regulations, in consultation with the Council and the 
Board, containing applicable risk-management standards.\2\
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    \2\ Under section 805(a)(2) of the Act, the CFTC and the SEC are 
also required to take relevant international standards and existing 
prudential requirements into consideration in prescribing 
regulations containing risk-management standards governing 
designated clearing entities.
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    Section 805(b) of the Act sets out the following objectives and 
principles for the risk-management standards: (a) Promote robust risk 
management, (b) promote safety and soundness, (c) reduce systemic 
risks, and (d) support the stability of the broader financial system. 
Section 805(c) of the Act states that risk-management standards may 
address areas such 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 resource requirements for designated FMUs, and (6) other 
areas that are necessary to achieve the objectives and principles for 
risk-management standards.
    In addition, section 806(e)(1) of the Dodd-Frank Act requires a 
designated FMU to provide 60 days' advance notice to its Supervisory 
Agency of any proposed change to its rules, procedures, or operations 
that could, as defined in rules of each Supervisory Agency, materially 
affect the nature or level of risks presented by the designated FMU. 
Under section 803(b) of the Act, a ``Supervisory Agency'' means the 
federal agency that has primary jurisdiction over a designated FMU 
under federal banking, securities, or commodity futures laws.\3\
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    \3\ A Supervisory Agency includes the SEC and CFTC with respect 
to their respective designated clearing entities (as defined above), 
the appropriate federal banking agencies (including the Board) with 
respect to FMUs that are institutions described in section 3(q) of 
the Federal Deposit Insurance Act (12 U.S.C. 1813(q)), and the Board 
with respect to a designated FMU that is otherwise not subject to 
the jurisdiction of any of the agencies listed above.
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    In April 2011, the Board published for comment a notice of proposed 
rulemaking (``NPRM'') to propose a new part to the Code of Federal 
Regulations (12 CFR part 234, Regulation HH) to establish risk-
management standards for designated FMUs and requirements for advance 
notice of material changes to a designated FMU's rules, procedures, or 
operations.\4\ The public comment period closed on May 19, 2011.
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    \4\ See 76 FR 18445 (Apr. 4, 2011).
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II. Summary of Public Comments and Analysis

    The Board received twelve public comment letters on the NPRM. 
Comments were submitted by two payment systems, seven industry and 
other groups, one bank, and two other commenters. In general, the 
comments pertained broadly to three categories: (i) Risk-management 
standards, (ii) advance notice requirements and the materiality 
definition, and (iii) other miscellaneous comments. The Board 
considered these comments in developing its final rule as discussed in 
more detail below.\5\
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    \5\ In addition, the Board is adopting several changes intended 
to clarify the requirements of the regulation.
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A. Risk-Management Standards

1. International Standards
    Proposed Sec.  234.3 sets out risk-management standards for 
designated FMUs that are payment systems, and proposed Sec.  234.4 sets 
out risk-management standards for central counterparties (``CCPs'') and 
central securities depositories (``CSDs''), based on the international 
risk-management standards developed by the Committee on Payment and 
Settlement Systems (``CPSS'') and the Technical Committee of the 
International Organization of Securities Commissions (``IOSCO''). These 
international standards were the Core Principles for Systemically 
Important Payment Systems (the ``Core Principles'') developed by the 
CPSS in 2001, and the Recommendations for Securities Settlement Systems 
and the Recommendations for Central Counterparties (collectively, the 
``CPSS-IOSCO Recommendations'') developed jointly by the CPSS and IOSCO 
in 2001 and 2004, respectively. The Board believes these standards are 
the appropriate basis for setting initial risk-management standards 
under Title VIII for several reasons. First, section 805(a)(1) of the 
Act directs the Board to consider relevant international standards in 
prescribing risk-management standards under Title VIII. As explained in 
the NPRM, the Core Principles and the CPSS-IOSCO Recommendations were 
the international standards most relevant to risk management of 
FMUs.\6\ Second, FMUs are familiar with these standards as the long-
standing basis for Part I of the Federal Reserve Policy on Payment 
System Risk (``PSR policy'').\7\ Third, the Board has significant 
experience applying these international standards to large-value 
payment and settlement systems pursuant to its PSR policy.
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    \6\ See 76 FR at 18447.
    \7\ The PSR policy is available on the Board's public Web site 
at: http://www.federalreserve.gov/paymentsystems/psr_policy.htm.
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    CPSS and IOSCO recently conducted a comprehensive review of risk-
management standards for PCS systems. On April 16, 2012, CPSS and IOSCO 
issued the final report on the ``Principles for Financial Market 
Infrastructures,'' which includes an updated, harmonized, and 
strengthened set of international risk-management standards (the 
``PFMI'').\8\ CPSS and IOSCO intend for the PFMI to replace the Core 
Principles and CPSS-IOSCO Recommendations. As noted in the NPRM, the 
Board anticipates that it will review the new international standards, 
consult with other appropriate agencies and the Council, and seek 
public comment on the adoption of revised

[[Page 45909]]

standards for designated FMUs based on the new international standards.
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    \8\ The Principles for Financial Market Infrastructures are 
available at http://www.bis.org/publ/cpss101a.pdf. The final report 
reflects comments received during the public consultation period 
from March 10, 2011 to July 29, 2011.
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    Commenters generally appeared to support the Board's approach of 
using the Core Principles and CPSS-IOSCO Recommendations as a basis for 
its risk-management standards for designated FMUs under section 805 of 
the Act. Two commenters explicitly stated their support for the Board's 
approach. Two other commenters stated that the proposed risk-management 
standards were largely prudent and sensible.
    One commenter was also supportive of the Board's intention to 
evaluate the new international standards once they are final for the 
purposes of revising Regulation HH. Two other commenters expressed some 
general reservations with respect to the new international standards; 
one of the commenters cautioned the Board against adopting the new 
international standards ``in full,'' because doing so would include 
principles that may not directly relate to the risks posed by the 
designated FMUs and contemplated by Title VIII.
    After considering the public comments and for the reasons stated 
above, the Board continues to believe that the most suitable approach 
to establishing initial risk-management standards under Title VIII of 
the Act is to use the Core Principles and CPSS-IOSCO Recommendations as 
the basis for the standards promulgated by this notice, and to proceed 
with consideration of the PFMI as the basis for any future revisions. 
The Board agrees with commenters that international standards that are 
not, in some way or to some degree, related to existing or potential 
risks posed to or by a designated FMU should not be adopted for 
purposes of section 805 of the Act. As noted in the NPRM, the Board 
acknowledged that the scope of the Core Principles and CPSS-IOSCO 
Recommendations is broad and proposed to adopt by regulation particular 
standards, or portions thereof, that relate to the risks presented to 
or by a designated FMU, rather than those standards, or portions 
thereof, that apply more generally to financial markets or regulators. 
Similarly, the Board anticipates evaluating the appropriateness of each 
of the new PFMI for the purpose of possible revisions to Regulation HH.
2. Applicability of Standards to Retail Payment Systems
    Proposed Sec.  234.3 is based on the entire set of the Core 
Principles. Some commenters questioned whether three standards included 
in the Core Principles could be applied to retail payment systems, 
particularly automated clearinghouses (``ACH'') and check 
clearinghouses, should those systems be designated as systemically 
important by the Council. Specifically, proposed Sec.  234.3(a)(3) 
would require any FMU that is designated on the basis of its role as 
operator of a payment system to have clearly defined procedures for the 
management of credit risks and liquidity risks, which specify the 
respective responsibilities of the system operator and the participants 
and which provide appropriate incentives to manage and contain those 
risks. Proposed Sec.  234.3(a)(4) would require any designated FMU that 
is designated on the basis of its role as operator of a payment system 
to provide prompt final settlement on the day of value, preferably 
during the day and at a minimum at the end of the day. Proposed Sec.  
234.3(a)(5) would require any designated FMU that is designated on the 
basis of its role as operator of a payment system, and in which 
multilateral netting takes place, to, at a minimum, be capable of 
ensuring the timely completion of daily settlements in the event of an 
inability to settle by the participant with the largest single 
settlement obligation.
    The Board received several comments on the applicability of these 
risk-management standards to retail payment systems, should they be 
designated by the Council. Several commenters stated their support for 
an exemption for retail payment systems from designation as 
systemically important by the Council under the Dodd-Frank Act. The 
Council, however, determined not to categorically exclude FMUs 
operating retail payment or other systems in its rule regarding the FMU 
designation process.\9\ As a result, commenters provided feedback on 
the ability of retail payment systems to meet certain of the Board's 
proposed risk-management standards in the event the Council decides to 
designate them.
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    \9\ See 76 FR 44763, 44769 (July 27, 2011).
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    One commenter specifically referenced proposed Sec.  234.3(a)(3)-
(5) as risk-management standards that, while appropriate risk controls 
for truly systemically important payment systems, were generally 
inapplicable (or had no relevance) to payments systems such as ACH 
clearing arrangements that permit the return of transactions within a 
certain timeframe. One commenter argued that the standard in proposed 
Sec.  234.3(a)(3) regarding the management of credit and liquidity risk 
would have no application where a system that did not assume credit and 
liquidity risks in the first place by committing to pay funds that it 
had not received and where the payment system participants expect to 
manage their own credit and liquidity risks. Two commenters also stated 
that proposed Sec.  234.3(a)(4) on settlement finality contradicts 
long-standing and established practices of ACH rules that allow for 
certain transactions to be reversed or returned for any reason until 
the banking day after the settlement date. One commenter stated that 
application of proposed Sec.  234.3(a)(5) regarding the ability to 
complete settlement in the event the single largest participant is 
unable to settle would require a fundamental change in the nature of 
ACH debit transactions and the abolishment of the right to return the 
transaction. In general, these commenters stated that they do not 
believe that, if designated, retail payment systems would be able to 
comply with these proposed standards and, accordingly, asked that such 
systems be exempted from them.
    The Board notes that the proposed risk-management standards were 
designed to apply to large-value payment systems. This approach is 
consistent with the direction of the Council expressed in its final 
rule on the FMU designation process. Specifically, the Council stated 
that, within payment systems, it expects to focus at this time on FMUs 
that operate large-value systems and not on FMUs that operate low-value 
systems (such as check and ACH).\10\ The Council also decided not to 
include considerations more narrowly tailored to the characteristics of 
retail payment systems because the Council did not believe they were 
necessary or appropriate given the current focus for designations.
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    \10\ See 76 FR at 44769. The Council also decided, however, 
against including in the final rule any categorical exclusion for 
FMUs operating retail payment or other systems, both because there 
are not clear distinctions between various types of systems, and 
because such an exclusion would impair the Council's ability to 
respond appropriately to new information, changed circumstances, and 
future developments.
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    Given the Council's focus on large-value systems, the Board does 
not anticipate that the Council will designate a FMU under Title VIII 
on the basis of its role as operator of a retail payment system. 
However, because the authority to designate systemically important FMUs 
resides with the Council, not the Board, the Board cannot be assured of 
the type of FMU the Council may designate in the future. In the event 
that the Council designates an FMU on the basis of its role as operator 
of a retail payment system, the Board would review, at that time, 
whether the risk-management standards in Sec.  234.3 were appropriate 
for that

