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2011-18777

  • Federal Register, Volume 76 Issue 142 (Monday, July 25, 2011)[Federal Register Volume 76, Number 142 (Monday, July 25, 2011)]

    [Rules and Regulations]

    [Pages 44262-44265]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2011-18777]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1 and 4

    RIN 3038-AD11

    Removing Any Reference to or Reliance on Credit Ratings in

    Commission Regulations; Proposing Alternatives to the Use of Credit

    Ratings

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

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    SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

    ``CFTC'') is adopting a final rule that amends existing CFTC

    regulations in order to implement new statutory provisions enacted by

    Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection

    Act (``Dodd-Frank Act''). The rule amendments set forth herein apply to

    futures commission merchants (``FCMs''), derivatives clearing

    organizations (``DCOs''), and commodity pool operators (``CPOs''). The

    rule amendments implement the new statutory framework that requires

    agencies to replace any reference to or reliance on credit ratings in

    their regulations with an appropriate alternative standard.

    DATES: This rule is effective September 23, 2011.

    FOR FURTHER INFORMATION CONTACT: Ward P. Griffin, Counsel, Office of

    General Counsel, Commodity Futures Trading Commission, Three Lafayette

    Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone: 202-418-

    5425. E-mail: wgriffin@cftc.gov.

    SUPPLEMENTARY INFORMATION:

    I. Background

    On July 21, 2010, President Obama signed into law the Dodd-Frank

    Act.\1\ In relevant part, Title IX of the Dodd-Frank Act directs

    Federal agencies to take certain actions concerning any reference to--

    or requirement of reliance on--credit ratings in each agency's

    respective regulations. Specifically, section 939A of the Dodd-Frank

    Act requires agencies to take three actions by July 21, 2011, the one-

    year anniversary of the enactment of the Dodd-Frank Act. First, section

    939A(a) directs each Federal agency to review ``any regulation issued

    by such agency that requires the use of an assessment of the credit-

    worthiness of a security or money market instrument [and] any

    references to or requirements in such regulations regarding credit

    ratings.'' Second, section 939A(b) requires that each Federal agency

    ``modify any such regulations identified by the review conducted under

    subsection (a) to remove any reference to or requirement of reliance on

    credit ratings and to substitute in such regulations such standard of

    credit-worthiness as each respective agency shall determine as

    appropriate for such regulations.'' To the extent feasible, Federal

    agencies should ``seek to establish * * * uniform standards of credit-

    worthiness for use by each such agency.'' And third, section 939A(c)

    directs each Federal agency to report to Congress ``a description of

    any modification of any regulation such agency made pursuant to

    subsection (b).''

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    \1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

    Pub. L. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank

    Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

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    Subsequent to the enactment of the Dodd-Frank Act, the Commission

    reviewed its regulations and identified instances in which credit

    ratings were referred to or relied upon.\2\ The identified regulations

    could be categorized into two groups: (1) those that rely on ratings to

    limit how Commission registrants may invest or deposit customer funds;

    and (2) those that require disclosing a credit rating to describe an

    investment's characteristics. In keeping with its efforts to comply

    fully with both the spirit and letter of the Dodd-Frank Act, the

    Commission proposed to amend all of the identified regulations that

    rely on credit ratings regarding financial instruments.

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    \2\ Commission regulations that are referenced herein are found

    at 17 CFR Ch. 1 (2010). They are accessible on the Commission's Web

    site at http://www.cftc.gov.

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    On November 2, 2010, the Commission published in the Federal

    Register proposed amendments to certain of its existing regulations

    (the ``Proposing Release'') in response to the directives set forth in

    section 939A of the Dodd-Frank Act.\3\ Specifically, the Commission

    addressed two regulations in the Proposing Release: (1) Regulation

    1.49, which places qualifications on the types of depositories where

    FCMs and DCOs might place customer funds; and (2) Regulation 4.24,

    wherein credit ratings are used to help disclose the characteristics of

    an investment.\4\

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    \3\ 75 FR 67254, Nov. 2, 2010.

    \4\ Separately, the Commission issued Notices of Proposed

    Rulemaking that addressed references to credit ratings in Commission

    Regulations 1.25 and 30.7, and in Appendix A to Part 40. See

    ``Investment of Customer Funds and Funds Held in an Account for

    Foreign Futures and Foreign Options Transactions,'' 75 FR 67642,

    Nov. 3, 2010 (proposing amendments to Regulations 1.25 and 30.7);

    ``Provisions Common to Registered Entities,'' 75 FR 67282, Nov. 2,

    2010 (proposing to delete the current Appendix A of Part 40). The

    amendments proposed in those Notices are not addressed herein and

    may be subject to future Commission rulemaking.

