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2010-7742

  • FR Doc 2010-7742[Federal Register: April 6, 2010 (Volume 75, Number 65)]

    [Rules and Regulations]

    [Page 17297-17303]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr06ap10-4]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 190

    RIN 3038-AC94

    Account Class

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rules.

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    SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')

    is amending its regulations (the ``Regulations'') \1\ to create a sixth

    and separate ``account class,'' \2\ applicable only to the bankruptcy

    of a commodity broker that is a futures commission merchant (``FCM''),

    for positions in cleared over-the-counter (``OTC'') derivatives (and

    money, securities, and/or other property margining, guaranteeing, or

    securing such positions).

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    \1\ The regulations of the Commission can be found at 17 CFR

    Chapter 1.

    \2\ In general, the concept of ``account class'' governs the

    manner in which the trustee calculates the net equity (i.e., claims

    against the estate) and the allowed net equity (i.e., pro rata share

    of the estate) for each customer of a commodity broker in

    bankruptcy.

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    Further, the Commission is amending the Regulations to codify the

    appropriate allocation, in a bankruptcy of any commodity broker, of

    positions in commodity contracts of one account class (and the money,

    securities, and/or other property margining, guaranteeing, or securing

    such positions), which, pursuant to an order issued by the Commission

    under Section 4d of the Commodity Exchange Act (the ``Act''),\3\ are

    commingled with positions in commodity contracts of the futures account

    class (and the money, securities, and/or other property margining,

    guaranteeing, or securing such positions).

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    \3\ The Act can be found at 7 U.S.C. 1-23.

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    DATES: Effective Date: The final rules are effective as of May 6, 2010.

    FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate

    Director, Division of Clearing and Intermediary Oversight, 202-418-

    5092, rwasserman@cftc.gov; or Nancy Schnabel, Special Counsel, Division

    of Clearing and Intermediary Oversight, 202-418-5344,

    nschnabel@cftc.gov; Commodity Futures Trading Commission, Three

    Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On August 13, 2009, the Commission published a Notice of Proposed

    Rulemaking, which contained the following three proposals (the

    ``Notice'').\4\ First, the Notice proposed amending Regulation

    190.01(a), as well as adding new Regulation 190.01(oo), to create a

    sixth and separate account class, applicable only to the bankruptcy of

    a commodity broker that is an FCM, for positions in ``cleared OTC

    derivatives'' (and money, securities, and/or other property margining,

    guaranteeing, or securing such positions).\5\ Second, the Notice

    proposed further amending Regulation 190.01(a) to codify the

    appropriate allocation, in a bankruptcy of any commodity broker, of

    positions in commodity contracts of one account class (and relevant

    collateral), which, pursuant to an order issued by the Commission under

    Section 4d of the Act \6\ (a ``Section 4d Order''), are commingled with

    positions in commodity contracts of the futures account class (and

    relevant collateral). Third, the Notice proposed making certain

    conforming amendments to Regulation 190.07(b)(2)(viii) and Form 4

    (Proof of Claim) in Appendix A to Regulation Part 190 (Bankruptcy

    Forms).

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    \4\ 74 FR 40794 (August 13, 2009).

    \5\ The Notice proposed defining ``cleared OTC derivatives'' as:

    Positions in commodity contracts that have not been entered into

    or traded on a contract market (as such term is defined in Sec.

    1.3(h) of this chapter) or on a derivatives transaction execution

    facility (within the meaning of Section 5a of the Act), but which

    nevertheless are submitted by a commodity broker that is a futures

    commission merchant (as such term is defined in Sec. 1.3(p) of this

    chapter) for clearing by a clearing organization (as such term is

    defined in this section), along with the money, securities, and/or

    other property margining, guaranteeing, or securing such positions,

    which are required to be segregated, in accordance with a rule,

    regulation, or order issued by the Commission, or which are required

    to be held in a separate account for cleared OTC derivatives only,

    in accordance with the rules or bylaws of a clearing organization

    (as such term is defined in this section).

    Id. at 40799.

    \6\ 7 U.S.C. 6d.

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    Although, as mentioned above, the Notice proposed creating a new

    account class for positions in cleared OTC derivatives (and relevant

    collateral), the Notice declined to propose substantive requirements,

    applicable prior to the bankruptcy of a commodity broker that is an

    FCM, for the treatment of such positions (and relevant collateral).

    Rather, the Notice stated that ``the Commission proposes to define

    `cleared OTC derivatives' in such a manner as to specify the sources

    from which such substantive requirements may

    [[Page 17298]]

    originate.'' \7\ According to the Notice, the rules or bylaws of a DCO

    constitute one such source.

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    \7\ 74 FR at 40796.

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    The public comment period on the Notice ended on September 14,

    2009. The Commission received four comments \8\ during the comment

    period: (i) One from an alternative investment industry trade

    association; \9\ (ii) one from a futures industry trade association;

    \10\ (iii) one from the holding company of four designated contract

    markets (each, a ``DCM'') and three DCOs; \11\ and (iv) one from a

    DCM.\12\

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    \8\ For purposes of this release, a comment letter is referenced

    by (i) its author, (ii) its file number (as shown in the comment

    file associated with the Notice on the Commission's Web site), and

    (iii) the page (if applicable). The comment file associated with the

    Notice is available at http://www.cftc.gov/lawandregulation/

    federalregister/federalregistercomments/2009/09-009.html.

    \9\ The Managed Funds Association (representing the global

    alternative investment industry) (``MFA'') (CL01).

    \10\ The Futures Industry Association (representing the

    commodity futures and options industry) (``FIA'') (CL02).