[[Page 45910]]

designated FMU, as it would for any type of newly designated FMU.
    In order to accommodate this review in the event that an 
unanticipated type of FMU is designated, and in consideration of the 
comments, the Board is adopting in the final rule a modification to 
proposed Sec. Sec.  234.3(b) and 234.4(b) that clarifies that the 
application of individual risk-management standards could be waived in 
a situation where such standards could not appropriately be applied to 
a particular designated FMU. Both Sec. Sec.  234.3(b) and 234.4(b) will 
be amended by inserting text that states ``[t]he Board, by order, may 
waive the application of a standard or standards to a particular 
designated financial market utility where the risks presented by or the 
design of that designated financial market utility would make the 
application of the standard or standards inappropriate.'' This revision 
is intended to bridge any gap between Council designation of a new type 
of designated FMU and the process of promulgating regulations 
appropriate for the new type of designated FMU, if necessary.
    In addition, the Board notes that with respect to a designated FMU 
that operates more than one payment system (e.g., one large-value and 
one retail), standards would apply only with respect to the system that 
provided the basis for the Council's designation of the FMU. The Board 
is modifying Sec.  234.3(a) and (b) to clarify this point. The Board 
also is making a parallel modification to Sec.  234.4(a) and (b).\11\
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    \11\ To conform to these modifications, the Board is revising 
the definitions in Sec.  234.2 (a), (b), and (e).
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    The Board is also modifying Sec. Sec.  234.3(a) and 234.4(a) to 
require a designated FMU to ``implement rules, procedures, or 
operations designed to ensure that it meets or exceeds'' the risk-
management standards set forth in these sections. In addition, the word 
``should'' has been deleted from the individual standards to clarify 
that these are requirements with which a designated FMU must comply.
3. Scope of Risk-Management Standards
    As noted above, the proposed risk-management standards for 
designated FMUs that operate as payment systems, CCPs, or CSDs are 
based on the Core Principles and CPSS-IOSCO Recommendations. Each set 
includes separate standards relating to efficiency, access criteria, 
and governance. Several commenters suggested that the Board eliminate 
some or all of these three proposed standards for payment systems, 
arguing that they address system operating issues that are outside the 
scope of the systemic risk issues contemplated by Title VIII of the 
Dodd-Frank Act. Specifically, the commenters questioned whether 
proposed Sec.  234.3(a)(8), (9), and (10) regarding efficiency, access 
criteria, and governance, respectively, were relevant to systemic 
risk.\12\ The applicability of the efficiency standard was a common 
concern of the commenters that raised questions about the scope of the 
risk-management standards; a subset of these commenters also questioned 
whether either the access criteria or governance standard was within 
the scope of risk management. These standards in general were viewed as 
admirable goals that designated FMUs should aim to achieve, but 
nevertheless as goals that should be driven by market forces and not by 
regulatory mandate.
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    \12\ One commenter raised similar concerns with the 
corresponding access criteria and governance standards in proposed 
Sec.  234.4(a)(2) and (8) with respect to CSDs and CCPs.
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    Efficiency. The efficiency standard in proposed Sec.  234.3(a)(8) 
states that an FMU that is designated on the basis of its role as 
operator of a payment system should provide a means of making payments 
that is practical for its users and efficient for the economy. Several 
commenters argued that the efficiency standard exceeds the Act's 
objectives because it addresses operating system issues and not risk 
matters. One commenter argued that whether a form of payment is 
practical and efficient is largely a matter of judgment that is better 
left to the market and its participants.
    The Board believes the efficiency standard furthers the objectives 
set out in Title VIII of the Act to reduce systemic risks and support 
the stability of the broader financial system.
    A designated FMU supports the ongoing functioning and stability of 
the market it serves by providing effective, reliable PCS services to 
its participants and, in particular, completing timely clearing and 
settlement of financial transactions. An FMU that is designed or 
managed inefficiently or impractically may ultimately distort financial 
activity and market structure, increasing not only the financial and 
other risks of an FMU's participants, but also the risks of their 
customers and end users. To avoid such outcomes, a designated FMU 
should consider the tradeoffs between, and seek a reasonable balance 
of, safety (i.e., risk management) and efficiency (i.e., direct and 
indirect costs) when designing and managing the system. For example, 
overly demanding financial resource requirements may create a liquidity 
demand so high that it would be impractical for participants to meet. 
Although liquidity is very important, an FMU that accumulates excessive 
liquid resources from its participants intraday may increase the 
participants' opportunity cost of sending each payment. In such cases, 
participants that become liquidity constrained may be forced to delay 
submitting certain time- or mission-critical payments.
    Additionally, an FMU's design, operating structure, scope of PCS 
activities, and use of technology can influence its efficiency and can 
ultimately provide incentives for market participants to use, or not 
use, the FMU's services. For example, in certain cases, inefficiently 
designed systems may increase costs to the point where it would be 
cost-prohibitive for participants to use the FMU, and possibly drive 
market participants toward less safe alternatives, such as bilateral 
clearing or settlement on the books of the participants. In such cases, 
risks to the market participants increase as they seek less safe 
opportunities to lower direct costs; this behavior may reintroduce risk 
into the market that the FMU was intended to mitigate.
    As these examples suggest, a designated FMU must function 
efficiently, as well as safely, and provide services that are 
appropriate to the needs of its users without becoming cost-prohibitive 
to use. A designated FMU that is inefficient can have a direct, 
negative impact on financial stability. Accordingly, the Board believes 
that it is appropriate for a supervisor of a designated FMU to take 
into account the need for practical and efficient design of the 
designated FMU as part of the set of risk-management standards set 
forth in Regulation HH. For these reasons, the Board is adopting the 
efficiency standards in proposed Sec. Sec.  234.3(a)(8) and 234.4(a)(6) 
essentially as set out in the NPRM.
    Access criteria. The access criteria standard in proposed Sec.  
234.3(a)(9) states that a payment system should have objective and 
publicly disclosed criteria for participation, which permit fair and 
open access. Some commenters argued that the access criteria standard 
did not relate to any of the risks contemplated by Title VIII of the 
Act. One commenter stated that the actions taken by the payment system, 
CSD, or CCP, create or mitigate risk, not the rules governing who can 
participate in them. Another commenter noted that the participation 
structure for payment systems can vary broadly and, while the 
participation criteria for these systems could be an issue for 
competition law, it was

[[Page 45911]]

difficult to see how the criteria could directly affect the risks that 
were the focus of Title VIII.
    The Board believes that access criteria are important to a 
designated FMU's risk-management framework and affect the level of risk 
a designated FMU presents to the financial system. Access criteria are 
typically referred to as an FMU's ``first line of defense'' in ensuring 
it admits financial institutions that will be able to meet their 
obligations and not expose the FMU or its other participants to 
unacceptable risk. Access criteria need to be designed to ensure that 
participants meet appropriate operational, financial, and legal 
requirements to allow them to meet their obligations on a timely 
basis.\13\ However, these criteria need to be balanced against the 
FMU's ability to effectively serve the market it supports, in 
particular markets that are subject to a statutory requirement for 
central clearing or settlement through an FMU. Although a designated 
FMU may use risk-based measures to control access, requirements that 
are unnecessarily discriminatory or overly restrictive can minimize the 
FMU's overall effectiveness.
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    \13\ For example, a designated FMU may set access criteria based 
on risk measures such as capital ratios, risk ratings, or other 
indicators.
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    Criteria that allow for fair and open access also may help achieve 
the Title VIII objectives of reducing systemic risk and supporting the 
overall stability of the financial system. A fair and open approach to 
participation criteria may help prevent the concentration of financial 
activity (and therefore risk) into a few large participants. By 
encouraging the reduction of risk concentration, the proposed standard 
helps lower the likelihood that a few financial institutions will be 
perceived as ``too big to fail.'' Broad participation in a designated 
FMU can, for example, increase the effectiveness of multilateral 
netting, facilitate crisis management by applying a consistent set of 
rules and procedures (e.g., default management, loss mutualization), 
and improve overall market transparency by increasing the number of 
transactions processed by the FMU. Accordingly, access criteria that do 
not permit fair and open access may reduce the overall risk-reduction 
benefits that a designated FMU can offer.
    For these reasons, the Board is adopting the access criteria 
standards in proposed Sec. Sec.  234.3(a)(9) and 234.4(a)(2) 
essentially as set out in the NPRM.
    Governance. The governance standard in proposed Sec.  234.3(a)(10) 
states that a payment system's governance arrangements should be 
effective, accountable, and transparent. Some commenters claimed that 
although the decisions made by a designated FMU's governing body can 
affect the risks it presents, the particular governance structure 
itself presents no such risks. Conversely, one commenter supported 
inclusion of the governance standard, stating that weak governance 
practices and poor risk-management procedures at designated FMUs could 
pose hazards both to participating financial institutions and to the 
market as a whole. Another commenter stated that risk management 
effectively encompasses governance, among other areas.
    The Board believes that effective, accountable, and transparent 
governance arrangements are critical to the effective risk management 
of a designated FMU. A strong governance arrangement provides a sound 
basis for compliance with the other risk-management standards in 
Regulation HH. A number of tools or techniques discussed in the Core 
Principles with respect to the governance standard have proved to be 
effective in ensuring effective governance, such as written strategic 
objectives and plans for achieving them and separation of risk 
management and audit functions from day-to-day operations. The Board 
expects supervisors to review a designated FMU's governance 
arrangements against the background of these and other relevant 
techniques in order to promote robust risk management. In addition, 
given the role of the FMU's board of directors in setting the overall 
risk-management framework of the designated FMU, the Board believes 
that a weak or ineffective governance structure could have systemic 
implications for the participants of the service, other FMUs, and other 
markets. Accordingly, the Board believes that a supervisor should 
consider a designated FMU's governance arrangements when performing its 
systemic risk review. For these reasons, the Board is adopting the 
governance standard in proposed Sec. Sec.  234.3(a)(10) and 234.4(a)(8) 
essentially as set out in the NPRM.
4. Independent Model Validation
    Proposed Sec.  234.4(a)(17) requires a designated FMU that operates 
as a CCP to use margin requirements to limit its credit exposures to 
participants in normal market conditions and use risk-based models and 
parameters that are reviewed regularly. In addition, proposed Sec.  
234.4(a)(17)(i) would require a CCP to provide for annual model 
validation consisting of evaluating the performance of the CCP's margin 
models and the related parameters and assumptions associated with such 
models by a qualified person who does not perform functions associated 
with the CCP's margin models (except as part of the annual model 
validation) and also does not report to such a person.\14\ Two 
commenters noted that proposed Sec.  234.4(a)(17)(i), although on the 
right track, should stress explicitly the complete independence of the 
organization conducting the validation. One of the commenters believed 
models must be validated annually by a qualified and independent 
organization with no financial stake in the outcome because no employee 
of a systemically important CCP should be expected to resist the 
inevitable direct and indirect pressures of management who may have 
incentives to achieve a less-appropriate and less-independent outcome. 
The other commenter also stated that model validation must be performed 
by a truly independent party with no financial stake in the outcome of 
the validation and expressed concern that a validator that is not 
sufficiently independent would face the conflict of interest that would 
lead designated FMUs to lower their margins in order to attract 
business and increase profits.
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    \14\ Proposed Sec.  234.4(a)(17)(i) inadvertently referred to 
the margin models of the ``clearing agency.'' The Board has revised 
these references to ``central counterparty'' in the final rule.
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    The Board believes that a validator must be able to offer 
independent, unbiased conclusions and recommendations as part of the 
margin model validation process. It is unlikely that the person who was 
responsible for initially developing the margin model would be able to 
provide an independent, unbiased assessment of the product. Similarly, 
it appears unlikely that a person under the functional control of the 
developer would be able to provide independent, unbiased validation of 
the model without the influence of the developer and concern for 
employment security. Accordingly, proposed Sec.  234.4(a)(17)(i) would 
require that the model validation be conducted by a qualified person 
who does not perform functions associated with the CCP's margin model, 
such as development and implementation, and does not report to such a 
person.\15\
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    \15\ This position is generally consistent with current 
supervisory guidance on model risk management by banks. See SR 
letter 11-7, p.3 (Apr. 4, 2011), which states:
    Validation involves a degree of independence from model 
development and use. Generally, validation is done by staff who are 
not responsible for model development or use and do not have a stake 
in whether a model is determined to be valid. As a practical matter, 
some validation work may be most effectively done by model 
developers and users; it is essential, however, that such validation 
work be subject to critical review by an independent party, who 
should conduct additional activities to ensure proper validation. 
Overall, the quality of the validation process is indicated by 
critical review by objective, knowledgeable parties and the actions 
taken to address issues identified by those parties.