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    Regulation 1.49, which mirrors Regulation 30.7,\5\ requires that an

    acceptable foreign depository must either: (1) Have in excess of $1

    billion of regulatory capital; or (2) issue commercial paper or a long-

    term debt instrument that is rated in one of the two highest rating

    categories by at least one nationally recognized statistical rating

    organization (``NRSRO''). In the Proposing Release, the Commission

    proposed to remove all ratings requirements from Regulation 1.49. The

    Commission based its proposal on its views regarding the uncertain

    reliability of ratings as currently administered, particularly in light

    of the significant weaknesses of the ratings industry that were

    revealed in recent years. The Commission noted the poor past

    performance of credit ratings in gauging the safety of certain types of

    investments, and its view that credit ratings are not necessary to

    gauge the future ability of certain types of investments to preserve

    customer funds. The proposal was intended to align Regulation 1.49 with

    proposed Regulations 1.25 and 30.7, and to greater simplify the

    regulatory treatment of the investment of customer funds.

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    \5\ See 68 FR 5545, 5548, Feb. 4, 2003 (noting the Commission's

    view that consistency between Regulations 1.49 and 30.7 on this

    issue is ``appropriate''). In a separate release, the Commission has

    proposed amendments to Regulation 30.7 that are similar to the

    amendments to Regulation 1.49 addressed herein. See supra note 4.

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    With respect to the proposed amendment of Regulation 1.49, the

    Commission requested comment on: (1) Whether relying on a minimum

    capital requirement of $1 billion dollars in regulatory capital is an

    adequate alternative standard to the current Regulation 1.49; and (2)

    whether another standard or measure of solvency and credit-worthiness

    should be used as an appropriate, additional test of a bank's safety,

    such as a leverage ratio or a capital adequacy ratio requirement

    consistent with or similar to those in the Basel III accords. The

    Commission also stated that it would welcome any other comments on the

    proposal.

    [[Page 44263]]

    In addition to the proposed amendment to Regulation 1.49, the

    Proposing Release also proposed to amend Regulation 4.24. Regulation

    4.24 requires CPOs to disclose the characteristics of the commodity and

    other interests that the pool will trade, including, if applicable,

    their investment rating. In order to comply fully with the spirit and

    letter of the Dodd-Frank Act, the Commission proposed removing the

    references to ratings in Regulation 4.24 and replacing that reference

    with the phrase ``credit-worthiness.'' In the Proposing Release, the

    Commission expressly noted that CPOs may still choose to reference an

    investment rating to describe the credit-worthiness of an investment in

    its disclosures. However, the Commission noted that the CPO as

    appropriate should make an independent assessment of the credit-

    worthiness of those investments.

    The Commission requested comment on its proposed amendment of

    Regulation 4.24, particularly with respect to what effect the removal

    of the credit ratings reference in Regulation 4.24 might have on the

    ability of investors and others to understand the disclosures of CPOs

    regarding the characteristics of a commodity pool. The Commission also

    requested comment on the ability of CPOs to make independent

    assessments of the credit-worthiness of their pool's investments.

    II. Comments on the Proposing Release

    In response to the Proposing Release, the Commission received three

    comments, two of which were not responsive to the issues presented in

    the Notice. The other commenter forwarded a letter originally submitted

    in response to an advance notice of proposed rulemaking issued by the

    Federal banking agencies.\6\ The commenter discussed issues and options

    surrounding the implementation of section 939A of the Dodd-Frank Act,

    and offered analytical services to refine alternatives to credit

    ratings. However, the commenter did not raise any factual or policy

    concern relating to the rule amendments proposed by the Commission in

    the Proposing Release.

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    \6\ See ``Advance Notice of Proposed Rulemaking Regarding

    Alternatives to the Use of Credit Ratings in the Risk-Based Capital

    Guidelines of the Federal Banking Agencies,'' 75 FR 52283, Aug. 25,

    2010.

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    After considering the comments received in response to the

    Proposing Release, the Commission has determined to amend Regulations

    1.49 and 4.24 as proposed. Section 939A of the Dodd-Frank Act directs

    each Federal agency, including the Commission, ``to remove any

    reference to or requirement of reliance on credit ratings and to

    substitute in such regulations such standard of credit-worthiness as

    each respective agency shall determine as appropriate for such

    regulations.'' As acknowledged in the Proposing Release, the Commission

    proposed the amendments to Regulations 1.49 and 4.24, in part, to

    facilitate ``its efforts to fully comply with both the spirit and

    letter of the Dodd-Frank Act.'' The amendments set forth herein are

    narrowly tailored to accomplish that task, while maintaining the

    commitment to the protection of customer funds that the Commission

    continually has promoted over the years.

