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2012-7477

  • Federal Register, Volume 77 Issue 68 (Monday, April 9, 2012)[Federal Register Volume 77, Number 68 (Monday, April 9, 2012)]

    [Rules and Regulations]

    [Pages 21278-21310]

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

    [FR Doc No: 2012-7477]

    [[Page 21277]]

    Vol. 77

    Monday,

    No. 68

    April 9, 2012

    Part III

    Commodity Futures Trading Commission

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    17 CFR Parts 1, 23, 37, et al.

    Customer Clearing Documentation, Timing of Acceptance for Clearing,

    and Clearing Member Risk Management; Final Rule

    Federal Register / Vol. 77 , No. 68 / Monday, April 9, 2012 / Rules

    and Regulations

    [[Page 21278]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1, 23, 37, 38, and 39

    RIN 3038-0092, -0094

    Customer Clearing Documentation, Timing of Acceptance for

    Clearing, and Clearing Member Risk Management

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

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

    ``CFTC'') is adopting rules to implement new statutory provisions

    enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer

    Protection Act. These rules address: The documentation between a

    customer and a futures commission merchant that clears on behalf of the

    customer; the timing of acceptance or rejection of trades for clearing

    by derivatives clearing organizations and clearing members; and the

    risk management procedures of futures commission merchants, swap

    dealers, and major swap participants that are clearing members. The

    rules are designed to increase customer access to clearing, to

    facilitate the timely processing of trades, and to strengthen risk

    management at the clearing member level.

    DATES: This rule will become effective October 1, 2012.

    FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director, 202-

    418-5480, jlawton@cftc.gov, and Christopher A. Hower, Attorney-Advisor,

    202-418-6703, chower@cftc.gov, Division of Clearing and Risk, and

    Camden Nunery, Economist, 202-418-5723, Office of the Chief Economist,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street NW., Washington, DC 20581; and Hugh J. Rooney, Assistant

    Director, 312-596-0574, hrooney@cftc.gov, Division of Clearing and

    Risk, Commodity Futures Trading Commission, 525 West Monroe Street,

    Chicago, Illinois 60661.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    yI. Background

    II. Customer Clearing Documentation

    A. Introduction

    B. Summary of Comments

    C. Discussion

    III. Time Frames for Acceptance Into Clearing

    A. Swap Dealer and Major Swap Participant Submission of Trades

    B. Swap Execution Facility and Designated Contract Market

    Processing of Trades

    C. Clearing Member and Clearing Organization Acceptance for

    Clearing

    D. Post-Trade Allocation of Bunched Orders

    IV. Clearing Member Risk Management

    A. Introduction

    B. Components of the Rule

    V. Effective Dates

    A. Summary of Comments

    B. Discussion

    VI. Consideration of Costs and Benefits

    VII. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    I. Background

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

    Reform and Consumer Protection Act (``Dodd-Frank Act'').\1\ Title VII

    of the Dodd-Frank Act amended the Commodity Exchange Act (``CEA'' or

    ``Act'') \2\ to establish a comprehensive new regulatory framework for

    swaps. The legislation was enacted to reduce risk, increase

    transparency, and promote market integrity within the financial system

    by, among other things: (1) Providing for the registration and

    comprehensive regulation of swap dealers and major swap participants;

    (2) imposing clearing and trade execution requirements on standardized

    derivative products; (3) creating rigorous recordkeeping and real-time

    reporting regimes; and (4) enhancing the Commission's rulemaking and

    enforcement authorities with respect to, among others, all registered

    entities and intermediaries subject to the Commission's oversight.

    Title VII also includes amendments to the federal securities laws to

    establish a similar regulatory framework for security-based swaps under

    the authority of the Securities and Exchange Commission (``SEC'').

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    \1\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Public Law 111-203, 124 Stat. 1376 (2010).

    \2\ 7 U.S.C. 1 et seq.

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    A fundamental premise of the Dodd-Frank Act is that the use of

    properly regulated central clearing can reduce systemic risk. Another

    tenet of the Dodd-Frank Act is that open access to clearing by market

    participants will increase market transparency and promote market

    efficiency by enabling market participants to reduce counterparty risk

    and by facilitating the offset of open positions. The Commission has

    adopted extensive regulations addressing open access and risk

    management at the derivatives clearing organization (``DCO'') level.\3\

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    \3\ Derivatives Clearing Organization General Provisions and

    Core Principles, 76 FR 69334 (Nov. 8, 2011).