    \11\ The CME Group, Inc. (the holding company for: (i) The

    Chicago Mercantile Exchange Inc. (``CME'') and CME Clearing, a

    division of CME; (ii) the Board of Trade of the City of Chicago,

    Inc. and its clearing house; (iii) the New York Mercantile Exchange,

    Inc. and its clearing house; and (iv) the Commodity Exchange, Inc.)

    (``The CME Group'') (CL03).

    \12\ ELX Futures, L.P. (``ELX'') (CL04).

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    Collectively, the comments raise the following five concerns with

    the Notice:

    The Commission may not have authority to promulgate the

    proposed amendments in the Notice;

    The Commission should make the proposed account class for

    cleared OTC derivatives applicable to the bankruptcy of a commodity

    broker that is a DCO, not simply to the bankruptcy of a commodity

    broker that is an FCM;

    The Commission should change the definition of cleared OTC

    derivatives in the Notice to better comport with the definition of

    ``cleared-only contracts'' \13\ in the Interpretative Statement that

    the Commission issued on September 26, 2008 (the ``Statement on Cleared

    OTC Derivatives''); \14\

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    \13\ In the Statement on Cleared OTC Derivatives, the Commission

    defined ``cleared-only contracts'' as those contracts that

    ``although not executed or traded on a Designated Contract Market or

    a Derivatives Transaction Execution Facility, are subsequently

    submitted for clearing through a Futures Commission Merchant * * *

    to a Derivatives Clearing Organization.'' 73 FR 65514 (November 4,

    2008).

    \14\ Id.

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    The Commission should establish objective standards for

    issuing Section 4d Orders; and

    The Commission should specify substantive requirements

    with respect to the treatment of positions in cleared OTC derivatives

    (and money, securities, and/or other property margining, guaranteeing,

    or securing such positions), if a DCO requires such positions (and

    relevant collateral) to be held in a separate account for cleared OTC

    derivatives.

    The Commission will address below each of the five concerns in

    turn.

    II. Concern That the Commission Does Not Have Authority To Promulgate

    the Proposed Amendments in the Notice

    A. Rationale for Concern

    Two commenters stated that certain participants in the OTC

    derivatives markets have questioned the authority of the Commission to

    promulgate the proposed amendments in the Notice. In support of their

    respective statements, both commenters referenced the Report to the

    Supervisors of the Major OTC Derivatives Dealers on the Proposals of

    Centralized CDS Clearing Solutions for the Segregation and Portability

    of Customer CDS Positions and Related Margin, dated June 30, 2009 (the

    ``Segregation and Portability Report'').\15\ One commenter quotes from

    a portion of the Segregation and Portability Report, which states that

    there exists a ``not insignificant'' risk that a court administering

    the bankruptcy of a commodity broker would disagree with the Statement

    on Cleared OTC Derivatives.\16\ In the Statement on Cleared OTC

    Derivatives, the Commission determined (i) that cleared-only contracts

    constituted ``commodity contracts'' \17\ within the meaning of

    Subchapter IV of Chapter 7 of the Bankruptcy Code (``Subchapter

    IV''),\18\ and (ii) that, therefore, customer positions in cleared-only

    contracts that, pursuant to a Section 4d Order, are commingled with

    customer positions in futures contracts should be afforded all

    protections available under Subchapter IV and Regulation Part 190 in

    the event of the bankruptcy of a commodity broker that is an FCM. For

    the reasons explained below, the Commission does not believe that the

    commenters' concerns are well founded.

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    \15\ The Segregation and Portability Report is available at

    http://www.newyorkfed.org/newsevents/news/markets/2009/

    an090713.html.

    According to the MFA, the Segregation and Portability Report

    states that ``there is uncertainty as to the proposition that

    cleared OTC derivatives contracts constitute `commodity contracts',

    thereby receiving account class protections under the [Act] and the

    Bankruptcy Code.'' See MFA CL01 at 3.

    According to the FIA, the Segregation and Portability Report

    ``concludes that there are reasonable arguments that cleared OTC

    derivatives may be viewed as `commodity contracts' for purposes of

    Subchapter IV and Part 190. However, `the risk of a contrary

    conclusion is not insignificant.' [Emphasis supplied.]'' See FIA

    CL02 at 6.

    \16\ Id. The FIA also quotes from another portion of the

    Segregation and Portability Report, which states:

    We believe there is a significant possibility (in a worst-case

    scenario) that the proposition that cleared [credit default swap]

    contracts constitute ``commodity contracts'' within the meaning of

    the Bankruptcy Code may be challenged * * * In addition, we also

    believe that any challenge to the proposition that [credit default

    swaps] constitute ``commodity contracts'' would likely result in

    significant delay for customers seeking the return of margin through

    the insolvent FCM.

    Id.

    To properly contextualize these expressed concerns, the

    Commission makes two observations.

    First, while the Segregation and Portability Report repeatedly

    makes portentous statements concerning the ``not insignificant''

    risk that a court might find that cleared-only contracts (as the

    Statement on Cleared OTC Derivatives defines such term) are not

    commodity contracts, the Segregation and Portability Report cites

    neither to statutory language nor to case law that might be relied

    upon to support such a conclusion. Indeed, the Report fails to

    specify any analytical basis for its concerns.

    Second, the Segregation and Portability Report's discussion of

    timing concerns in this context is somewhat incongruous, given that

    the report contains the following description of its own scope:

    We do not principally focus on timing issues in this Report--

    e.g., when customers will be able to recover their margin. Although

    we note certain instances in which timing concerns may be

    particularly relevant, our primary focus is on whether customers

    will be able to recover their margin. Timing issues are critical to

    the analysis of any CCP's customer protection framework. However, we

    do not focus on them in this Report because of their inherently

    complex and unpredictable nature.

    See the Segregation and Portability Report at 3. In any event,

    the prosaic observation that the conclusions of the Statement on

    Cleared OTC Derivatives may be the subject of a challenge, and that

    such a challenge might take time to resolve, provides no reason for

    rejecting the proposals contained in the Notice that are based on

    those conclusions.