    III. Consideration of Costs and Benefits Under Section 15(A) of the

    Commodity Exchange Act (``CEA'')

    Section 15(a) of the CEA requires the Commission to consider the

    costs and benefits of its actions before issuing a rulemaking under the

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

    be evaluated in light of the five broad areas of market and public

    concern: (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.\7\ The Commission may in its discretion

    give greater weight to any one of the five enumerated areas and could

    in its discretion determine that, notwithstanding its costs, a

    particular rule is necessary or appropriate to protect the public

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

    the purposes of the Act.

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    \7\ The rule amends the qualifications required of non-U.S.

    depositories in which customer funds may be held and alters the

    disclosures that CPOs must provide to their customers. Given the

    characteristics of the rule and its anticipated effect, the

    Commission does not believe that the rule will impact the efficiency

    or competitiveness of futures markets, or have any effect on price

    discovery.

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    Although the Commission specifically requested public comment on

    appropriate alternatives to the rule language contained in the

    Proposing Release,\8\ the Commission received no such comments, nor did

    the Commission receive any substantive comments on the costs and

    benefits related to the rule. Section 939A instructs the Commission to

    implement the removal of any references to or reliance on credit

    ratings in its rules and regulations.

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    \8\ See 75 FR 67254, 67256, Nov. 2, 2010.

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    Because of the statutory requirement to remove the reference to

    credit ratings from Regulation 1.49, investments in foreign

    depositories that have less than $1 billion in regulatory capital, but

    that previously were eligible depositories in reliance upon their

    credit ratings, may no longer be eligible depositories for customer

    funds. The consequences of this regulatory action may impose

    transaction costs associated with transferring customer funds, if

    necessary, to another depositor if a foreign depository is no longer

    eligible. Costs also may be borne by foreign banks or trusts that will

    no longer be eligible to receive deposits of customer funds under

    Regulation 1.49, given the resultant loss of business.

    However, the amendments to Regulation 1.49 reflect the statutory

    mandate set forth under section 939A of the Dodd-Frank Act. The

    Commission acknowledged in the Proposing Release the uncertain

    reliability of ratings as currently administered, the poor past

    performance of credit ratings in gauging the safety of certain types of

    investments, and the Commission's view that credit ratings are not

    necessary to gauge the future ability of certain types of investments

    to preserve customer funds. Although the Commission specifically

    ``request[ed] comment on whether there is another standard or measure

    of solvency and creditworthiness that might be used as an appropriate,

    additional test of a bank's safety,'' \9\ the Commission received no

    comments offering an appropriate alternative to the amendments to

    Regulation 1.49 that were contained in the Proposing Release. In light

    of the uncertain reliability of ratings and their poor past

    performance, the Commission believes that the elimination of references

    to credit ratings in Regulation 1.49 will enhance the protection of

    market participants and the public, as well as enhance sound risk

    management practices, by requiring that if customer funds are held in a

    non-U.S. bank or trust company, the non-U.S. bank or trust company have

    more than $1 billion of regulatory capital. The capital standard will

    afford greater protection of customer funds. Such protections will, in

    turn, promote the financial integrity of futures markets by reducing

    the likelihood of loss, relative to the status quo.

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    \9\ Id.

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    Similarly, the statutory requirement to modify Regulation 4.24 has

    the potential benefit of reducing risk in the financial system by

    placing more responsibility on CPOs to fully understand the credit-

    [[Page 44264]]

    worthiness of investments. CPOs will be required to make an independent

    assessment, as appropriate, of the credit-worthiness of investments in

    their portfolio rather than relying solely on credit ratings, though

    CPOs will not be prohibited from relying on credit ratings, as

    appropriate. Customers of CPOs may benefit from improved disclosure of

    the credit-worthiness of the investments in which funds are placed. In

    light of the specific issues identified by the Commission concerning

    the reliance of credit ratings, as discussed in greater detail supra,

    the Commission believes that the rule will enhance the protection of

    market participants and the public, promote the financial integrity of

    futures markets, and enhance sound risk management practices. Costs may

    be imposed on CPOs in improving their ability to make independent

    assessments of credit-worthiness. Although CPOs will not be prohibited

    from relying on credit ratings under Regulation 4.24, circumstances may

    require a CPO to engage in further assessments of the credit-worthiness

    of the investments in which funds are placed, as appropriate, beyond

    merely citing the ratings of those investments by a NRSRO. However,

    notwithstanding its costs, this rule is necessary and appropriate to

    protect the public interest, and effectuates the mandate prescribed in

    section 939A of the Dodd-Frank Act.