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[[Page 45912]]

    The Board recognizes the concern expressed in the comments that 
there may be financial considerations beyond the validator's immediate 
employment security, and that there may be situations where a validator 
from outside the CCP may be needed to provide an appropriately 
independent validation. In such cases, the Board may hold a particular 
designated FMU to a stricter definition of independent validation that 
is appropriate for the level of risk presented by the designated FMU. 
Proposed Sec.  234.4(b) allows for the Board, by order, to apply 
heightened risk-management standards to a particular designated FMU in 
response to the risks presented by that designated FMU. As a generally 
applicable standard, however, the Board believes it is appropriate to 
recognize basic requirements for an independent validation. For these 
reasons, the Board is adopting proposed Sec.  234.4(a)(17)(i) 
essentially as set out in the NPRM.
5. Financial Resource Coverage
    Proposed Sec.  234.4(a)(15) would require a designated FMU that is 
acting as a CSD to institute risk controls that include collateral 
requirements and limits, and ensure timely settlement in the event that 
the participant with the largest payment obligation is unable to settle 
when the CSD extends intraday credit. Proposed Sec.  234.4(a)(18) would 
require a designated FMU that is acting as a CCP to maintain sufficient 
financial resources to withstand, at a minimum, a default by the 
participant to which it has the largest exposure in extreme but 
plausible market conditions. The Board specifically requested comment 
on whether such designated FMUs should be required to maintain 
sufficient financial resources to withstand the default by the 
participant with the largest exposure or obligation in extreme but 
plausible market conditions, where the ``participant'' means the family 
of affiliated participants when there is more than one affiliated 
participant (``cover one''), or whether such designated FMUs should be 
required to maintain sufficient financial resources to withstand the 
defaults by the two participants, plus any affiliated participants, 
with the largest exposures or obligations in extreme but plausible 
market conditions (``cover two'').
    Two commenters stated that, if the Board continued to base its 
financial resources standard on the number of participants that pose 
large risk exposures to a CCP, they supported the higher cover two 
requirement. One commenter cited the ``interconnectedness of financial 
institutions'' as one of the central dangers, which must be addressed 
by financial reforms and a reason for adopting a cover two standard. 
This commenter also suggested that the Board's rule should conform to a 
similar standard proposed by the CFTC for systemically important DCOs, 
which included a cover two requirement.\16\ The other commenter 
supported a cover two standard because, during a period of extreme 
market stress, it cannot be guaranteed that there will be only a single 
default. Neither commenter, however, provided any analysis to support 
its contention that a cover two standard would be more appropriate as a 
generally applicable standard.
---------------------------------------------------------------------------

    \16\ On November 8, 2011, pursuant to its authority under Title 
VII of the Dodd-Frank Act, the CFTC published its final rule on 
risk-management standards for DCOs. The CFTC elected to adopt a 
cover one requirement for all DCOs, and delay risk-management 
related rulemakings for systemically important DCOs until a later 
time. See 76 FR 69334 (Nov. 8, 2011).
---------------------------------------------------------------------------

    Both commenters, however, expressed a preference for a financial 
resource coverage requirement based on an additional measurement as 
determined by a percentage of aggregate exposure, and suggested that 
the default rate used in stress tests be based on the larger of (a) the 
two members representing the largest exposure to the CCP and (b) the 
members constituting at least 33 percent of the exposures in aggregate 
to the CCP. The two commenters believed that the additional measurement 
captures the risk of a diverse, but interconnected, membership.
    As noted in the NPRM, the Board's proposed financial resources 
standards would apply a heightened cover one requirement because the 
term ``participant'' would be interpreted as the largest family of 
affiliated participants if there was more than one affiliated 
participant. The Board believes that this interpretation will address 
the interconnectedness of participants through corporate ownership 
structures. With respect to risks presented by other types of 
interconnectedness (i.e., through common participation across markets 
or FMUs), the standards for a designated FMU's financial resource 
coverage, as with all other standards set out in the regulation, are 
generally applicable standards. The Board expects that a designated FMU 
would employ a risk-management framework that is appropriate for the 
risks faced by the FMU and the FMU may, at its own initiative, 
institute a cover two financial resource coverage requirement. In 
addition, the Board may require, by order, a particular designated FMU 
to exceed the generally applicable standards set out in the regulation 
to address the risks presented by, including those borne by, the 
FMU.\17\ Although the existing cover one standard was adopted by the 
Board in its PSR policy and applied in its supervision of payment and 
settlement systems since 1994, the Board has applied heightened 
financial resource coverage requirements when the appropriate situation 
arose. Therefore, although the Board agrees with the commenters that, 
in some cases, a higher requirement would be more appropriate to the 
level of risk presented by a particular designated FMU, the Board 
believes, at this time, that the most appropriate course is to adopt 
the cover one standard as generally applicable and impose a higher 
standard, including possibly a cover two standard, on a case-by-case 
basis when appropriate. The Board will consider the appropriateness of 
adopting a cover two standard in the context of possible revisions to 
Regulation HH in light of the PFMI. Accordingly, the Board is adopting 
the cover one standard in Sec.  234.4(a)(15) and (18) essentially as 
set out in the NPRM.
---------------------------------------------------------------------------

    \17\ See Sec.  234.4(b).
---------------------------------------------------------------------------

    The Board believes the commenters' concern regarding appropriately 
addressing the interconnectedness of a designated FMU's participants 
and the suggestion of applying the additional measurement using a 
percentage of aggregate exposure are important to consider. Before 
determining the viability of this approach, however, the Board believes 
further analysis is needed regarding how the suggested additional 
measure would be applied, and such analysis could include identifying 
situations in which the additional aggregate exposure measure would 
capture risk that is not addressed by either a cover one or cover two 
standard, an explanation of how the additional measure would be 
calculated (including the appropriate time horizon to use), and an 
explanation of why a 33 percent aggregate exposure standard would be 
most appropriate for this approach. The Board will consider this 
approach further in the context of revisions to Regulation HH in light 
of

[[Page 45913]]

the PFMI. The Board welcomes and will review any supporting research on 
this issue that is submitted.
6. Legal Certainty of Netting Arrangements
    One commenter raised an issue regarding designated FMUs that allow 
netting of payments to and from individual participants. The commenter 
stated that, to ensure that the netting will be honored in a bankruptcy 
or other insolvency proceeding, Regulation HH must require that the 
designated FMU demonstrate that, under the policies, procedures, and 
documentation of the designated FMU, the netting permitted by the 
designated FMU will be given legal effect in default and insolvency 
situations through an analysis provided by outside legal counsel that 
is a nationally recognized expert in matters of corporate insolvency.
    The Board recognizes the importance of legal certainty of a 
designated FMU's transactions, not only during default and insolvency 
situations, but also at all other times. To address these concerns, the 
Board proposed standards regarding a designated FMU's legal framework 
for payment systems, as well as CSDs and CCPs. For example, proposed 
Sec.  234.4(a)(1) states that the CSD or CCP should have a well-
founded, transparent, and enforceable legal framework for each aspect 
of its activities in all relevant jurisdictions. As explained in the 
NPRM, the Board expects that a designated FMU will manage its legal 
risks within the context of currently applicable statutes and 
regulations, so it can ensure that its rules, procedures, and 
contractual provisions will be enforceable with a high degree of 
certainty.\18\
---------------------------------------------------------------------------

    \18\ 76 FR at 18447.
---------------------------------------------------------------------------