    \17\ 11 U.S.C. 761(4)(A).

    \18\ 11 U.S.C. Chapter 7, Subchapter IV.

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    B. ``Commodity Contract'' Definition

    In both the Statement on Cleared OTC Derivatives and the Notice,

    the Commission relied on clear statutory authority that the Commodity

    Futures Modernization Act of 2000 (the ``CFMA'') \19\ introduced in the

    Act and in Subchapter IV to conclude that cleared OTC derivatives are

    ``commodity contracts'' within the meaning of Section 761(4)(A) of the

    Bankruptcy Code.\20\ The CFMA created the opportunity for OTC

    derivatives to be cleared.\21\ The CFMA also extended Subchapter IV to

    cleared OTC derivatives. Section 761(4)(A) of the Bankruptcy Code

    defines ``commodity contract,'' with respect to an FCM, as a ``contract

    for the purchase or sale of a commodity for future delivery on, or

    subject to the rules of, a contract market

    [[Page 17299]]

    or board of trade.'' \22\ Section 112(c)(6) of the CFMA amended the

    definition of ``contract market'' in Section 761(7) of the Bankruptcy

    Code to include reference to a ``registered entity.'' \23\ It also

    amended Section 761(8) of the Bankruptcy Code to incorporate by

    reference the definition of ``registered entity'' in the Act.\24\

    Section 1a(29) of the Act defines a ``registered entity'' to include

    ``(iii) a derivatives clearing organization registered under Section 5b

    * * *''.\25\

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    \19\ Appendix E of Public Law 106-554, 114 Stat. 2763 (2000).

    \20\ See supra note 17.

    \21\ See, e.g., Sections 2(d), (e), and (g) of the Act (7 U.S.C.

    2(d), (e), (g)).

    \22\ See supra note 17.

    \23\ 11 U.S.C. 761(7).

    \24\ 11 U.S.C. 761(8).

    \25\ 7 U.S.C. 1a(29).

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    Therefore, the Commission believes that the CFMA permitted cleared

    OTC derivatives, which are subject to the rules of a DCO, to become

    ``commodity contracts,'' with respect to an FCM, within the meaning of

    Section 761(4) of the Bankruptcy Code.\26\ The Commission further

    believes that a court administering the bankruptcy of an FCM would

    consider the abovementioned CFMA interpretation to be a ``reasonable''

    ``construction of a statutory scheme'' that the Commission has been

    ``entrusted to administer'' under Chevron U.S.A. Inc. v. Natural

    Resources Defense Council, Inc., et al., 467 U.S. 837, 844 (1984).\27\

    Indeed, the Segregation and Portability Report states: ``Ultimately, we

    believe a court is likely to conclude that [credit default swaps] are

    `commodity contracts' (on account of which [credit default swap]

    clearing customers are `customers' within the meaning of the Bankruptcy

    Code) * * *''.\28\

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    \26\ See supra note 17.

    \27\ As mentioned above, ``account class'' governs the manner in

    which the trustee calculates the net equity (i.e., claims against

    the estate) and the allowed net equity (i.e., pro rata share of the

    estate) for each customer of a commodity broker in bankruptcy. As

    the NPRM states, ``[t]he Commission is empowered by Section 20 of

    the Commodity Exchange Act * * * (i) to define the `net equity' of a

    customer of a commodity broker in bankruptcy, and (ii) to prescribe,

    by rule or regulation, the procedures for calculating such `net

    equity.' '' See 74 FR at 40795. The Commission is exercising its

    powers under Section 20 of the Act in determining whether cleared

    OTC derivatives could, with respect to an FCM that is a commodity

    broker, constitute a sixth and separate account class. The plain

    language of the Bankruptcy Code recognizes the authority of the

    Commission to make such determination. For example, Section 761(17)

    of the Bankruptcy Code subjects the definition of ``net equity,'' in

    the case of a commodity broker, to such ``rules and regulations as

    the Commission promulgates under the Act.'' Moreover, the

    legislative history of the 1978 amendments to the Bankruptcy Code

    supports the authority of the Commission. Cf. H.R. Rep. No. 95-595

    (1977) (stating that ``a final distinction [between Subchapter III

    of Title 7 of the Bankruptcy Code (11 U.S.C., Title 7, Subchapter

    III) and Subchapter IV] concerns the creation of a rule-making power

    in the Commodity Futures Trading Commission to carry out the

    provisions * * * The bill contains such a rule-making power with

    respect to * * * net equity * * * The rule-making power was

    requested by the CFTC and is appropriate in light of the germinal

    state of regulation in this area'').

    \28\ The Segregation and Portability Report does note that

    ``this outcome is not at all certain.'' See the Segregation and

    Portability Report at 35. However, the Segregation and Portability

    Report also observes that, in the event that a court administering

    the bankruptcy of a commodity broker disagrees with the

    determination of the Commission that cleared-only contracts (as the

    Statement on Cleared OTC Derivatives defines such term) constitute

    ``commodity contracts'' under Subchapter IV, ``if the [commodity

    broker] segregates assets solely for the cleared [credit default

    swap] customers, then the cleared [credit default swap] customers'

    interest in those assets may be superior to any interest of the

    commodities customers or unsecured creditors of the [commodity

    broker] * * *''. See the Segregation and Portability Report at 37.

    Therefore, the Segregation and Portability Report appears to imply

    that the creation, in the event of the bankruptcy of a commodity

    broker that is an FCM, of a separate account class for customer

    positions in cleared OTC derivatives (and money, securities, and/or

    other property margining, guaranteeing, or securing such positions),

    as the Notice proposed, may benefit customers, even if a court does

    not accord such positions (and relevant collateral) full protection

    under Subchapter IV and Regulation Part 190.