    IV. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires Federal agencies,

    in promulgating rules, to consider the impact of those rules on small

    businesses, and whether the rules will have a significant economic

    impact on a substantial number of small entities.\10\ The rule

    amendments proposed herein will affect FCMs, DCOs, and CPOs. The

    Commission previously has established certain definitions of ``small

    entities'' to be used by the Commission in evaluating the impact of its

    regulations on small entities in accordance with the RFA, and has

    determined that registered FCMs,\11\ DCOs,\12\ and CPOs \13\ are not

    small entities for the purpose of the RFA. Accordingly, as set forth in

    the Proposing Release,\14\ the Chairman, on behalf of the Commission

    and pursuant to 5 U.S.C. 605(b), certifies that the proposed rules will

    not have a significant economic impact on a substantial number of small

    entities.

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    \10\ 5 U.S.C. 601 et seq.

    \11\ 47 FR 18618, 18619, Apr. 30, 1982.

    \12\ 66 FR 45604, 45609, Aug. 29, 2001.

    \13\ 47 FR at 18619-20.

    \14\ See 75 FR 67254, 67256, Nov. 2, 2010.

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    B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \15\ imposes certain

    requirements on Federal agencies (including the Commission) in

    connection with their conducting or sponsoring any collection of

    information as defined by the PRA. These rule amendments do not require

    a new collection of information on the part of any entities subject to

    the rule amendments. Accordingly, for purposes of the PRA, the

    Commission certifies that these rule amendments will not impose any new

    reporting or recordkeeping requirements.

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    \15\ 44 U.S.C. 3501 et seq.

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    List of Subjects

    17 CFR Part 1

    Brokers, Commodity futures, Consumer protection.

    17 CFR Part 4

    Advertising, Commodity futures, Commodity pool operators, Commodity

    trading advisors, Consumer protection, Disclosure, Principals,

    Reporting and recordkeeping requirements.

    For the reasons stated in this release, the Commission hereby

    amends 17 CFR parts 1 and 4 as follows:

    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    0

    1. The authority citation for part 1 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

    6i, 6k, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a-1,

    16, 16a, 19, 21, 23, and 24, as amended by the Dodd-Frank Wall

    Street Reform and Consumer Protection Act, Pub. L. 111-203, 124

    Stat. 1376 (2010), and the Commodity Futures Modernization Act of

    2000, Appendix E of Pub. L. 106-554, 114 Stat. 2763 (2000).

    0

    2. Section 1.49 is amended by revising paragraph (d)(3) to read as

    follows:

    Sec. 1.49 Denomination of customer funds and location of

    depositories.

    * * * * *

    (d) * * *

    (3) A depository, if located outside the United States, must be:

    (i) A bank or trust company that has in excess of $1 billion of

    regulatory capital;

    (ii) A futures commission merchant that is registered as such with

    the Commission; or

    (iii) A derivatives clearing organization.

    * * * * *

    PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS

    0

    3. The authority citation for part 4 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a

    and 23, as amended by the Dodd-Frank Wall Street Reform and Consumer

    Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

    0

    4. Section 4.24 is amended by revising paragraph (h)(1)(i) to read as

    follows:

    Sec. 4.24 General disclosures required.

    * * * * *

    (h) * * *

    (1) * * *

    (i) The approximate percentage of the pool's assets that will be

    used to trade commodity interests, securities and other types of

    interests, categorized by type of commodity or market sector, type of

    security (debt, equity, preferred equity), whether traded or listed on

    a regulated exchange market, maturity ranges and credit-worthiness, as

    applicable;

    * * * * *

    By the Commodity Futures Trading Commission.

    Dated: July 20, 2011.

    David A. Stawick,

    Secretary.

    Appendices to Removing Any Reference to or Reliance on Credit Ratings

    in Commission Regulations; Proposing Alternatives to the Use of Credit

    Ratings--Commission Voting Summary and Statements of Commissioners

    Note: The following appendices will not appear in the Code of

    Federal Regulations.

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Dunn,

    Sommers, Chilton and O'Malia voted in the affirmative; no

    Commissioner voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the final rulemaking to remove references to credit

    ratings within the CFTC's regulations. Under Title IX of the Dodd-

    Frank Wall Street Reform and Consumer Protection Act, Congress

    required the Commission to review credit rating references in our

    existing regulations and remove reliance upon them. The rule removes

    them from Regulation 1.49, which limits the types of non-U.S. banks

    in which futures commission merchants and derivatives clearing

    organizations may place customer funds. The rule also removes them

    from Regulation 4.24, which requires commodity pool operators to

    disclose to their customers where they are putting customer

    [[Page 44265]]

    money. Other references included in Regulations 1.25 and 30.7 will

    be taken up when the Commission considers the proposed rulemaking

    related to investment of customer funds.

    [FR Doc. 2011-18777 Filed 7-22-11; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: July 25, 2011



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