    Legal certainty of each aspect of a designated FMU's activities 
(including its netting function) is expected to be supported by 
existing law in all relevant jurisdictions. Obtaining an opinion of 
outside counsel is one method for a designated FMU to judge legal 
certainty of its rules and procedures, but it is not the only method. 
In many cases, the designated FMU's in-house counsel may be better 
positioned to evaluate the intricacies of the designated FMU's netting 
arrangements and the law of the jurisdictions that are relevant to the 
designated FMU's operations. In addition, obtaining an opinion of 
outside counsel could involve significant expense for the designated 
FMU, depending on the complexity and number of relevant jurisdictions. 
The Board does not believe it is appropriate to impose such costs as a 
general expectation when they may not be necessary in all cases. 
Whether legal certainty must be supported by an opinion of outside 
counsel or may be verified by in-house counsel is a decision that may 
be made initially by management of the designated FMU. In the event the 
Board determines in a particular situation that an opinion by outside 
counsel is warranted, it could require such an opinion in that case. 
For these reasons, the Board believes that the legal framework standard 
as proposed is sufficient to address the concerns raised by the 
commenter.
7. Costs of Risk-Management Standards to Participants
    One commenter urged the Board to ensure that the benefits of 
enhanced risk-management standards exceed the costs of implementing the 
standards on banks and their customers. The commenter stated that banks 
will feel the effects of the risk-management standards because any 
designated FMUs with whom the banks transact business will likely pass 
on the costs and constraints of enhanced supervisory oversight to their 
participants.
    The Board is keenly aware of the need to weigh the costs and 
benefits of particular rulemakings. Section 805(a) of the Act requires 
the Board to prescribe risk-management standards governing the 
operations related to the PCS activities of designated FMUs. The 
Board's discretion lies not in whether risk-management standards must 
be promulgated, but rather in how the Board can best avoid unnecessary 
burden associated with the standards.
    With respect to the benefits of the risk-management standards, 
section 805(b) states that the objectives and principles for the 
standards are to (1) Promote robust risk management; (2) promote safety 
and soundness; (3) reduce systemic risks; and (4) support the stability 
of the broader financial system. The benefit of reducing systemic risk 
is, of course, difficult to quantify. Generally speaking, however, an 
FMU that is better positioned to withstand disruptive systemic events 
would result in much smaller costs being borne by the FMU, and its 
participants, and, more generally, the financial system and taxpayers.
    The costs of the risk-management standards can be viewed as a 
designated FMU's incremental expenses in establishing and maintaining 
the systems and procedures necessary to meet the standards, and other 
Regulation HH requirements, over and above the risk-management measures 
the FMU would have otherwise adopted for business reasons. As the 
commenter noted, such costs are generally passed on to a designated 
FMU's participants. These costs could take the form of higher 
transaction costs, margin or collateral costs, and capital 
requirements. These costs should be weighed against the societal 
benefit of stability in the financial system and the economy more 
broadly.
    As explained in the NPRM, the Board proposed to adopt the Core 
Principles and CPSS-IOSCO Recommendations as the basis for the risk-
management standards required by the Act, in part because that approach 
strikes a reasonable balance between furthering the Act's goals of 
enhanced risk management and financial stability and controlling the 
costs imposed on the FMUs. As explained in the NPRM, the Core 
Principles and CPSS-IOSCO Recommendations were formulated by central 
banks and securities regulators over several years and with 
considerable discussion and input from the financial services industry. 
The Federal Reserve collaborated with participating financial system 
authorities in developing the three sets of standards. In addition, the 
SEC and CFTC participated in the development of the CPSS-IOSCO 
Recommendations. The three sets of standards, particularly those 
relevant to payment systems, have been incorporated into the Board's 
PSR policy for many years. Further, the Board has used these standards, 
in conjunction with relevant laws and other Federal Reserve policies, 
when exercising its authority with respect to supervising payment and 
securities settlement systems.\19\ FMUs that are likely to be 
designated by the Council, as well as their participants, are well-
acquainted with these standards and, in many cases, such FMUs have 
already incorporated these standards into their governance, risk-
management, and operating frameworks. The Board, therefore, does not 
anticipate material additional costs associated with adopting the Core 
Principles and CPSS-IOSCO Recommendations into its regulation for 
participants in payment systems already managing towards these 
standards.
---------------------------------------------------------------------------

    \19\ The Core Principles and the Recommendations for Securities 
Settlement Systems were incorporated into the PSR policy in 2004 
(http://www.federalreserve.gov/boarddocs/press/other/2004/20041126/default.htm). The Recommendations for Central Counterparties was 
incorporated into the PSR policy in 2007 (http://www.federalreserve.gov/newsevents/press/other/20070112a.htm).
---------------------------------------------------------------------------

    Although these standards would be generally applicable, the Board 
is retaining the authority to impose a more stringent standard or waive 
a standard

[[Page 45914]]

on a case-by-case basis in situations where it is warranted.\20\ The 
Board believes this is a more cost-effective approach to achieving the 
risk management objectives of Title VIII of the Act. For example, when 
a situation that warrants a higher standard is discovered, the Board 
will exercise its authority to tailor a higher standard for the risks 
presented. In addition, alternatively, if review of the PFMI 
demonstrates that a higher standard is more appropriate for general 
application, the Board will consider a revision to the regulation.
---------------------------------------------------------------------------

    \20\ One example of this approach is the financial resource 
coverage standard in Sec.  234.4(a)(15) and (18) (cover one versus 
cover two).
---------------------------------------------------------------------------

B. Advance Notice of Material Changes

1. Materiality Threshold
    Section 806(e) of the Act requires a designated FMU to provide 60 
days' advance notice to its Supervisory Agency of any proposed change 
to its rules, procedures, or operations ``that could, as defined in 
rules of each Supervisory Agency, materially affect the nature or level 
of risks presented'' by the designated FMU. Proposed Sec.  234.5(c)(1) 
states that the term ``materially affect the nature or level of risks 
presented'' means matters as to which there is a ``reasonable 
possibility that the change could materially affect the performance of 
clearing, settlement, or payment functions or the overall nature or 
level of risk presented by the designated financial market utility.'' 
Proposed Sec.  234.5(c)(2) provides a non-exclusive list of changes 
that would materially affect the nature or level of risks presented, 
including changes that affect participant eligibility or access 
criteria; product eligibility; risk management; settlement failure or 
default procedures; financial resources; business continuity and 
disaster recovery plans; daily or intraday settlement procedures; scope 
of services; non-routine changes to the underlying technological 
framework for PCS functions; or governance. Proposed Sec.  234.5(c)(3) 
provides a non-exclusive list of changes that would not materially 
affect the nature or level of risks presented, including a change that 
does not modify the contractual rights or obligations of the designated 
FMU or its participants; a change that does not adversely affect the 
safeguarding of securities, collateral, or funds for which the 
designated FMU is responsible; a routine technology upgrade; a routine 
administrative change; or a non-substantive change to rules, 
procedures, or other documentation.
    The Board requested comments on all aspects of its proposed 
materiality rule, particularly on the appropriateness of the definition 
of ``materially affect the nature or level of risks presented'' and the 
utility of the non-exclusive lists for material and non-material 
changes. Commenters generally stated that the materiality standard 
would benefit from one or more of the following three adjustments: (1) 
A narrower scope of the definition itself, (2) a shorter list of 
inclusions, or (3) a more expansive list of exclusions.
    ``Reasonable possibility.'' Several commenters stated that the 
definition of ``materially affect the nature or level of risks 
presented'' is overly vague and were concerned that the Board would be 
flooded with advance notices of non-material changes as a result. Three 
commenters generally stated that the definition of materiality is too 
vague and suggest a more narrowly drawn definition to provide for 
expeditious review. One commenter suggested revising the proposed 
materiality standard, which requires notice of proposed changes that 
have ``a reasonable possibility'' of material effect, to require notice 
only for those changes that are ``reasonably likely'' to have a 
material effect. The commenter stated that, with the proposed 
definition, designated FMUs were highly likely to err in favor of 
significantly ``over-disclosing'' changes to their rules, procedures, 
and operations, which would be overly burdensome to both the Board and 
the industry.
    The Board believes the proposed definition sets an appropriate 
minimum threshold for advance notices at this time. Proposed Sec.  
234.5(c) asks the designated FMU to consider whether it is reasonably 
possible that a change could have a material effect on the performance 
of its PCS functions or its overall risk profile. The Board recognizes 
that ``possible'' is a lower threshold than ``likely.'' Section 
806(e)(1) of the Act uses the phrase ``could * * * materially affect'' 
the PCS functions or its overall risk profile of the designated FMU. 
This word choice indicates possibility, rather than likelihood.\21\ If 
Congress had intended that advance notices be submitted only for 
changes that were likely to have a material effect, it could easily 
have framed it in that way. In addition, when the Board seeks to 
fulfill its statutory responsibility, the lower threshold is 
appropriate to ensure that it is able to review a broad sampling of the 
types of material changes that the designated FMU normally makes in its 
operations. As the designated FMU submits advance notices, the Board 
will be able to provide feedback and filter out the specific types of 
rule changes normally considered by that particular designated FMU that 
do not warrant advance notices. Within this framework, the Board 
anticipates that it will be able to more precisely balance the 
regulatory burden of the advance notice requirement with its need to 
receive advance notice of material changes for the supervision of a 
particular designated FMU contemplated by Title VIII of the Act.
---------------------------------------------------------------------------

    \21\ ``Could'' is commonly defined as the past tense of ``can,'' 
and is used to indicate ``possibility.'' ``Likely'' is defined as 
``possessing or displaying the qualities or characteristics that 
make something probable.'' American Heritage Dictionary of the 
English Language (Fourth Edition), http://ahdictionary.com/.
---------------------------------------------------------------------------

    Further, the suggested revision would require the designated FMU to 
determine which changes were likely to materially affect the 
performance of its PCS functions or its overall risk profile. Making 
this judgment without any input from the Board would increase the risk 
that the designated FMU would not submit an advance notice to the Board 
that the Board would determine could have a material effect. This not 
only could subject the designated FMU to supervisory criticism and 
possible modification or rescission of the change, but also could 
prevent the Board from obtaining valuable insight into the operations 
of the designated FMU as contemplated by the statute.
    Although a lower materiality threshold initially may result in a 
higher number of advance notice filings, the Board does not believe 
that this is a reason to change the definition. The Board will provide 
guidance, through ongoing dialogue during the supervisory process, to 
assist a designated FMU in determining whether a proposed change 
requires advanced notice. For the reasons set out above, the Board is 
retaining the ``reasonable possibility'' language in the definition of 
``materially affect the nature or level of risks presented'' in Sec.  
234.5(c)(1) of the final rule.
    ``Performance of clearing, settlement, or payment functions.'' One 
commenter suggested deleting from the materiality definition the phrase 
``performance of clearing, settlement, or payment functions.'' The 
commenter stated that the proposed definition of materiality 
overreaches the statutory purpose of ensuring sound risk management by 
requiring advance notice of changes that affect the performance of PCS 
functions in addition to the overall nature or level or risks 
presented. The commenter stated that changes implemented by the