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    C. Support for Legislative Changes

    One commenter notes that the Commission proposed to Congress on

    August 17, 2009 certain amendments to the Bankruptcy Code that would

    achieve the same effect as the amendments proposed in the Notice. The

    commenter then speculated that the Commission may have been motivated

    to make such proposal because it believed that it otherwise lacks

    authority to promulgate the proposed amendments in the Notice.\29\ Such

    speculation is mistaken. As stated above, the Commission believes that

    cleared OTC derivatives are ``commodity contracts'' within the meaning

    of Section 761(4)(A) of the Bankruptcy Code.\30\ The commenter

    references proposals that Chairman Gary Gensler made to Congress. These

    proposals included the abovementioned amendments to the Bankruptcy Code

    in order to clarify the status of swaps, in the context of the

    improvements to regulation of over-the-counter derivatives markets that

    the Administration proposed \31\ and other, more extensive changes to

    the Bankruptcy Code. The proposal that Congress make explicit what the

    CFMA left implicit does not mean that the interpretation of the

    existing statute that the Commission has advanced is not

    reasonable.\32\

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    \29\ As mentioned above, according to the FIA, the Segregation

    and Portability Report ``concludes that there are reasonable

    arguments that cleared OTC derivatives may be viewed as `commodity

    contracts' for purposes of Subchapter IV and Part 190. However, `the

    risk of a contrary conclusion is not insignificant.' [Emphasis

    supplied.]'' The FIA then further observes:

    The Commission may have reached the same conclusion. In its

    August 17, 2009 recommendations to Congress, the Commission has

    proposed amendments to the Bankruptcy Code that amend the definition

    of a ``contract market'' to remove the reference to ``registered

    entity,'' which is currently the Commission's basis for finding that

    cleared-only derivatives contracts are ``commodity contracts'' under

    the Bankruptcy Code. Instead, the Commission recommends that the

    definition of a ``commodity contract'' be amended to include a

    ``swap that is submitted to a derivatives clearing organization for

    clearing'' by a ``swap clearer'' (as defined). The broad definition

    of a ``swap'' in the Bankruptcy Code would encompass all cleared OTC

    derivatives contracts.

    See FIA CL02 at 6-7.

    \30\ See supra note 17.

    \31\ Such proposals are available at http://

    financialstability.gov/docs/regulatoryreform/titleVII.pdf.

    \32\ See United States v. Sepulveda, 115 F.3d 882, 885 (11th

    Cir. 1997) (quoting Hawkins v. United States, 30 F.3d 1077, 1082

    (9th Cir. 1994)) (stating that ``Congress may, however, `amend a

    statute to clarify existing law * * *' Thus, an amendment to a

    statute does not necessarily indicate that the unamended statute

    meant the opposite.'' See also Wesson v. United States, 48 F.3d 894,

    900-901 (5th Cir. 1995); Fowler v. Unified School District No. 259,

    Sedgwick County, Kansas, 128 F.3d 1431 (10th Cir. 1997)).

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    III. Recommendation That the Commission Extend the Application of the

    Proposed Account Class for Cleared OTC Derivatives

    One commenter recommends that the Commission extend the application

    of the account class for cleared OTC derivatives, as proposed in the

    Notice, to the bankruptcy of a commodity broker that is a DCO, rather

    than limit such application to the bankruptcy of a commodity broker

    that is an FCM. That commenter argues that the absence of such an

    extension would cause confusion, in the event of a DCO bankruptcy,

    regarding the treatment of the money, securities, and/or other property

    that the DCO holds to margin, guarantee, or secure positions in cleared

    OTC derivatives belonging to customers of DCO members.\33\

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    \33\ Specifically, The CME Group states:

    If, as proposed by the Commission, an FCM were to utilize a

    separate account for customers' cleared OTC derivatives in the

    absence of a 4d order, the DCO must also maintain a similar account

    for holding such positions and their accompanying margins. If the

    cleared OTC derivatives account class will not apply in the unlikely

    event of a DCO bankruptcy, then it is unclear what account class

    would apply to the funds in the DCO's separate account for those OTC

    derivatives that it clears on behalf of its clearing FCMs'

    customers.

    See The CME Group CL03 at 3.

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    While sympathetic to these arguments, the Commission continues to

    believe that a DCO bankruptcy would be sui generis.\34\ Therefore, the

    [[Page 17300]]

    Commission believes that the best approach, at present, would be to

    limit the application of the account class for cleared OTC derivatives

    to the bankruptcy of a commodity broker that is an FCM.

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    \34\ The proposing release to Regulation Part 190 states:

    The Commission is proposing that all open commodity contracts,

    even those in a deliverable position, be liquidated in the event of

    a clearing organization bankruptcy because it would be highly

    unlikely that an exchange could maintain a properly functioning

    futures market in the event of the collapse of its clearing

    organization. The Commission has proposed no other rules with

    respect to the operation of clearing organization debtors * * *

    Because the bankruptcy of a clearing organization would be unique,

    the Commission is not proposing a general rule in this regard. The

    potential for disruption of the Markets, and of the nation's economy

    as a whole, in the case of a clearing organization bankruptcy,

    together with the desirability of the Commission's active

    participation in developing a means of meeting such an emergency,

    has disposed the Commission to take a case-by-case approach with

    respect to clearing organizations.

    See 46 FR 57535, 57545 (November 24, 1981).

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    IV. Recommendation That the Commission Change the Proposed Definition

    of Cleared OTC Derivatives

    One commenter recommends that the Commission change the definition

    of cleared OTC derivatives, as proposed in the Notice,\35\ to better

    comport with the definition of cleared-only contracts in the Statement

    on Cleared OTC Derivatives.\36\ Specifically, the commenter notes that

    the definition of cleared OTC derivatives proposed in the Notice

    appears to require that an FCM actually submit a contract for clearing.