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    Clearing members provide the portals through which market

    participants gain access to DCOs. Clearing members also provide the

    first line of risk management. Accordingly, in three related

    rulemakings, the Commission proposed regulations to increase customer

    access to clearing,\4\ to facilitate the timely processing of

    trades,\5\ and to strengthen risk management at the clearing member

    level.\6\ In addition, in a fourth rulemaking, the Commission proposed

    regulations relating to the allocation of bunched orders.\7\ The

    Commission is issuing final rules in each of these areas.

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    \4\ Customer Clearing Documentation and Timing of Acceptance for

    Clearing, 76 FR 45730 (Aug. 1, 2011).

    \5\ Requirements for Processing, Clearing, and Transfer of

    Customer Positions, 76 FR 13101 (Mar. 10, 2011).

    \6\ Clearing Member Risk Management, 76 FR 45724 (Aug. 1, 2011).

    \7\ Adaption of Regulations to Incorporate Swaps, 76 FR 33066

    (Jun. 7, 2011).

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    More specifically, the regulations contained in this Adopting

    Release were proposed in four separate notices of proposed rulemaking

    (``NPRMs''). Sections 1.72, 1.74, 23.608, 23.610, 39.12(a)(1)(iv), and

    39.12(b)(7) were proposed in Customer Clearing Documentation and Timing

    of Acceptance for Clearing,\8\ sections 23.506, 37.702(b), and

    38.601(b) were proposed in Requirements for Processing, Clearing, and

    Transfer of Customer Positions,\9\ sections 1.73 and 23.609 were

    proposed in Clearing Futures Commission Merchant Risk Management,\10\

    and 1.35(a-1)(5)(iv) was proposed in Adaptation of Regulations to

    Incorporate Swaps.\11\ The Commission is finalizing the rules contained

    in this Adopting Release together because they address three

    overarching, closely-connected aims: (1) Non-discriminatory access to

    counterparties and clearing; (2) straight-through processing; and (3)

    effective risk management among clearing members. Each of these

    provides substantial benefits for the markets and market participants.

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    \8\ See 76 FR 45730 (Aug. 1, 2011).

    \9\ See 76 FR 13101 (Mar. 10, 2011).

    \10\ See 76 FR 45724 (Aug. 1, 2011).

    \11\ See 76 FR 33066 (Jun. 6, 2011).

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    II. Customer Clearing Documentation

    A. Introduction

    As discussed in the notice of proposed rulemaking,\12\ industry

    groups have developed a template for use by swap market participants in

    negotiating execution-related agreements with counterparties to swaps

    that are intended to be cleared.\13\ The template

    [[Page 21279]]

    includes optional annexes that make the clearing member to one or both

    of the executing parties a party to the agreement (the trilateral

    agreements). The trilateral agreements contain provisions that would

    permit a customer's futures commission merchant (``FCM''), in

    consultation with the swap dealer (``SD'') that is the customer's

    counterparty, to establish specific credit limits for the customer's

    swap transactions with the SD. The provisions further provide that the

    FCM will only accept for clearing those transactions that fall within

    these specific limits. The limits set for trades with the SD or MSP

    might be less than the overall limits set for the customer for all

    trades cleared through the FCM. The result would be to create a

    ``sublimit'' for the customer when trading with that SD or MSP.

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    \12\ See 76 FR 45730 at 45731, Aug. 1, 2011.

    \13\ See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf.

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    When a trade is rejected for clearing, the parties to that trade

    may incur significant costs. As the clearing of swaps increases

    pursuant to the Dodd-Frank Act, the likelihood and size of such

    potential costs could also increase, according to the proponents of the

    trilateral agreements. The trilateral agreements were intended to limit

    these potential costs.

    The Commission expressed concern in the notice of proposed

    rulemaking that such arrangements potentially conflict with the

    concepts of open access to clearing and competitive execution of

    transactions.\14\ To address these concerns and to provide further

    clarity in this area, the Commission proposed Sec. 1.72 relating to

    FCMs, Sec. 23.608 relating to SDs and MSPs, and Sec. 39.12(a)(1)(vi)

    relating to DCOs. These regulations would prohibit arrangements

    involving FCMs, SDs, MSPs, or DCOs that would (a) disclose to an FCM,

    SD, or MSP the identity of a customer's original executing

    counterparty; (b) limit the number of counterparties with whom a

    customer may enter into a trade; (c) restrict the size of the position

    a customer may take with any individual counterparty, apart from an

    overall credit limit for all positions held by the customer at the FCM;

    (d) impair a customer's access to execution of a trade on terms that

    have a reasonable relationship to the best terms available; or (e)

    prevent compliance with specified time frames for acceptance of trades

    into clearing.