[[Page 45915]]

designated FMU that relate to the broad category of ``performance,'' as 
opposed to risk, are more appropriately vetted in the competitive 
marketplace.
    In referring to the performance of PCS functions, the Board 
intended to provide additional guidance to the scope of the advance 
notice requirement by including an express focus on the PCS functions 
of a designated FMU. The Board believes that the language in proposed 
Sec.  234.5(c)(1) appropriately implements the statutory authority 
provided by the Act. To address the commenters' concerns and provide 
clarity regarding the scope of the advance notice requirement in Sec.  
234.5(c)(1), the Board is adopting a revision to the proposed 
regulatory text to state that the term ``materially affect the nature 
or level of risks presented'' means matters as to which there is a 
reasonable possibility that the change could ``materially affect the 
overall nature or level of risk presented by the designated financial 
market utility, including risk arising in the performance of payment, 
clearing, or settlement functions.'' \22\ This revision ensures that 
the definition follows the statutory authority, while also providing an 
indication that the Board expects designated FMUs to pay particular 
attention to providing advance notice of proposed changes to its rules, 
procedures, or operations regarding the performance of its PCS 
functions that could materially affect the nature or level of risks 
presented by the designated FMU. The additional guidance, however, does 
not limit the scope of ``materially affect the nature or level of risks 
presented'' to only those risks arising in the performance of PCS 
functions. A proposed change to any of the designated FMU's rules, 
procedures, or operations that could materially affect the nature or 
level of risks presented by the designated FMU should be the subject of 
an advance notice, regardless of whether it is regarding the 
performance of PCS functions.
---------------------------------------------------------------------------

    \22\ The risks presented by the designated FMU's performance of 
its PCS functions can go beyond the effect on the designated FMU 
itself and reach its participants or the market more broadly.
---------------------------------------------------------------------------

    Non-exclusive lists. Four commenters stated that the non-exclusive 
list of material changes in proposed Sec.  234.5(c)(2) was too broad or 
the non-exclusive list of non-material changes in proposed Sec.  
234.5(c)(3) was too narrow. The commenters acknowledged the value of 
providing guidance regarding changes that were material or not 
material, but generally stated that the proposed lists did not 
appropriately draw this dividing line.
    One commenter stated that most items included on the material list 
in proposed Sec.  234.5(c)(2) are described in a manner that would 
require a designated FMU to provide the Board notice of changes that 
would not necessarily affect the nature or level of risk in any manner. 
In particular, the commenter noted that ``financial resources'' is 
included in the list in proposed Sec.  234.5(c)(2)(v), but is not 
modified by any quantitative or qualitative measure, so a designated 
FMU would be required to submit advance notice of any change in its 
financial resources, even changes that are not material, such as any 
changes that in any way affect capital, access to credit, or liquidity. 
Two commenters cited the ``scope of services'' item in proposed Sec.  
234.5(c)(2)(viii) as another example of an overly broad requirement 
that is unrelated to risk. For similar reasons, two commenters 
suggested deleting the ``governance'' item in proposed Sec.  
234.5(c)(2)(x). One commenter also suggested deleting the ``participant 
eligibility or access'' item in proposed Sec.  234.5(c)(2)(i).
    The Board believes that material changes in the areas listed in 
proposed Sec.  234.5(c)(2) could affect a designated FMU's core 
functions and, as a result, might affect its ability to manage its 
risks appropriately and to continue to conduct systemically important 
PCS services. This may, in turn, affect the designated FMU's ability to 
comply with the risk-management standards set out in Sec. Sec.  234.3 
and 234.4 to which they will be held. The list of material changes 
provided in proposed Sec.  234.5(c)(2) was intended to track those 
risk-management standards, and the reasons for including these items in 
the list of material changes requiring an advance notice are similar in 
most cases. For example, the importance of understanding material 
changes in the financial resources of a designated FMU acting as a 
payment system would be critical to assessing the ability of the 
designated FMU to continue to provide systemically important PCS 
services in the event of a default, as well as its compliance with 
several of the proposed risk-management standards, such as the 
capability to ensure timely completion of daily settlements as set out 
in proposed Sec.  234.3(a)(5).
    To address the commenters' concerns that de minimis changes to the 
areas listed in Sec.  234.5(c)(2) would require an advance notice, the 
Board is adopting revised language in the final rule to clarify that 
the changes that ``materially affect'' the areas listed would be 
considered changes that materially affect the nature or level of risks 
presented by the designated FMU.
    Also, as explained above regarding the risk-management standard for 
governance in proposed Sec.  234.3(a)(10), the Board believes that 
effective, accountable, and transparent governance arrangements are 
critical to effective risk management of a designated FMU. As a result, 
changes that materially affect a designated FMU's governance 
arrangements should be submitted pursuant to the advance notice 
process.
    Similarly, the Board believes that access criteria can help ensure 
that a designated FMU admits financial institutions that will be able 
to meet their obligations and not expose the FMU or its other 
participants to risk, including through risk measures such as capital 
ratios, risk ratings, or other indicators. For this reason, the Board 
will have an interest in receiving advance notice of any material 
changes to a designated FMU's participant eligibility or access 
criteria. Finally, understanding the scope of services offered by an 
FMU that is designated on the basis of its role as operator of a 
payment system is fundamental to being able to have a clear 
understanding of the payment system's risk profile. A designated FMU's 
services could affect the financial risks participants face through 
their participation in the system, as well as the level of risk that 
the designated FMU is incurring by providing the services.
    Commenters also suggested revising the list of non-material changes 
in proposed Sec.  234.5(c)(3).\23\ One commenter stated that certain 
examples on the non-material list are so narrowly drawn as to be 
unhelpful in marking a reasonable line between circumstances that may 
compel advance notice and those that may not. As an example, the 
commenter cited the example of ``a change that does not modify the 
contractual rights or obligations of the designated financial market 
utility or persons using its payment, clearing, or settlement 
services'' set out in proposed Sec.  234.5(c)(3)(i) and noted these 
types of changes, in essence, would be the types of clerical, non-
substantive changes separately identified in proposed Sec.  
234.5(c)(3)(v). Another commenter

[[Page 45916]]

supported a broad application of the example set forth in Sec.  
234.5(c)(3)(ii) (``a change to an existing procedure, control, or 
service that does not adversely affect the safeguarding of securities, 
collateral, or funds in the custody or control of the designated 
financial market utility or for which it is responsible'').
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    \23\ One commenter suggested that the final rule include in the 
non-material list of proposed Sec.  234.5(c)(3) a greater range of 
operating rule changes for designated FMUs participating in the 
retail payment systems. As explained above, however, the Council has 
indicated that it expects to focus at this time on FMUs that operate 
large-value systems and not on FMUs that operate low-value systems, 
such as check or ACH. 76 FR 44763, 44769 (July 2011).
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    After taking into consideration the comments noted above and 
reexamining the list of non-material changes, the Board is eliminating 
the examples in proposed Sec. Sec.  234.5(c)(3)(i) and (ii). With 
respect to proposed Sec.  234.5(c)(3)(i), the Board recognizes the 
commenter's concern; however, the Board believes it is more prudent to 
capture a wider range of proposed changes at this time and therefore is 
reluctant to expand the example's breadth. In addition, the Board is 
concerned that a broad application of the non-material change set forth 
in proposed Sec.  234.5(c)(3)(ii) might inadvertently create an overlap 
with the advance notice requirement for material change set forth in 
Sec.  234.5(c)(2)(iii) because both changes fall broadly within the 
area of risk management. In order to avoid this overlap, and any 
resulting confusion, the Board is removing the example in proposed 
Sec.  234.5(c)(3)(ii).
    The list provided by the Board in Sec.  234.5(c)(3) is not meant to 
be exhaustive. The Board believes that it is difficult to draw a bright 
line that could be uniformly applicable to all designated FMUs between 
changes that would require advance notice and those that would not 
because of the range of different designs and functions. The Board 
believes, at this time, that routine changes like those listed in the 
remaining examples of Sec.  234.5(c)(3) would be considered clearly 
non-material for the purposes of triggering the 60-day advance notice 
requirement. In addition, the Board believes that changes to fees, 
prices, or other charges for services provided by the designated FMU 
constitute business decisions that would not require advance notice. To 
that end, the Board is adopting an explicit exclusion for fees, prices, 
or other charges in Sec.  234.5(c)(3)(ii). As mentioned above, as the 
supervisory process develops with a particular designated FMU, the 
Board anticipates that it will reach an understanding with the FMU 
about what constitutes a non-material rule change for that FMU that 
would not require advance notice.
2. Expedited Review
    Proposed Sec.  234.5(a) includes procedural requirements regarding 
advance notices of material changes, such as the required content of 
the notices and the procedures and timing for the methods for approving 
such changes. These provisions essentially reiterate similar provisions 
in section 806(e) of the Dodd-Frank Act. Some commenters were concerned 
that the open-ended time frame for the Board to request additional 
information on a material change would unnecessarily delay action on 
certain changes to rules, procedures, or operations that are time 
sensitive, but do not materially affect the level of risks posed by the 
designated FMU. As a means of expediting the processing of advance 
notice submissions, commenters made several suggestions to limit the 
time of the Board's review, such as (a) establishing a 10-day 
preliminary determination window in which the Board determines whether 
a proposed change requires advance notice or a full 60-day review and 
(b) limiting the Board's authority to request additional information to 
assess the effects of the proposed change to within the first 30 days 
of the review period. The commenters were generally concerned that the 
Board would engage in an indefinite and extended review of advance 
notices that would hinder a designated FMU's ability to manage its 
business.
    As a general matter, the Board recognizes the importance of 
reducing regulatory burden and being diligent in reviewing proposed 
material changes in a timely manner. Section 806(e)(1)(I) of the Act 
permits a designated FMU to implement a change in less than 60 days 
from the filing of the advance notice if its Supervisory Agency 
notifies the designated FMU that it does not object to the proposed 
change and authorizes the designated FMU to implement the change at an 
earlier date. The Board incorporated this statutory provision in 
proposed Sec.  234.5(a)(8) and is retaining this provision in the final 
rule. This provision provides a mechanism for the Board to complete its 
review and inform the designated FMU that it may proceed before the 
expiration of the 60-day advance notice period. The Board expects to 
use this procedure as appropriate. The Board, however, recognizes that 
it must balance the need for expediency with the need to conduct a 
thorough review of any necessary supporting documentation or 
information related to a proposed change, in order to make an informed 
decision consistent with its statutory responsibilities. Therefore, the 
timeliness of the Board's review may depend, in part, on the 
completeness of the information provided by and level of engagement 
with the designated FMU prior to and following the submission of the 
advance notice.
3. Advance Notice by Rule-Setting Bodies
    Two commenters responsible for developing and setting rules for 
retail payment systems suggested that the Board's advance notice 
procedure permit the submission of a proposed rule change by the rule-
writing body and that such submission satisfy the advance notice 
requirement for any designated payment system operating subject to the 
rules. As an initial matter, the Board will be mindful of the need for 
efficiency and minimizing regulatory burden, while also ensuring that 
the Board receives the necessary information on a timely basis in order 
to fulfill its responsibilities under the Act. The Board notes, 
however, that although such rule-writing arrangements exist for several 
retail payment networks, as noted above, such systems are not expected 
to be designated by the Council as systemically important at this time. 
If the Council designates any payment systems subject to such rule-
writing arrangements and the Board is the Supervisory Agency for that 
system, the Board would review, at that time, the appropriate means for 
such systems to submit advance notices.
4. Emergency Changes
    One commenter requested that the Board take care in allowing 
designated FMUs to make immediate emergency changes to their governing 
rules under proposed Sec.  234.5(b), particularly with respect to 
customer collateral and margin requirements. The commenter stated that 
situations that justify alteration of loss mutualization standards from 
international standards are rare and should be carefully scrutinized. 
The commenter also requested that the Board incorporate CPSS-IOSCO 
principles with regard to customer collateral and margin requirements 
so as to ensure that designated FMUs will apply loss mutualization 
standards that comport with international standards.
    Section 806(e)(2) of the Act contemplates the possibility that 
designated FMUs may need to implement material changes to their rules, 
procedures, or operations in emergency situations and includes a 
mechanism allowing for the ex-post notification of the Supervisory 
Agency regarding such emergency material changes. This mechanism was 
incorporated into proposed Sec.  234.5(b). In order to take advantage 
of the emergency change process, a designated