    In contrast, the definition of cleared-only contracts in the Statement

    on Cleared OTC Derivatives only requires that a contract is submitted

    through an FCM for clearing.\37\ The commenter states that, if the

    Commission adopts the recommendation, the Commission would render

    patent that it ``does not intend to prohibit clearing FCMs from

    authorizing their customers to directly enter their transactions into

    the clearing system, in order to meet the definition of cleared OTC

    derivatives, as long as the transactions are cleared through an FCM.''

    \38\ The Commission agrees with this commenter, and has modified, in

    this release, the definition of cleared OTC derivatives proposed in the

    Notice in accordance with the recommendation from this commenter.

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    \35\ See supra note 5.

    \36\ See supra note 13.

    \37\ See The CME Group CL03 at 5.

    \38\ Id.

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    Another commenter poses two questions about the definition of

    cleared OTC derivatives proposed in the Notice.\39\ All such questions

    appear related to whether the Commission may deem a contract listed for

    trading on a contract market (as Regulation 1.3(h) defines such term)

    to have been executed OTC, if such contract fails to reach a certain

    liquidity threshold on the contract market. The Commission believes

    that the definition of cleared OTC derivatives, as proposed in the

    Notice (i.e., proposed Regulation 190.01(oo)), plainly limits such term

    to contracts that ``have not been entered into or traded on a contract

    market (as such term is defined in Sec. 1.3(h) of this chapter) * *

    *.'' Regulation 1.3(h), in turn, defines ``contract market'' in terms

    of a board of trade's designation as a DCM, not in terms of the

    liquidity of any particular contract.

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    \39\ Specifically, ELX asks:

    ``What constitutes a `cleared only' contract? If an OTC

    derivative is offered for exchange trading (thus losing the moniker

    OTC derivative) but fails to trade, or trades fewer than 100

    contracts per day, is it considered cleared only?''

    ``How much time will a contract be given to reach a

    liquidity threshold before being deemed `cleared only' and required

    to be placed in a new account class?''

    See ELX CL04 at 2.

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    V. Recommendations That the Commission Establish Objective Standards

    for Section 4d Orders

    Two commenters recommend that the Commission propose objective

    standards for determining which cleared OTC derivatives would be

    eligible for a Section 4d Order.\40\ The first commenter states that

    ``it would be beneficial to DCOs and the Commission if the Commission

    were to adopt standards that would define the requirements that must be

    met for a cleared OTC derivative to qualify for 4d treatment.'' \41\ In

    contrast, the second commenter states that the Commission must propose

    such objective standards ``[i]n order to assure that `cleared OTC

    derivatives' customers receive the benefits intended'' by the proposed

    rules contained in the Notice.\42\ The second commenter contends that,

    without such standards, customers with positions (and money,

    securities, and/or other property margining, guaranteeing, or securing

    such positions) in the account class for cleared OTC derivatives may

    argue, in the bankruptcy of a commodity broker that is an FCM, that:

    (i) Such positions share certain characteristics with positions in the

    futures account class; and (ii) thus such customers ``should have

    access to the same pool of assets, i.e., the futures account.'' \43\

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    \40\ A Section 4d Order would permit positions in a cleared OTC

    derivative (and relevant collateral) to be included in the futures

    account class rather than another account class (e.g., the account

    class for cleared OTC derivatives).

    \41\ See The CME Group CL03 at 7.

    \42\ See FIA CL02 at 3.

    \43\ Id. at 3-5.

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    The proposed regulations contained in the Notice (i.e., the

    proposed amendment to Regulation 190.01(a)) unambiguously state that

    ``positions in commodity contracts of one account class (and the money,

    securities, and/or other property margining, guaranteeing, or securing

    such positions)'' would be treated, in the bankruptcy of any commodity

    broker, ``as being held in the futures account class'' only if,

    ``pursuant to a Commission order,'' such positions are ``commingled

    with positions in commodity contracts of the futures account class (and

    the money, securities, and/or other property margining, guaranteeing,

    or securing such positions).'' \44\ Pursuant to that plain language, in

    the bankruptcy of a commodity broker, the decisive factor as to whether

    a position in a cleared OTC derivative contract (and relevant

    collateral) would be treated as belonging to the futures account class

    is whether the Commission has issued a Section 4d Order covering such

    contract, not whether the Commission should have or could have issued

    such a Section 4d Order.\45\

    ---------------------------------------------------------------------------

    \44\ 74 FR at 40798-99.

    \45\ To enhance clarity on this point, the reference in the

    definition of cleared OTC derivatives, as proposed in the Notice, to

    positions (and relevant collateral) that are ``segregated * * * in

    accordance with a rule, regulation, or order issued by the

    Commission,'' see id. at 40799, has been changed in this release to

    a reference to positions (and relevant collateral) that are

    ``segregated or set aside * * * in accordance with a rule,

    regulation, or order issued by the Commission.'' Also, Regulation

    190.01(a), as proposed in the Notice, has been changed to include

    the following emphasized language: ``Provided, further, that, if

    positions in commodity contracts that would otherwise belong to one

    account class (and the money, securities, and/or other property

    margining, guaranteeing, or securing such positions), are, pursuant

    to a Commission order, commingled with positions in commodity

    contracts of the futures account class (and the money, securities,

    and/or other property margining, guaranteeing, or securing such

    positions), then the former positions (and the relevant money,

    securities, and/or other property) shall be treated, for purposes of

    this part, as being held in an account of the futures account

    class.''