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    \14\ Id. at 45732.

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    B. Summary of Comments

    The Commission received a total of 38 comment letters directed

    specifically at the proposed documentation rules.\15\ Of the 38

    commenters, 30 supported the proposed rules.\16\ They included asset

    managers, market makers, trading platforms, clearing organizations,

    bank/dealers, a non-profit organization, and a private citizen. Within

    this group, some commenters addressed only certain aspects of the rules

    and were silent on other sections and some requested clarification of

    certain provisions.

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    \15\ Comment files for each proposed rulemaking can be found on

    the Commission Web site, www.cftc.gov. Commenters include: Chris

    Barnard (``Barnard''); MarkitSERV (``Markit''); Swaps & Derivatives

    Market Association (``SDMA''); Better Markets;

    IntercontinentalExchange, Inc. (``ICE''); ISDA FIA (``ISDA''); The

    Alternative Investment Management Association Ltd. (``AIMA''); CME

    Group Inc. (``CME''); Morgan Stanley; Edison Electric Institute

    (``EEI''); State Street Corporation (``State Street''); New York

    Portfolio Clearing (``NYPC''); Asset Management Group of the

    Securities Industry and Financial Markets Association (``SIFMA'');

    Vanguard; AllianceBernstein L.P. (``Alliance Bernstein'');

    Minneapolis Grain Exchange, Inc. (``MGEX''); Atlantic Trading USA

    LLC; Belvedere Trading; Bluefin Trading, LLC; Chopper Trading LLC;

    CTC Trading Group, LLC; DRW Holdings, LLC; Eagle Seven, LLC;

    Endeavor Trading, LLC; Flow Traders US LLC; Geneva Trading USA, LLC;

    GETCO; Hard Eight Futures; HTG Capital Partners; IMC Financial

    Markets; Infinium Capital Management LLC; Kottke Associates, LLC;

    Marquette Partners, LP; Nico Holdings LLC; Optiver US LLC; RGM

    Advisors, LLC; Templar Securities, LLC; Tower Research Capital LLC;

    TradeForecaster Global Markets LLC; Traditum Group, LLC; WH Trading

    LLC; XR Trading LLC (``Trading Firms''); Managed Funds Association

    (``MFA''); Arbor Research & Trading Inc. (``Arbor''); Eris Exchange

    (``Eris''); ICI; DRW Trading Group (``DRW''); Spring Trading, Inc.

    (``Spring Trading''); Javelin Capital Markets, LLC (``Javelin'');

    The Committee on Investment of Employee Benefit Assets (``CIEBA'');

    Citadel LLC (``Citadel''); Vizier Ltd. (``Vizier''); Federal Home

    Loan Banks (``FHLB''); Jefferies & Company, Inc. (``Jeffries''); UBS

    Securities LLC (``UBS''); Wells Fargo Securities (``WF'');

    LCH.Clearnet Group Limited (``LCH''); D. E. Shaw group (``D. E.

    Shaw''); Bank of America, Merrill Lynch, BNP Paribas, Citi, Credit

    Suisse Securities (USA) LLC, Deutsche Bank AG, Goldman Sachs, HSBC,

    J.P. Morgan, Morgan Stanley (``Banks''); Deutsche Bank (``DB'');

    Societe Generale (``SG''); The Association of Institutional

    Investors (``AII''); and The Committee on Capital Markets Regulation

    (``Committee'').

    \16\ AII, AIMA, AllianceBernstein, Arbor, Better Markets,

    Barnard, CIEBA, Citadel, CME, D. E. Shaw, DRW, Eris, FHLB, ICE, ICI,

    Javelin, Jeffries, LCH, Markit, MFA, MGEX, NYPC, SDMA, SIFMA, Spring

    Trading, State Street, Trading Firms, Vanguard, Vizier, and WF.

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    Eight commenters expressed opposition.\17\ They include bank/

    dealers, an association of electric utilities, and an asset manager.

    Within this group as well, some commenters addressed only certain

    aspects of the rules and were silent on other sections and some

    requested clarification of certain provisions.