[[Page 45917]]

FMU is required to explain to the Board within 24 hours of the 
implementation of the change, among other things, the nature of the 
emergency and the reason the changes was necessary for the designated 
FMU to continue to provide its services in a safe and sound manner. 
Pursuant to Title VIII and the proposed rule, the Board may require 
modification or rescission of the change if it finds that the change is 
not consistent with the purposes of the Act or rules or standards 
prescribed thereunder. The Board expects that emergency changes, 
including any changes to customer collateral and margin requirements, 
will occur rarely and will be carefully scrutinized.
5. Advance Notice and Competitive Issues
    Two commenters raised concerns regarding the advance notice 
procedure for designated FMUs that offer services that compete with 
services offered by the Federal Reserve Banks (``Reserve Banks''). One 
commenter involved in check imaging stated that if Reserve Banks 
engaged in check image services were not subject to the advance notice 
procedure under proposed Sec.  234.5(a) and private-sector check-image-
exchange rules were subject to the advance notice procedure, the 
Reserve Banks would enjoy a significant competitive advantage over the 
private-sector competitors. This commenter believed that the Reserve 
Banks would be able to change their check-image rules without being 
subject to the same delay and uncertainty as the competing designated 
FMU under the advance notice procedure. The commenter suggested that 
the Board include within the final rule provisions that seek to 
mitigate the potential for a negative impact on competition that may 
arise from the advance notice procedure for designated FMUs. Another 
commenter stated that it was beyond the scope of systemic risk 
regulation for the Board to ``force a delay in implementing business-
related changes; particularly in a competitive market in which the 
Reserve Banks offer the competing alternative.''
    The Board is cognizant of the competition between the Reserve Banks 
and private-sector service providers in certain financial services, 
including check and funds transfer services, and has long-standing 
policies to address such competitive issues. Under the Federal Reserve 
Act, the Board has general supervisory authority over the Reserve 
Banks, including the Reserve Banks' provision of payment and settlement 
services (``Reserve Bank financial services''), that is much more 
extensive in scope than the authority provided under Title VIII over 
designated FMUs.\24\ In practice, Board oversight of the Reserve Banks 
in many ways goes beyond the typical supervisory framework for private-
sector entities, including the framework provided by Title VIII. For 
example, the Board applies robust risk-management standards to the 
relevant Reserve Bank financial services; conducts regular 
examinations; and reviews key strategic initiatives, prices and service 
terms, proposed material changes, and ongoing operations.
---------------------------------------------------------------------------

    \24\ 12 U.S.C. 221 et seq.
---------------------------------------------------------------------------

    The Board conducts regular examinations of the Reserve Bank 
financial services covering, among other things, operational safety and 
soundness and management effectiveness. It also regularly monitors the 
services' operations and initiatives through reports, discussions with 
Reserve Bank management, and its oversight liaison roles on various 
Reserve Bank management groups. The Board is also involved in reviewing 
or approving proposed changes to the Reserve Banks' rules, procedures, 
and operations, including those involving Reserve Bank financial 
services, from their inception. The Board's oversight of these proposed 
changes is significantly broader and more detailed than the Title VIII 
advance notice procedures. For example, the Board reviews all changes 
to the Reserve Banks' operating circulars, approves the Reserve Banks' 
budgets, including budgets related to the Reserve Bank financial 
services, and approves major strategic initiatives, and the associated 
expenditures.
    Moreover, the Board recognizes the critical role Reserve Bank 
financial services, particularly the Fedwire Funds and Fedwire 
Securities services, play in the financial system and is committed to 
strong and effective supervision of these services that is comparable 
to, or exceeds, the requirements placed on similar private-sector 
entities. For example, the Board expects the Fedwire services to meet 
or exceed the Board's PSR policy standards, which are consistent with 
the Regulation HH standards applied to designated FMUs. In addition, 
the Board will hold the Reserve Banks to advance notice requirements 
with respect to proposed material changes to Fedwire rules, procedures, 
and operations that are the same as, or higher than, the requirements 
for designated FMUs that are supervised by the Board.\25\ Moreover, if 
the Council designates an FMU on the basis of its role as operator of a 
payment system that competes with another Reserve Bank service, the 
Board will ensure that the competing Reserve Bank service is held to 
the same or higher requirements as those set forth in Regulation HH.
---------------------------------------------------------------------------

    \25\ See the Board's policy on ``Oversight of Key Financial 
Infrastructures'' related to Reserve Bank Systems at http://www.federalreserve.gov/paymentsystems/over_rbsystems.htm.
---------------------------------------------------------------------------

    In addition, in order to address any competitive inequalities 
between Reserve Bank priced services and similar services provided by 
private sector entities, the Monetary Control Act of 1980 (the ``MCA'') 
requires Reserve Bank priced services to be priced explicitly and that 
fees be established on basis of all direct and indirect costs actually 
incurred, including taxes that would have been paid and a return on 
capital that would have been provided had the services been furnished 
by a private business firm.\26\ As required by the MCA, the Board also 
has established a set of pricing principles that governs the schedule 
of fees for the Reserve Bank priced services, which must give due 
regard to competitive factors.\27\ Board policy also requires that 
Federal Reserve actions are implemented in a manner that ensures 
fairness to other providers of payment services.\28\ In light of these 
policies, the Board believes that changes to Reserve Bank priced 
services rules or operating circulars are subject to no less scrutiny, 
and in many cases more scrutiny, than the review contemplated by Title 
VIII's advance notice procedure.
---------------------------------------------------------------------------

    \26\ 12 U.S.C. 248a. These costs are included in the private-
sector adjustment factor for pricing Reserve Bank priced services.
    \27\ 12 U.S.C. 248a(c)(3).
    \28\ The Board policy can be found at: http://www.federalreserve.gov/paymentsystems/pfs_standards.htm.
---------------------------------------------------------------------------

III. Administrative Law Matters

A. Regulatory Flexibility Act Analysis

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (``RFA'') 
generally requires an agency to perform an initial and a final 
regulatory flexibility analysis on the impact a rule is expected to 
have on small entities. However, under section 605(b) of the RFA, the 
regulatory flexibility analysis otherwise required under section 604 of 
the RFA is not required if an agency certifies, along with a statement 
providing the factual basis for such certification, that the rule will 
not have a significant economic impact on a substantial number of small 
entities. Based on current information, the Board believes that the 
payment systems that would likely be designated by the Council would 
not be ``small entities'' for purposes of the RFA, and

[[Page 45918]]

