Alert August 04, 2009

Proposed Legislation for the Supervision of Systemically Important Payment, Clearing and Settlement Systems

As part of its financial regulatory reform program, the Obama Administration, through the Treasury, submitted to Congress proposed legislation that authorizes the Board of Governors of the Federal Reserve System (the “FRB”) to designate systemically important payment, clearing and settlement systems and prescribe uniform standards for such systems.  The proposed legislation is designed to implement recommendations made in the Treasury’s June 2009 White Paper on financial regulatory reform (as discussed in the June 23, 2009 Alert).

Designation of Systemically Important Payment, Clearing and Settlement Systems.  Pursuant to the proposed legislation, the FRB may designate a financial market utility (defined by the proposed legislation as a person who operates a payment, clearing or settlement system) or payment, clearing or settlement activity as, or likely to become, systemically important.  A systemically important system is one that if it failed or was disrupted would create or increase the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system.  In making these determinations, the proposed legislation instructs the FRB to consider (i) the aggregate monetary value of transactions carried out through the financial market utility or the payment, clearing or settlement activity; (ii) the relationship, interdependencies and other interactions of the financial market utility or payment, clearing or settlement activity with other financial market utilities or payment, clearing or settlement activities; (iii) the effect of the failure or disruption of the financial market utility or payment, clearing or settlement activity would have on the financial market; (iv) the recommendation of the Financial Services Oversight Council; and (v) such other considerations as the FRB determines to be necessary.  A designation that a financial market utility or payment, clearing or settlement activity is systemically important is subject to reevaluation, rescission, notice and an opportunity to be heard.

Standards for Systemically Important Payment, Clearing and Settlement Systems.  The proposed legislation authorizes the FRB to prescribe risk management standards governing the operations of designated systemically important financial market utilities or payment, clearing or settlement activities.  These standards would be designed to promote robust risk management, promote safety and soundness, reduce systemic risk and support the stability of the broader financial system.  Such standards could address risk management policies and procedures, margin, collateral, capital and default policies and procedures, and the ability to complete timely clearing and settlement of financial transactions.

Operations of Designated Financial Market Utilities.  The proposed legislation authorizes the FRB to maintain accounts and provide services for designated financial market utilities, including allowing such financial market utilities to have access to borrow from the discount window.  The FRB may also exempt a designated financial market utility from the reserve requirements of the Federal Reserve Act, or modify such requirements to apply to designated financial market utilities. 

Examination and Enforcement.  The proposed legislation provides for an annual examination of a designated financial market utility by the federal agency with primary jurisdiction over the designated financial market utility under banking, securities or commodity futures laws.  Service providers to a designated financial market utility may also be examined in connection with their provision of integral services to that designated financial market utility.  The proposed legislation also authorizes the appropriate federal regulator to examine a financial institution engaged in systemically important payment, clearing or settlement activities.  These examinations of designated financial market utilities, service providers and financial institutions would be conducted in consultation with the FRB, which has back-up examination powers.  Under the proposed legislation, designated financial market utilities will be subject to the same manner of enforcement actions as insured depository institutions.  Financial institutions engaging in systemically important payment, clearing or settlement activities would also be subject to enforcement actions.  The FRB also has back-up enforcement powers relating to designated financial market utilities and systemically important payment, clearing or settlement activities. 

Requests for Information, Reports or Records.  The proposed legislation authorizes the FRB to require any financial market utility or financial institution engaged in systemically important payment, clearing or settlement activities to submit information to FRB to allow the FRB to determine whether the financial market utility or financial institution engaged in systemically important payment, clearing or settlement activities is systemically important.  Financial market utilities and financial institutions engaged in systemically important payment, clearing or settlement activities may be required to make regular reports to the FRB.  Such reports may be disclosed by the FRB to the appropriate federal regulator who supervises the designated financial market utility or financial institution engaged in systemically important payment, clearing or settlement activities.  Such federal regulators are also authorized to share their reports with the FRB.