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    \17\ DB, ISDA, SG, UBS, Morgan Stanley, the Banks, EEI, and the

    Committee.

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    Three commenters in support--Arbor, Citadel, and Eris--urged the

    Commission to make these rules a top priority in the final rulemaking

    process. Numerous commenters stated that the proposed rules would

    increase open access to clearing and execution, reduce risk, foster

    competition, lower costs, and increase transparency. FHLB expressed the

    view that the proposed rules will facilitate the transition to central

    clearing. Barnard and Vanguard asserted that the proposed rules will

    prevent conflicts of interest, and achieve clear walls between clearing

    and trading activities involving FCMs and affiliates. Six commenters

    went into detail why the trilateral agreements are bad for the markets,

    noting that such agreements discourage competition and efficient

    pricing, compromise anonymity, reduce liquidity, increase the time

    between execution and clearing, introduce conflicts of interest, and

    prevent the success of swap execution facilities (``SEFs'').\18\ SDMA

    commented that while ``the SDMA is philosophically loathe to encourage

    possible government [interference] with private contracts between two

    parties,'' the proposed rules are necessary in their entirety in this

    instance, and that the proposed rules are not overly prescriptive.

    Vanguard, estimated that if it was required to enter into trilateral

    agreements, it would have to negotiate approximately 4,800 new

    trilateral agreements per year.\19\

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    \18\ AIMA, Javelin, SG, SIFMA, Spring Trading, and Vanguard.

    \19\ Vanguard.

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    Seven commenters in opposition contended that without the

    trilateral agreements, some market participants may have reduced access

    to markets.\20\ (ISDA and the Committee did not address this issue.)

    They asserted that the trilateral agreements facilitate risk management

    and certainty of execution. DB believes that the trilateral agreements

    provide a means of ensuring compliance with mandatory clearing. DB also

    commented that if an SD does not know whether a swap will be cleared

    prior to execution, it will not know whether it should apply risk

    filters that take account of the swap as a cleared transaction or a

    bilateral one. SG commented that the rules will decrease liquidity and

    limit market participation, and that without the certainty of

    trilateral agreements, the rules may foster competing and inconsistent

    technology.

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    \20\ Banks, DB, EEI, ISDA, Morgan Stanley, SG, and UBS.

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    UBS believes that potential abuse of credit arrangements could be

    more narrowly tailored than the proposed rule. The Banks asserted that

    the credit filter infrastructure necessary to

    [[Page 21280]]

    maximize execution choice for customers while ensuring prudent risk

    management is not currently available. The Banks suggested that instead

    of prohibiting the trilateral agreements, the Commission could require

    that the allocation of credit limits across executing counterparties be

    specified by the customer, rather than the FCM, who would confirm the

    customer's allocation to the identified executing counterparties.

    Morgan Stanley requested clarification that the proposed rules only

    apply to arrangements between clearing firms and executing swap dealers

    and customers with respect to swaps, not futures. Morgan Stanley also

    commented that the Commission should alter the language in proposed

    Sec. 1.72 and Sec. 23.608 from ``relationship to the best terms

    available'' to ``execution with an executing swap dealer of the

    customer's choice.''

    Spring Trading requested clarification that ``on terms that have a

    reasonable relationship to the best terms available'' refers to the

    best terms available on any market regulated by the Commission, which

    would prohibit an FCM from establishing special hurdles for its

    clearing customers in order to trade on a particular SEF.

    C. Discussion

    The Commission found persuasive the comments stating that the

    proposed rules would increase open access to clearing and execution,

    reduce risk, foster competition, lower costs, and increase

    transparency. The Commmission notes that cleared futures markets have

    operated for decades without any need for the types of provisions

    prohibited by the rules. Similarly, trades executed over-the-counter

    (``OTC'') have been successfully cleared by CME and ICE on behalf of

    customers for approximately ten years without such provisions.

    Specifically, the Commission believes that, as discussed by

    numerous commenters, (1) disclosure of a customer's original executing

    counterparty could have potentially anticompetitive effects, (2)

    limiting the number of counterparties would hurt the customer's access

    to the best price as well as general market liquidity, (3) restricting

    the size of trades with particular counterparties also would hurt the

    customer's access to the best price as well as general market

    liquidity, and (4) restrictions on the number of counterparties and on

    the size of trades with them would slow down acceptance for clearing

    thereby causing the very problem the restrictions were purportedly

    designed to address.