    In making the abovementioned changes, the Commission intends to

    remove any possible doubt that:

    OTC derivatives subject to a Section 4d Order

    (including from inception) are ``cleared OTC derivatives'' within

    the meaning of Regulation 190.01(oo), but that such derivatives

    shall be treated, pursuant to Regulation 190.01(a), as belonging to

    the futures account class and not the cleared OTC derivative account

    class; and

    OTC derivatives not subject to a Section 4d Order may

    become ``cleared OTC derivatives'' within the meaning of Regulation

    190.01(oo), but that such derivatives shall be treated, pursuant to

    Regulation 190.01(a), as belonging to the cleared OTC derivative

    account class and not the futures account class.

    ---------------------------------------------------------------------------

    It is outside the purview of this release to propose objective

    standards for determining which cleared OTC derivative contracts would

    be eligible

    [[Page 17301]]

    for a Section 4d Order. For the abovementioned reasons, such standards

    are not necessary to effectuate the purposes of the proposed rules

    contained in the Notice (including the proposed amendment to Regulation

    190.01(a)).\46\

    ---------------------------------------------------------------------------

    \46\ As the Notice states: ``The Commission is proposing [to

    create an account class for cleared OTC derivatives] at this time

    because of increased interest among DCOs in clearing OTC

    derivatives, and the need to enhance certainty regarding the

    treatment of cleared OTC derivatives in the bankruptcy of a

    commodity broker in bankruptcy.'' 74 FR at 40796.

    ---------------------------------------------------------------------------

    A third commenter poses questions pertaining to the operation of

    the futures account class after the Commission establishes a separate

    account class for cleared OTC derivatives.\47\ In answer to such

    questions, the Commission makes the following three observations.

    First, the Commission will continue to review petitions for Section 4d

    Orders and will approve such petitions in appropriate cases. Second,

    the only effect of this release on contracts (and relevant collateral)

    that, pursuant to a previously issued Section 4d Order, are permitted

    to be commingled with contracts (and relevant collateral) of the

    futures account class, is to codify the Statement on Cleared OTC

    Derivatives and the Interpretative Statement that the Commission issued

    on November 30, 2004 (the ``Statement on Commingling Foreign Futures

    Positions''),\48\ which, in each case, provides that such contracts

    (and relevant collateral) are to be treated as part of the futures

    account class. This release does not in any way vitiate any previously

    issued Section 4d Order. Finally, in the absence of an appropriate

    order, the Commission does not intend to permit positions in the

    futures account class and positions in the separate account class for

    cleared OTC derivatives to be margined as a single portfolio.

    ---------------------------------------------------------------------------

    \47\ Specifically, ELX asks:

    ``[W]hether the DCO will be permitted to cross margin

    the new account class envisioned by the Proposed Rules against

    related products in different account classes * * *''

    ``Will 4d exemptions still be granted after the new

    account class is created?''

    ``What will be the status of previously granted 4d

    exemptions, and will they be grandfathered or required to be

    transferred into the new account class?''

    ELX CL04 at 2.

    \48\ The Statement on Cleared OTC Derivatives can be found at 73

    FR 65514 (November 4, 2008). The Statement on Commingling Foreign

    Futures Positions can be found at 69 FR 69510 (November 30, 2004).

    ---------------------------------------------------------------------------

    VI. Recommendation That the Commission Establish Rules for the

    Treatment of Positions in Cleared OTC Derivatives (and Relevant

    Collateral)

    In the Notice, the Commission stated that it ``[did] not intend to

    specify substantive requirements for the treatment of cleared OTC

    derivatives (and the money, securities, and/or other property

    margining, guaranteeing, or securing such derivatives). Rather, the

    Commission propose[d] to define `cleared OTC derivatives' in such a

    manner as to specify the sources from which such substantive

    requirements may originate.'' As the Notice indicates, a DCO rule or

    bylaw constitutes one possible source for such substantive

    requirements. Because different DCOs may adopt different substantive

    requirements, such DCOs may afford varying levels of protection to

    positions in cleared OTC derivatives (and relevant collateral).\49\

    ---------------------------------------------------------------------------

    \49\ As The CME Group accurately observed, the proposed

    definition of ``cleared OTC derivatives'' in the Notice would

    permit, for example, ``one DCO [to] model its rule on the

    requirements for 4d segregated accounts which limit the instruments

    in which such funds may be invested to those set forth in Regulation

    1.25,'' and ``another DCO [to] use Regulation 30.7 requirements as

    its guide, and choose not to specify permissible investments.'' The

    CME Group CL03 at 6.

    ---------------------------------------------------------------------------

    Two commenters disagree with such approach. They recommend that the

    Commission specify substantive requirements with respect to the

    treatment of positions in cleared OTC derivatives (and relevant

    collateral), if the DCO requires such positions (and relevant

    collateral) to be held in a separate account for cleared OTC

    derivatives.\50\ One commenter observes:

    ---------------------------------------------------------------------------

    \50\ FIA states: ``In adopting these standards, the Commission

    should also provide guidance regarding the treatment of funds

    deposited to margin `cleared OTC derivatives.' '' FIA CL02 at 4.

    In addition, The CME Group states:

    Given that the Commission's goal is to ensure that customers

    clearing OTC derivatives receive bankruptcy protection, and in the

    interest of providing consistency in the safeguards for OTC customer

    positions and margins, the Commission should define the minimum

    requirements that must apply to cleared OTC derivatives accounts for

    transactions that are cleared through any DCO with respect to those

    areas that the Commission has already addressed for 4d accounts,

    including permitted investments, recordkeeping, and acknowledgement

    letters. The CME Group CL03 at 6-7.