so, the final rule likely would not have a significant economic impact 
on a substantial number of small entities. The authority to designate 
FMUs, however, resides with the Council, rather than the Board, and the 
Board therefore cannot be assured of the identity of the FMUs that the 
Council may designate in the future. Accordingly, the Board has 
prepared the following final regulatory flexibility analysis pursuant 
to section 604 of the RFA.
    1. Statement of the need for, and objectives of, the final rule. In 
accordance with Sections 805(a) and 806(e) of the Dodd-Frank Act, the 
Board is adopting the final rule as Regulation HH, new Part 234 of 
Title 12 of the Code of Federal Regulations. The final rule establishes 
risk-management standards for systemically important FMUs and standards 
for determining when advance notice is required to be provided by a 
designated FMU that proposes to change to its rules, procedures, or 
operations that could materially affect the nature or level of risks 
presented by the designated financial market utility. The reasons and 
justification for the final rule are described above in the 
Supplementary Information.
    2. Summary of the significant issues raised by public comment on 
Board's initial analysis, the Board's assessment of such issues, and a 
statement of any changes made as a result of such comments. The Board 
did not receive any public comments regarding its initial regulatory 
flexibility analysis.
    3. Small entities affected by the final rule. The final rule would 
affect FMUs that the Council designates as systemically important to 
the U.S. financial system for which the Board is the Supervisory 
Agency. The Board estimates that fewer than five large-value payment 
systems would meet these conditions and be affected by this rule. 
Pursuant to regulations issued by the Small Business Administration 
(the ``SBA'') (13 CFR 121.201), a ``small entity'' includes an 
establishment engaged in providing financial transaction processing, 
reserve and liquidity services, or clearinghouse services with an 
average revenue of $7 million or less (NAICS code 522320). As noted in 
the NPRM, the Board does not currently believe that any of the payment 
systems that would likely be designated by the Council would be ``small 
entities'' pursuant to the SBA regulation. In addition, the Board does 
not believe at this time that, pursuant to section 803(8) of the Dodd-
Frank Act, it would be the Supervisory Agency for any FMU that operates 
as a central securities depository or central counterparty and that 
would likely be designated by the Council.
    4. Recordkeeping, reporting, and compliance requirements. The final 
rule imposes certain reporting and recordkeeping requirements for a 
designated FMU. (See, for example, Sec.  234.3(a)(3) (requiring clearly 
defined procedures for the management of credit risks and liquidity 
risks); Sec.  234.5(a)(1) and (2) (requiring advance notice of changes 
that could materially affect the nature or level of risks presented by 
the designated FMU), and Sec.  234.5(b)(2) and (3) (requiring notice of 
an emergency change implemented by a designated FMU).) The final rule 
also contains a number of compliance requirements, including the 
standards that the designated FMU must meet, such as having a well-
founded legal basis under all relevant jurisdictions and having rules 
and procedures that enable participants to understand clearly the FMU's 
impact on each of the financial risks they incur by participation in 
it. Payment systems under the Board's jurisdiction (including certain 
payment systems the Board believes could be designated as systemically 
important) are generally already expected to meet these standards, or 
are at least familiar with these standards, so the rule would not 
likely impose material additional costs on those payment systems.
    5. Significant alternatives to the revisions. Section 805(a) of the 
Act requires the Board to prescribe risk-management standards governing 
the operations related to PCS activities of designated FMUs, so other 
administrative methods for accomplishing the goals of the Act were not 
considered. One alternative to adopting risk-management standards based 
on the relevant international standards was to develop a different set 
of risk-management standards specifically for purposes of section 
805(a) of the Act. As explained in the NPRM and above, the Board 
proposed to adopt the Core Principles and CPSS-IOSCO Recommendations as 
the basis for establishing initial risk-management standards required 
by section 805(a) of the Act, in part, because this approach presented 
advantageous cost efficiencies for the regulators and the FMUs. 
Furthermore, the new standards set forth in the PFMI were still under 
development at the time of the NPRM and not available for consideration 
as an alternative. As explained above, the Core Principles and CPSS-
IOSCO Recommendations were formulated by central banks and securities 
regulators with considerable discussion and industry consultation. In 
particular, the Federal Reserve collaborated with participating 
financial system authorities and consulted with FMUs and their 
participants in developing the standards. In addition, the SEC and CFTC 
participated in the development of the CPSS-IOSCO Recommendations. The 
Board incorporated these standards in its PSR policy in 2004 and 2007 
and has been guided by the policy, in conjunction with relevant laws 
and other Federal Reserve policies, when exercising its authority with 
respect to supervising large-value payment and securities settlement 
systems.\29\ Payment systems that would likely be designated by the 
Council, therefore, would likely be familiar with the Core Principles 
and could implement them promptly with relatively less burden than if 
the Board developed a different set of standards to implement section 
805(a) of the Act.
---------------------------------------------------------------------------

    \29\ See footnote 19.
---------------------------------------------------------------------------

B. Competitive Impact Analysis

    As a matter of policy, the Board subjects all operational and legal 
changes that could have a substantial effect on payment system 
participants to a competitive impact analysis, even if competitive 
effects are not apparent on the face of the proposal.\30\ Pursuant to 
this policy, the Board assesses whether proposed changes ``would have a 
direct and material adverse effect on the ability of other service 
providers to compete effectively with the Federal Reserve in providing 
similar services'' and whether any such adverse effect ``was due to 
legal differences or due to a dominant market position deriving from 
such legal differences.'' If, as a result of this analysis, the Board 
identifies an adverse effect on the ability to compete, the Board then 
assesses whether the associated benefits--such as improvements to 
payment system efficiency or integrity--can be achieved while 
minimizing the adverse effect on competition.
---------------------------------------------------------------------------

    \30\ See ``The Federal Reserve in the Payments System,'' Fed. 
Res. Reg. Svc. Sec.  9-1550, 9-1558 (Apr. 2009).
---------------------------------------------------------------------------

    This final rule promulgates risk-management standards and advance 
notice requirements for designated FMUs, as required by Title VIII of 
the Act. Some FMUs may be designated on the basis of their role as 
operators of payment systems that compete with similar services 
provided by the Reserve Banks, and designation subjects the FMU to an 
enhanced supervisory framework. Commenters have raised concerns 
regarding the Reserve Banks obtaining a competitive advantage over 
private-sector competitors through the

[[Page 45919]]

Board imposing a less-stringent supervisory framework on the Reserve 
Banks priced services than would be imposed on a competing designated 
FMU. As noted above, Board oversight of the Reserve Banks goes well 
beyond the typical supervisory framework for private-sector entities, 
including the framework provided by Title VIII. The Board applies risk-
management standards to the Reserve Banks' Fedwire and other financial 
services that are at least as stringent as those applied to designated 
FMUs pursuant to Title VIII. Further, the Board will hold Reserve Banks 
to procedural requirements that are the same as, or higher than, the 
requirements for designated FMUs supervised by the Board, with respect 
to advance notice of material changes to the rules, procedures, or 
operations of Reserve Bank priced services that compete with designated 
FMUs. Therefore, the Board does not believe the final rule promulgating 
risk-management standards or advance notice requirements for designated 
FMUs under Title VIII will have any direct and material adverse effect 
on the ability of other service providers to compete with the Reserve 
Banks.

C. Paperwork Reduction Act Analysis

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CFR part 1320, Appendix A.1), the Board reviewed the final rule 
under the authority delegated to the Board by the Office of Management 
and Budget. As noted in the proposal, for purposes of calculating 
burden under the Paperwork Reduction Act, a ``collection of 
information'' involves 10 or more respondents. Any collection of 
information addressed to all or a substantial majority of an industry 
is presumed to involve 10 or more respondents (5 CFR 1320.3(c), 
1320.3(c)(4)(ii)). The Board estimates there are fewer than 10 
respondents, and these respondents do not represent all or a 
substantial majority of the participants in payment, clearing, and 
settlement systems. Therefore, no collections of information pursuant 
to the Paperwork Reduction Act are contained in the final rule. The 
Board did not receive any comments on this analysis.
    The Board has a continuing interest in the public's opinion of the 
collection of information. Comments on the collection of information 
should be sent to Cynthia Ayouch, Acting Federal Reserve Board 
Clearance Officer, Division of Research and Statistics, Mail Stop 95-A, 
Board of Governors of the Federal Reserve System, Washington, DC 20551, 
with copies of such comments sent to the Office of Management and 
Budget, Paperwork Reduction Project (7100-0199), Washington, DC 20503.

List of Subjects in 12 CFR Part 234

    Banks, Banking, Credit, Electronic funds transfers, Financial 
market utilities, Securities.

Authority and Issuance

    For the reasons set forth in the preamble, the Board amends 12 CFR, 
Chapter II by adding part 234, as set forth below.

PART 234--DESIGNATED FINANCIAL MARKET UTILITIES (REGULATION HH)

Sec.
234.1 Authority, purpose, and scope.
234.2 Definitions.
234.3 Standards for payment systems.
234.4 Standards for central securities depositories and central 
counterparties.
234.5 Changes to rules, procedures, or operations.

    Authority:  12 U.S.C. 5461 et seq.


Sec.  234.1  Authority, purpose, and scope.

    (a) Authority. This part is issued under the authority of sections 
805, 806, and 810 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act) (Pub. L. 111-203, 124 Stat. 1376; 12 
U.S.C. 5464, 5465, and 5469).
    (b) Purpose and scope. This part establishes risk-management 
standards governing the operations related to the payment, clearing, 
and settlement activities of designated financial market utilities. The 
risk-management standards do not apply, however, to a designated 
financial market utility that is a derivatives clearing organization 
registered under section 5b of the Commodity Exchange Act (7 U.S.C. 7a-
1) or a clearing agency registered with the Securities and Exchange 
Commission under section 17A of the Securities Exchange Act of 1934 (15 
U.S.C. 78q-1), which are governed by the risk-management standards 
promulgated by the Commodity Futures Trading Commission or the 
Securities and Exchange Commission, respectively, for which each is the 
Supervisory Agency (as defined below). In addition, this part sets out 
requirements and procedures for a designated financial market utility 
that proposes to make a change to its rules, procedures, or operations 
that could materially affect the nature or level of risks presented by 
the designated financial market utility and for which the Board is the 
Supervisory Agency.


Sec.  234.2  Definitions.

    As used in this part:
    (a) Central counterparty means an entity that interposes itself 
between the counterparties to trades, acting as the buyer to every 
seller and the seller to every buyer.
    (b) Central securities depository means an entity that holds 
securities in custody to enable securities transactions to be processed 
by means of book entries or an entity that enables securities to be 
transferred and settled by book entry either free of or against 
payment.
    (c) Designated financial market utility means a financial market 
utility (as defined in paragraph (d) of this section) that the 
Financial Stability Oversight Council has designated under section 804 
of the Dodd-Frank Act (12 U.S.C. 5463).
    (d) Financial market utility has the same meaning as the term 
defined in section 803(6) of the Dodd-Frank Act (12 U.S.C. 5462(6)).
    (e) Payment system means a set of payment instructions, procedures, 
and rules for the transfer of funds among system participants.
    (f) Supervisory Agency has the same meaning as the term is defined 
in section 803(8) of the Dodd-Frank Act (12 U.S.C. 5462(8)).


Sec.  234.3  Standards for payment systems.