    The Commission believes that the risks the trilateral agreements

    were designed to address can be mitigated by other means without

    incurring the negative consequences described above. Specifically, the

    processing rules described in section III. below and the risk

    management rules described in section IV. below would significantly

    diminish the exposure of dealers, their counterparties, and their

    respective FCMs to risk.

    Moreover, the Commission notes that there are several sections of

    the CEA and Commission regulations that support the premise underlying

    these final rules. Section 4d(c) of the CEA, as amended by the Dodd-

    Frank Act, directs the Commission to require FCMs to implement conflict

    of interest procedures that address such issues the Commission

    determines to be appropriate. Similarly, section 4s(j)(5), as added by

    the Dodd-Frank Act, requires SDs and MSPs to implement conflict of

    interest procedures that address such issues the Commission determines

    to be appropriate. Section 4s(j)(5) also requires SDs and MSPs to

    ensure that any persons providing clearing activities or making

    determinations as to accepting clearing customers are separated by

    appropriate informational partitions from persons whose involvement in

    pricing, trading, or clearing activities might bias their judgment or

    contravene the core principle of open access.

    Pursuant to these provisions, the Commission promulgated Sec.

    1.71(d) relating to FCMs and Sec. 23.605(d) relating to SDs and

    MSPs.\21\ These regulations prohibit SDs and MSPs from interfering or

    attempting to influence the decisions of affiliated FCMs with regard to

    the provision of clearing services and activities, and prohibit FCMs

    from permitting them to do so.

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    \21\ ``Swap Dealer and Major Swap Participant Recordkeeping and

    Reporting, Duties, and Conflicts of Interest Policies and

    Procedures; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Policies and Procedures; Swap Dealer, Major

    Swap Participant, and Futures Commission Merchant Chief Compliance

    Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

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    Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting

    any process or taking any action that results in any unreasonable

    restraint on trade or imposes any material anticompetitive burden on

    trading or clearing, unless necessary or appropriate to achieve the

    purposes of the Act. To implement Section 4s(j)(6) of the CEA, the

    Commission has promulgated Sec. 23.607 in a separate rulemaking.\22\

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    \22\ Id.

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    Section 2(h)(1)(B)(ii) of the CEA requires that DCO rules provide

    for the non-discriminatory clearing of swaps executed bilaterally or

    through an unaffiliated designated contract market (``DCM'') or SEF.

    The Commission has adopted Sec. 39.12(b)(3) to implement this

    provision.\23\

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    \23\ 76 FR 69334, Nov. 8, 2011.

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    The trilateral agreements potentially conflict with the recently-

    adopted Sec. Sec. 1.71(d), 23.605(d), 23.607, and 39.12. As certain

    commenters have stated, the provisions of the trilateral agreements

    described above could lead to undue influence by FCMs on a customer's

    choice of counterparties or undue influence by SDs on a customer's

    choice of clearing member. They could constrain a customer's

    opportunity to obtain competitive execution of the trade by limiting

    the number of potential counterparties.

    The documentation rules covered by this rulemaking are consistent

    with, and complementary to, the recently adopted rules. The rules in

    this Federal Register release address specific circumstances that have

    been identified to the Commission by market participants, while the

    previously adopted rules set forth more general principles. The

    Commission believes that, in this case, market participants and the

    general public would be best served by providing both the clarity of a

    bright-line test for certain identifiable situations and the guidance

    of more broadly-articulated principles.

    Contrary to the assertion of some commenters, the rules do not

    prohibit trilateral agreements; they prohibit certain provisions

    whether contained in a trilateral or a bilateral agreement. The rules

    have been tailored to address specific issues identified by market

    participants.

    The Commission emphasizes that nothing in these rules would

    restrain an SD or MSP from establishing bilateral limits with each of

    its counterparties. Further, nothing in these rules would impair an

    SD's or MSP's ability to conduct due diligence with regard to each of

    its counterparties, including evaluation of balance sheet, credit

    ratings, overall market exposure, or similar factors.