    Depending on how much the requirements for cleared OTC

    derivatives accounts vary among DCOs, FCMs could find themselves in

    the position of having to maintain multiple cleared OTC derivatives

    accounts with respect to different DCOs. Moreover, under the

    Commission proposal, all cleared OTC derivatives accounts are

    considered to be part of the same account class, even if the

    accounts relate to multiple DCOs with varying requirements for such

    accounts. Therefore, the available funds in the cleared OTC

    derivatives account class could be diluted for customers of a

    bankrupt FCM who hold OTC derivatives cleared by a DCO with more

    stringent requirements because the account class also contains the

    margins of customers who hold OTC derivatives cleared by a DCO with

    less stringent requirements.\51\

    ---------------------------------------------------------------------------

    \51\ See The CME Group CL03 at 6.

    The Commission does not disagree with the recommendations of the

    two commenters, and has directed staff to recommend for the

    Commission's consideration proposals that would impose substantive

    requirements with respect to the treatment of positions in cleared OTC

    derivatives (and relevant collateral).

    The Commission has decided to promulgate the final rules contained

    in this release, without waiting to propose the abovementioned

    requirements, because the Commission believes that it is important, in

    light of recent market events (including disruptions in global credit

    markets), to enhance certainty, as soon as possible, with respect to

    the protections available under Subchapter IV and Regulation Part 190

    to positions in cleared OTC derivatives (and relevant collateral),

    however the FCM and the DCO treat such collateral. Moreover, the

    Commission believes that it is important to enhance certainty, as soon

    as possible, regarding the treatment, in a bankruptcy of any commodity

    broker, of customers with positions (and relevant collateral) subject

    to a Section 4d Order. Therefore, for the avoidance of doubt, the

    Commission clarifies that, after the final rules become effective, a

    position in an OTC derivative (and relevant collateral) that a customer

    clears through an FCM with a DCO, which position (and collateral) is

    not subject to a Section 4d Order, would be considered part of the

    cleared OTC derivative account class, as soon as, but only after, a DCO

    rule or bylaw that requires such positions (and relevant collateral) to

    be held in a separate account for cleared OTC derivatives becomes

    effective, either through self-certification or approval by the

    Commission.\52\ Such rule or bylaw need not specify any particular

    treatment of such positions (and relevant collateral) at this time in

    order for such positions to be considered within the OTC derivative

    account class.

    ---------------------------------------------------------------------------

    \52\ See Regulations 40.5 and 40.6 (17 CFR 40.5, 40.6).

    ---------------------------------------------------------------------------

    [[Page 17302]]

    VII. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \53\ requires Federal

    agencies, in promulgating regulations, to consider the impact of those

    regulations on small businesses. The final rules promulgated in this

    release will affect only FCMs and DCOs. The Commission has previously

    established certain definitions of ``small entities'' to be used by the

    Commission in evaluating the impact of its regulations in accordance

    with the RFA.\54\ The Commission has previously determined that FCMs

    \55\ and DCOs \56\ are not small entities for the purpose of the RFA.

    Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman, on behalf of

    the Commission, certifies that the final rules promulgated herein will

    not have a significant impact on a substantial number of small

    entities.

    ---------------------------------------------------------------------------

    \53\ 5 U.S.C. 601 et seq.

    \54\ 47 FR 18618 (April 30, 1982).

    \55\ Id. at 18619.

    \56\ 66 FR 45604, 45609 (August 29, 2001).

    ---------------------------------------------------------------------------

    B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \57\ imposes certain

    requirements on Federal agencies in connection with their conducting or

    sponsoring any ``collection of information'' as defined by the PRA. The

    final rules promulgated in this release do not require the new

    collection of information on the part of DCOs or FCMs. Accordingly, for

    purposes of the PRA, the Commission certifies that the final rules

    promulgated in this release would not impose any new reporting or

    recordkeeping requirements.

    ---------------------------------------------------------------------------

    \57\ 44 U.S.C. 3501-3520.

    ---------------------------------------------------------------------------

    C. Cost-Benefit Analysis

    Section 15(a) of the Act requires that the Commission, before

    promulgating a regulation under the Act or issuing an order, consider

    the costs and benefits of its action. By its terms, Section 15(a) of

    the Act does not require the Commission to quantify the costs and

    benefits of a new regulation or determine whether the benefits of the

    regulation outweigh its costs. Rather, Section 15(a) of the Act simply

    requires the Commission to ``consider the costs and benefits'' of its

    action.

    Section 15(a) of the Act further specifies that costs and benefits

    shall be evaluated in light of the following considerations: (1)

    Protection of market participants and the public; (2) efficiency,

    competitiveness, and financial integrity of futures markets; (3) price

    discovery; (4) sound risk management practices; and (5) other public

    interest considerations. Accordingly, the Commission could, in its

    discretion, give greater weight to any one of the five considerations

    and could determine that, notwithstanding its costs, a particular

    regulation was necessary or appropriate to protect the public interest

    or to effectuate any of the provisions or to accomplish any of the

    purposes of the Act.

    The Commission has evaluated the costs and benefits of the final

    rules promulgated in this release in light of (i) the comments that it

    has received on the Notice and (ii) the specific considerations

    identified in Section 15(a) of the Act, as follows:

    1. Protection of Market Participants and the Public

    The final rules promulgated in this release would benefit FCMs and

    DCOs, as well as customers of the futures and options markets, by

    providing greater certainty, (i) in a bankruptcy of a commodity broker

    that is an FCM, regarding the treatment of cleared OTC derivatives, and

    (ii) in a bankruptcy of any commodity broker, regarding the allocation

    of positions in commodity contracts (and relevant money, securities,

    and/or other property) of one account class that are commingled in an

    FCM or DCO account, pursuant to a Section 4d Order, with positions in

    commodity contracts (and relevant money, securities, and/or other

    property) of the futures account class.

    2. Efficiency and Competition

    The final rules promulgated in this release are not expected to

    have an effect on efficiency or competition.