    (a) A designated financial market utility that is designated on the 
basis of its role as the operator of a payment system must implement 
rules, procedures, or operations designed to ensure that it meets or 
exceeds the following risk-management standards with respect to the 
payment, clearing, and settlement activities of that payment system:
    (1) The payment system has a well-founded legal basis under all 
relevant jurisdictions.
    (2) The payment system's rules and procedures enable participants 
to have a clear understanding of the payment system's impact on each of 
the financial risks they incur through participation in it.
    (3) The payment system has clearly defined procedures for the 
management of credit risks and liquidity risks, which specify the 
respective responsibilities of the payment system operator and the 
participants and which provide appropriate incentives to manage and 
contain those risks.
    (4) The payment system provides prompt final settlement on the day 
of value, during the day and at a minimum at the end of the day.
    (5) A payment system in which multilateral netting takes place is, 
at a

[[Page 45920]]

minimum, capable of ensuring the timely completion of daily settlements 
in the event of an inability to settle by the participant with the 
largest single settlement obligation.
    (6) Assets used for settlement are a claim on the central bank or 
other assets that carry little or no credit risk and little or no 
liquidity risk.
    (7) The payment system ensures a high degree of security and 
operational reliability and has contingency arrangements for timely 
completion of daily processing.
    (8) The payment system provides a means of making payments that is 
practical for its users and efficient for the economy.
    (9) The payment system has objective and publicly disclosed 
criteria for participation, which permit fair and open access.
    (10) The payment system's governance arrangements are effective, 
accountable, and transparent.
    (b) The Board, by order, may apply heightened risk-management 
standards to a particular designated financial market utility in 
accordance with the risks presented by that designated financial market 
utility. The Board, by order, may waive the application of a standard 
or standards to a particular designated financial market utility where 
the risks presented by or the design of that designated financial 
market utility would make the application of the standard or standards 
inappropriate.


Sec.  234.4  Standards for central securities depositories and central 
counterparties.

    (a) A designated financial market utility that is designated on the 
basis of its role as a central securities depository or a central 
counterparty must implement rules, procedures, or operations designed 
to ensure that it meets or exceeds the following risk-management 
standards with respect to the payment, clearing, and settlement 
activities of that central securities depository or central 
counterparty:
    (1) The central securities depository or central counterparty has a 
well-founded, transparent, and enforceable legal framework for each 
aspect of its activities in all relevant jurisdictions.
    (2) The central securities depository or central counterparty 
requires participants to have sufficient financial resources and robust 
operational capacity to meet obligations arising from participation in 
the central securities depository or central counterparty. The central 
securities depository or central counterparty has procedures in place 
to monitor that participation requirements are met on an ongoing basis. 
The central securities depository's or central counterparty's 
participation requirements are objective and publicly disclosed, and 
permit fair and open access.
    (3) The central securities depository or central counterparty holds 
assets in a manner whereby risk of loss or of delay in its access to 
them is minimized. Assets invested by a central securities depository 
or central counterparty are held in instruments with minimal credit, 
market, and liquidity risks.
    (4) The central securities depository or central counterparty 
identifies sources of operational risk and minimizes them through the 
development of appropriate systems, controls, and procedures; has 
systems that are reliable and secure, and has adequate, scalable 
capacity; and has business continuity plans that allow for timely 
recovery of operations and fulfillment of the central securities 
depository's or central counterparty's obligations.
    (5) The central securities depository or central counterparty 
employs money settlement arrangements that eliminate or strictly limit 
its settlement bank risks, that is, its credit and liquidity risks from 
the use of banks to effect money settlements with its participants and 
requires funds transfers to the central securities depository or 
central counterparty be final when effected.
    (6) The central securities depository or central counterparty is 
cost-effective in meeting the requirements of participants while 
maintaining safe and secure operations.
    (7) The central securities depository or central counterparty 
evaluates the potential sources of risks that can arise when the 
central securities depository or central counterparty establishes links 
either cross-border or domestically to settle transactions or clear 
trades, and ensures that the risks are managed prudently on an ongoing 
basis.
    (8) The central securities depository or central counterparty has 
governance arrangements that are clear and transparent to fulfill 
public interest requirements and to support the objectives of owners 
and participants and promotes the effectiveness of a central securities 
depository's or central counterparty's risk-management procedures.
    (9) The central securities depository or central counterparty 
provides market participants with sufficient information for them to 
identify and evaluate accurately the risks and costs associated with 
using its services.
    (10) The central securities depository or central counterparty 
establishes default procedures that ensures that the central securities 
depository or central counterparty can take timely action to contain 
losses and liquidity pressures and to continue meeting its obligations 
and provides for key aspects of the default procedures to be publicly 
available.
    (11) The central securities depository or central counterparty 
ensures that final settlement occurs no later than the end of the 
settlement day and requires that intraday or real-time finality be 
provided where necessary to reduce risks.
    (12) The central securities depository or central counterparty 
eliminates principal risk by linking securities transfers to funds 
transfers in a way that achieves delivery versus payment.
    (13) The central securities depository or central counterparty 
states its obligations with respect to physical deliveries, and the 
risks from these obligations are identified and managed.
    (14) The central securities depository immobilizes or 
dematerializes securities certificates and transfers them by book entry 
to the greatest extent possible.
    (15) The central securities depository institutes risk controls 
that include collateral requirements and limits, and ensure timely 
settlement in the event that the participant with the largest payment 
obligation is unable to settle when the central securities depository 
extends intraday credit.
    (16) The central counterparty measures its credit exposures to its 
participants at least once a day and limits its exposures to potential 
losses from defaults by its participants in normal market conditions so 
that the operations of the central counterparty would not be disrupted 
and non-defaulting participants would not be exposed to losses that 
they cannot anticipate or control.
    (17) The central counterparty uses margin requirements to limit its 
credit exposures to participants in normal market conditions and uses 
risk-based models and parameters to set margin requirements and reviews 
them regularly. Specifically, the central counterparty--
    (i) Provides for annual model validation consisting of evaluating 
the performance of the central counterparty's margin models and the 
related parameters and assumptions associated with such models by a 
qualified person who does not perform functions associated with the 
central counterparty's margin models (except as part of the annual 
model validation) and does not report to such a person.
    (ii) Reviews and backtests margin models and parameters at least 
quarterly.

[[Page 45921]]

    (18) The central counterparty maintains sufficient financial 
resources to withstand, at a minimum, a default by the participant to 
which it has the largest exposure in extreme but plausible market 
conditions.
    (b) The Board, by order, may apply heightened risk-management 
standards to a particular designated financial market utility in 
accordance with the risks presented by that designated financial market 
utility. The Board, by order, may waive the application of a standard 
or standards to a particular designated financial market utility where 
the risks presented by or the design of that designated financial 
market utility would make the application of the standard or standards 
inappropriate.


Sec.  234.5  Changes to rules, procedures, or operations.

    (a) Advance notice.
    (1) A designated financial market utility shall provide at least 
60-days advance notice to the Board of any proposed change to its 
rules, procedures, or operations that could materially affect the 
nature or level of risks presented by the designated financial market 
utility.
    (2) The notice of the proposed change shall describe--
    (i) The nature of the change and expected effects on risks to the 
designated financial market utility, its participants, or the market; 
and
    (ii) How the designated financial market utility plans to manage 
any identified risks.
    (3) The Board may require the designated financial market utility 
to provide additional information necessary to assess the effect the 
proposed change would have on the nature or level of risks associated 
with the utility's payment, clearing, or settlement activities and the 
sufficiency of any proposed risk-management techniques.
    (4) A designated financial market utility shall not implement a 
change to which the Board has an objection.
    (5) The Board will notify the designated financial market utility 
of any objection before the end of 60 days after the later of--
    (i) The date the Board receives the notice of proposed change; or
    (ii) The date the Board receives any further information it 
requests for consideration of the notice.
    (6) A designated financial market utility may implement a change if 
it has not received an objection to the proposed change before the end 
of 60 days after the later of--
    (i) The date the Board receives the notice of proposed change; or
    (ii) The date the Board receives any further information it 
requests for consideration of the notice.
    (7) With respect to proposed changes that raise novel or complex 
issues, the Board may, by written notice during the 60-day review 
period, extend the review period for an additional 60 days. Any 
extension under this paragraph will extend the time periods under 
paragraphs (a)(5) and (a)(6) of this section to 120 days.
    (8) A designated financial market utility may implement a proposed 
change before the expiration of the applicable review period if the 
Board notifies the designated financial market utility in writing that 
the Board does not object to the proposed change and authorizes the 
designated financial market utility to implement the change on an 
earlier date, subject to any conditions imposed by the Board.
    (b) Emergency changes.
    (1) A designated financial market utility may implement a change 
that would otherwise require advance notice under this section if it 
determines that--
    (i) An emergency exists; and
    (ii) Immediate implementation of the change is necessary for the 
designated financial market utility to continue to provide its services 
in a safe and sound manner.
    (2) The designated financial market utility shall provide notice of 
any such emergency change to the Board as soon as practicable and no 
later than 24 hours after implementation of the change.
    (3) In addition to the information required for changes requiring 
advance notice in paragraph (a)(2) of this section, the notice of an 
emergency change shall describe--
    (i) The nature of the emergency; and
    (ii) The reason the change was necessary for the designated 
financial market utility to continue to provide its services in a safe 
and sound manner.
    (4) The Board may require modification or rescission of the change 
if it finds that the change is not consistent with the purposes of the 
Dodd-Frank Act or any applicable rules, order, or standards prescribed 
under section 805(a) of the Dodd-Frank Act.
    (c) Materiality.
    (1) The term ``materially affect the nature or level of risks 
presented'' in paragraph (a)(1) of this section means matters as to 
which there is a reasonable possibility that the change would 
materially affect the overall nature or level of risk presented by the 
designated financial market utility, including risk arising in the 
performance of payment, clearing, or settlement functions.
    (2) A change to rules, procedures, or operations that would 
materially affect the nature or level of risks presented includes, but 
is not limited to, changes that materially affect any one or more of 
the following:
    (i) Participant eligibility or access criteria;
    (ii) Product eligibility;
    (iii) Risk management;
    (iv) Settlement failure or default procedures;
    (v) Financial resources;
    (vi) Business continuity and disaster recovery plans;
    (vii) Daily or intraday settlement procedures;
    (viii) The scope of services, including the addition of a new 
service or discontinuation of an existing service;
    (ix) Technical design or operating platform, which results in non-
routine changes to the underlying technological framework for payment, 
clearing, or settlement functions; or
    (x) Governance.
    (3) A change to rules, procedures, or operations that does not meet 
the conditions of paragraph (c)(2) of this section and would not 
materially affect the nature or level of risks presented includes, but 
is not limited to the following:
    (i) A routine technology systems upgrade;
    (ii) A change in a fee, price, or other charge for services 
provided by the designated financial market utility;
    (iii) A change related solely to the administration of the 
designated financial market utility or related to the routine, daily 
administration, direction, and control of employees; or
    (iv) A clerical change and other non-substantive revisions to 
rules, procedures, or other documentation.

    By order of the Board of Governors of the Federal Reserve 
System, July 27, 2012.
Robert deV. Frierson,
Deputy Secretary of the Board.
[FR Doc. 2012-18762 Filed 8-1-12; 8:45 am]
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