    The Commission is revising the language in Sec. Sec. 23.608 and

    23.608(c) to clarify that, for swaps that will be submitted for

    clearing, an SD or MSP may continue to manage its risk by limiting its

    exposure to the counterparty with whom it is trading. This

    [[Page 21281]]

    clarification is intended to emphasize that SDs and MSPs may continue

    to conduct appropriate risk management exercises. Moreover, the

    Commission believes that this modification is responsive to the concern

    raised by some commenters that until straight through processing is

    achieved, SDs and MSPs will still need to manage risk to a counterparty

    before a trade is accepted or rejected for clearing.\24\ Furthermore,

    the Commission also believes that Sec. 23.608 does not preclude an SD

    or MSP from requiring that a counterparty confirm that the counterparty

    has an account with an FCM through which the counterparty will clear.

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    \24\ ISDA.

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

    In response to the Morgan Stanley request for clarification, the

    Commission confirms that the rules, as drafted, only apply to swaps. As

    noted, similar provisions have never been needed and, therefore, were

    not proposed for futures.

    The Commission has determined not to modify the language in

    Sec. Sec. 1.72 and 23.608 as suggested by Morgan Stanley from

    ``relationship to the best terms available'' to ``execution with an

    executing swap dealer of the customer's choice.'' The rule should not

    imply that customers may only trade with swap dealers. Moreover, some

    swap markets operate anonymous central limit order books. In these

    instances, the counterparty is immaterial; trading decisions are based

    on solely the terms of the trade.

    The Commission also has determined not to adopt the clarification

    suggested by Spring Trading. Requiring execution on the best terms

    available on any market regulated by the Commission could impose

    burdensome search costs.\25\ Moreover, there could be operational costs

    in establishing connectivity to every market. It is not clear how many

    markets there will be or how compatible their systems will be with one

    another or with the systems of all FCMs and SDs. Upon review of the

    comments, the Commission is adopting Sec. Sec. 1.72, and

    39.12(a)(1)(vi) as proposed, and Sec. 23.608 with the modification

    described above.

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    \25\ The Commission notes that this rule does not impose a best

    execution requirement. This rule merely prohibits a contractual

    provision that would impair a customer's access to execution of a

    trade on terms that have a reasonable relationship to the best terms

    available.

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    III. Time Frames for Acceptance Into Clearing

    A. Swap Dealer and Major Swap Participant Submission of Trades

    1. Introduction

    Section 731 of the Dodd-Frank Act amended the CEA by adding a new

    section 4s, which sets forth a number of requirements for SDs and MSPs.

    Specifically, section 4s(i) of the CEA establishes swap documentation

    standards for those registrants. Section 4s(i) requires SDs and MSPs to

    ``conform with such standards as may be prescribed by the Commission by

    rule or regulation that relate to timely and accurate confirmation,

    processing, netting, documentation, and valuation of all swaps.''

    Section 8a(5) of the CEA authorizes the Commission to promulgate such

    regulations as, in the judgment of the Commission, are reasonably

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

    the purposes of the Act.\26\ Pursuant to these provisions, and in order

    to ensure compliance with any mandatory clearing requirement issued

    pursuant to section 2(h)(1) of the CEA and to promote the mitigation of

    counterparty credit risk through the use of central clearing, the

    Commission proposed Sec. 23.506.

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    \26\ 7 U.S.C. 12a(5).

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

    As proposed, Sec. 23.506(a)(1) would require that SDs and MSPs

    have the ability to route swaps that are not executed on a SEF or DCM

    to a DCO in a manner that is acceptable to the DCO for the purposes of

    risk management. Under Sec. 23.506(a)(2), as proposed, SDs and MSPs

    would also be required to coordinate with DCOs to facilitate prompt and

    efficient processing in accordance with proposed regulations related to

    the timing of clearing by DCOs.

    As proposed, Sec. 23.506(b) would set forth timing requirements

    for submitting swaps to DCOs in those instances where the swap is

    subject to a clearing mandate and in those instances when a swap is not

    subject to a mandate. Under Sec. 23.506(b)(1), as proposed, an SD or

    MSP would be required to submit a swap that is not executed on a SEF or

    DCM, but is subject to a clearing mandate under section 2(h)(1) of the

    CEA (and has not been electively excepted from mandatory clearing by an

    end user under section 2(h)(7) of the CEA) as soon as technologically

    practicable following execution of the swap, but no later than the

    close of business on the day of execution.\27\

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    \27\ The Commission notes that it is not expressing an opinion

    at this time as to whether a mandatory clearing determination must

    be made in conjunction with a mandatory trading determination.