    3. Financial Integrity of Futures Markets and Price Discovery

    The final rules promulgated in this release would enhance the

    protection, in the bankruptcy of a commodity broker that is an FCM, of

    customers with positions in cleared OTC derivatives by providing an

    account class in which to hold such positions (and relevant money,

    securities, and/or other property). Further, the final rules would

    enhance certainty regarding the treatment, in a bankruptcy of any

    commodity broker, of customers with positions (and relevant money,

    securities, and/or other property) subject to a Section 4d Order, by

    removing concerns regarding whether the Statement on Cleared OTC

    Derivatives, as well as the Statement on Commingling Foreign Futures

    Positions, would be limited to the specific factual patterns addressed

    therein. Thus, the final rules would contribute to the financial

    integrity of the futures and options markets as a whole.

    4. Sound Risk Management Practices

    The final rules promulgated in this release would reinforce the

    sound risk management practices already required of FCMs and DCOs, by

    (i) providing an account class, in the bankruptcy of a commodity broker

    that is an FCM, in which to hold positions in cleared OTC derivatives

    (and relevant money, securities, and/or other property), and (ii)

    providing certainty to FCMs and DCOs regarding the allocation between

    account classes, in a bankruptcy of any commodity broker, of customer

    positions (and relevant money, securities, and/or other property)

    subject to a Section 4d Order.

    5. Other Public Considerations

    Recent market events, including disruptions in global credit

    markets, render it prudent to enhance certainty regarding the treatment

    of customer positions (and relevant money, securities, and/or other

    property) in a commodity broker bankruptcy.

    Accordingly, after considering the five factors enumerated in the

    Act, the Commission has determined to promulgate the final rules as set

    forth below.

    List of Subjects in 17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures.

    0

    For the reasons stated in the preamble, the Commission hereby amends 17

    CFR part 190 as follows:

    PART 190--BANKRUPTCY

    0

    1. The authority citation for part 190 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24,

    and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise

    noted.

    0

    2. In Sec. 190.01, revise paragraph (a) and add paragraph (oo) to read

    as follows:

    Sec. 190.01 Definitions.

    * * * * *

    (a) Account class means each of the following types of customer

    accounts which must be recognized as a separate class of account by the

    trustee: futures accounts, foreign futures accounts, leverage accounts,

    commodity option accounts, delivery accounts as defined in Sec.

    190.05(a)(2), and, only with respect to the bankruptcy of a commodity

    broker that is a futures commission merchant, cleared OTC derivatives

    accounts; Provided, however, That to the extent that the equity

    balance, as defined in Sec. 190.07, of a customer in a

    [[Page 17303]]

    commodity option, as defined in Sec. 1.3(hh) of this chapter, may be

    commingled with the equity balance of such customer in any domestic

    commodity futures contract pursuant to regulations under the Act, the

    aggregate shall be treated for purposes of this part as being held in a

    futures account; Provided, further, that, if positions in commodity

    contracts that would otherwise belong to one account class (and the

    money, securities, and/or other property margining, guaranteeing, or

    securing such positions), are, pursuant to a Commission order,

    commingled with positions in commodity contracts of the futures account

    class (and the money, securities, and/or other property margining,

    guaranteeing, or securing such positions), then the former positions

    (and the relevant money, securities, and/or other property) shall be

    treated, for purposes of this part, as being held in an account of the

    futures account class.

    * * * * *

    (oo) Cleared OTC derivatives shall mean positions in commodity

    contracts that have not been entered into or traded on a contract

    market (as such term is defined in Sec. 1.3(h) of this chapter) or on

    a derivatives transaction execution facility (within the meaning of

    Section 5a of the Act), but which nevertheless are submitted through a

    commodity broker that is a futures commission merchant (as such term is

    defined in Sec. 1.3(p) of this chapter) for clearing by a clearing

    organization (as such term is defined in this section), along with the

    money, securities, and/or other property margining, guaranteeing, or

    securing such positions, which are required to be segregated or set

    aside, in accordance with a rule, regulation, or order issued by the

    Commission, or which are required to be held in a separate account for

    cleared OTC derivatives only, in accordance with the rules or bylaws of

    a clearing organization (as such term is defined in this section).

    0

    4. In Sec. 190.07, revise paragraph (b)(2)(viii) to read as follows:

    Sec. 190.07 Calculation of allowed net equity.

    (b) * * *

    (2) * * *

    (viii) Subject to paragraph (b)(2)(ix) of this section, the futures

    accounts, leverage accounts, options accounts, foreign futures

    accounts, and cleared OTC derivatives accounts of the same person shall

    not be deemed to be held in separate capacities: Provided, however,

    That such accounts may be aggregated only in accordance with paragraph

    (b)(3) of this section.

    * * * * *

    0

    5. Amend ``bankruptcy appendix form 4--proof of claim'' in Appendix A

    to Part 190 by revising paragraph a in section III to read as follows:

    Appendix A to Part 190--Bankruptcy Forms

    * * * * *

    bankruptcy appendix form 4--proof of claim

    * * * * *

    III. * * *

    a. Whether the account is a futures, foreign futures, leverage,

    option (if an option account, specify whether exchange-traded or

    dealer), ``delivery'' account, or, only with respect to a bankruptcy

    of a commodity broker that is a futures commission merchant, a

    cleared OTC derivatives account. A ``delivery'' account is one which

    contains only documents of title, commodities, cash, or other

    property identified to the claimant and deposited for the purposes

    of making or taking delivery on a commodity underlying a commodity

    contract or for payment of the strike price upon exercise of an

    option.

    Issued in Washington, DC, on March 31, 2010, by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. 2010-7742 Filed 4-5-10; 8:45 am]

    BILLING CODE P

    Last Updated: April 6, 2010



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