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    For those swaps that are not subject to a clearing mandate, but for

    which both counterparties to the swap have elected to clear the swap,

    under Sec. 23.506(b)(2), as proposed, the SD or MSP would be required

    to submit the swap for clearing not later than the next business day

    after execution of the swap, or the agreement to clear, if later than

    execution. This time frame reflects the possibility that in the case of

    a bilateral swap, the parties may need time to agree to terms that

    would conform with a DCO's requirements for swaps it will accept for

    clearing. As noted previously, any delay between execution and novation

    to a clearinghouse potentially presents credit risk to the swap

    counterparties and the DCO because the value of the position may change

    significantly between the time of execution and the time of novation,

    thereby allowing financial exposure to accumulate in the absence of

    daily mark-to-market. The proposed regulation was designed to limit

    this delay as much as reasonably possible.

    2. Summary of Comments

    MFA generally supported proposed Sec. Sec. 23.506(a) and

    23.506(b).

    CME commented that the regulations should not require any

    particular system or methodology that SDs or MSPs must use for

    submitting swaps to DCOs. Instead, the regulations should give each DCO

    the flexibility to work with SDs and MSPs to implement various systems

    and methodologies for swap submission, which may be subject to change

    over time as cleared swap markets continue to develop and grow.

    ISDA also indicated that the rule should permit SDs and MSPs,

    coordinating with their DCOs, to be free to select the manner by which

    they route their swaps to DCOs. ISDA, however, commented that it is not

    apparent what proposed Sec. 23.506(a) adds to the Sec. 39.12(a)(3)

    requirement that clearing members have adequate operational capacity to

    meet obligations arising from their participation in DCOs. ISDA also

    noted that market participants have for some time been developing

    industry standards for the prompt and efficient processing of cleared

    swap transactions, and it suggested that the Commission study these

    standards and defer to them wherever possible.

    MarkitSERV commented that the requirement to submit swaps ``as soon

    as technologically practicable following

    [[Page 21282]]

    execution'' may be inappropriate in light of the Commission's proposed

    rule regarding confirmation requirements, which requires that swap

    transactions be confirmed within a certain time period after execution.

    MarkitSERV suggested that the regulation reference the time of

    confirmation as opposed to the time of execution. MarkitSERV also noted

    that requiring SDs and MSPs to submit swaps for clearing ``no later

    than the close of business on the day of execution'' fails to

    accommodate transactions that occur late in the day and suggested a 24

    hour time period.

    MarkitSERV also commented that there are numerous benefits to using

    third party middleware providers for routing and processing services,

    and it suggested that the Commission permit swap counterparties to

    control how they process transactions. According to MarkitSERV,

    counterparties should be permitted to use independent third party

    providers for confirming, routing, and satisfying the portfolio

    reconciliation requirements proposed by the Commission. MarkitSERV also

    suggested that the Commission clarify how proposed Sec. 23.506 would

    interact with proposed Sec. 23.501, which requires confirmation of all

    swaps, and with the then-proposed rules requiring reporting of swap

    transactions to an SDR.\28\

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

    \28\ Swap Data Repositories: Registration Standards, Duties and

    Core Principles, 76 FR 54538 (Oct. 31, 2011).

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

    FIA commented that SDs and MSPs are unlikely to submit a swap

    directly to a DCO for clearing. Instead, they will first affirm the

    swap by, for example, submitting the relevant details to an affirmation

    platform and then submit the swap to their respective clearing members

    for submission to a DCO.

    FIA suggested that the Commission should require SDs and MSPs to

    have a clearing arrangement in place with clearing members that, in

    turn, have the capacity to route orders to a DCO in a manner acceptable

    to it.

    FIA also believes that the ``no later than close of business''

    could not be satisfied by swaps that are entered into later in the day

    and suggests the proposed rule be revised to provide the parties

    greater flexibility to submit a swap for clearing within a reasonable

    time as prescribed by the applicable DCO. Finally, to encourage the

    voluntary use of clearing where such swaps are not required to be

    cleared, FIA suggests that the proposed Sec. 23.506(b)(2) be revised

    to permit the parties to submit such trades for clearing on any date to

    which the parties and their respective clearing firms agree.

    The Options Clearing Corporation (``OCC'') commented that the

    phrase ``for purpose of risk management'' in proposed Sec. Sec.

    23.506(a)(1) and 37.702(b)(1) creates ambiguity because a DCO may have

    established routing requirements for reasons unrelated to risk

    management such as increased efficiency or decreased administrative

    costs. OCC believes that a party that submits transactions to a DCO for

    clearing should be required to ensure that it has the ability to route

    the transactions to the DCO in a manner that meets all of the DCO's

    legitimate requirements, and not only those that are related to risk

    management. OCC suggests that the Commission delete the phrase ``for

    purpose of risk management'' and substitute the phrase ``for

    clearing.''

    SDMA supported the amendments to proposed Sec. 23.506, and

    suggested that the Commission promulgate rules that ensure post-trade

    and pre-trade integrity. According to SDMA, the buyer and seller must

    know immediately whether their trade has been accepted for clearing.

    Trade uncertainty, SDMA continued, caused by the time delay between the

    time of trade execution and the time of trade acceptance into clearing,

    undermines market integrity in the post-trade work process. SDMA also

    stated that trade uncertainty also directly impedes liquidity,

    efficiency, and market stability.

    CME commented that the technology for SDs and MSPs to route swaps

    to a DCO may be as simple as entering the necessary data in a web page.

    It suggested that a more apt standard may be ``as soon as operationally

    feasible.'' CME also believes that the proposed time frames for

    submission of swaps are appropriate and operationally feasible, and it

    is not aware of systemic obstacles to the coordination between DCOs,

    MSPs, and SDs required under the proposed regulation.

    FHLBanks commented that the time frames are appropriate provided

    that the Commission establishes a cut-off time for determining the day

    on which a swap is executed because it may not be ``technologically

    practicable'' for a swap that is executed towards the end of a day to

    be submitted for clearing that day. FHLBanks suggests the rule specify

    that swaps executed after 4 p.m. New York time shall be deemed to be

    executed on the following business day.

    ISDA commented that submission by the close of business may not be

    technologically practicable. In addition, ISDA suggested that trades

    will need to go through an affirmation platform and clearing members

    will need to screen trades for compliance with their own standards and

    with DCO standards, and this may not occur before the end of the

    business day. ISDA also expressed concern that mandatory, same day

    submission may invite error because clearing members may focus on speed

    over accuracy. ISDA suggested that the Commission impose an ``as soon

    as reasonably and technologically practicable'' standard.

    ISDA also commented that Sec. 23.506(b)(2) should not set forth a

    time period for clearing. According to ISDA, limiting the flexibility

    of parties voluntarily seeking to clear will only create disincentives

    to such voluntarism, including confusion and potential legal

    uncertainty. Thus, ISDA suggested that where parties voluntarily elect

    to submit a swap for clearing, all aspects of that election should be

    left to the parties to determine contractually.

    Freddie Mac commented that swap dealers periodically enter

    mismatched data and send swap confirmations that incorrectly reflect

    the principal terms of transactions. As a result, Freddie Mac believes

    that a standard for submitting clearing submissions that starts the

    clock at execution would be confusing and impractical and it could be

    detrimental to counterparties who are subject to undue pressure to

    quickly assent to terms dictated by a market professional. Freddie Mac

    also commented that establishing a close of business deadline for

    submission of swaps for clearing would impair late day trading and

    potentially reduce market integrity. Freddie Mac suggested that the

    Commission modify proposed Sec. 23.506(b)(1) to provide that SDs and

    MSPs are required to submit swaps that are not executed on a SEF or DCM

    but that are subject to a clearing mandate as soon as commercially and

    operationally practical for both parties but no later than 24 hours

    after execution.

    LCH commented that swaps not subject to mandatory clearing

    obligations should not be subject to any timeline. LCH believes that a

    DCO should be able to accept such trades whenever they are submitted,

    provided that it has sufficient margin from both sides.

    3. Discussion

    Proposed Sec. 23.506(a) does not prescribe the manner by which SDs

    or MSPs route their swaps to DCOs and provide for prompt and efficient

    processing. It is possible that DCOs will enable SDs and MSPs to submit

    their swaps to clearing via third-party platforms and other service

    providers. DCOs will certainly specify the role of their clearing

    members in the process.

    [[Page 21283]]

    The flexibility of the rule makes it consistent with the comments

    of MFA, CME, ISDA, MarkitSERV, and FIA. The Commission concurs with

    OCC's comment that a DCO may have requirements beyond risk management.

    The issue raised by SDMA is addressed in the customer documentation

    provisions.

    As discussed above, any delay between the time of execution and the

    time of clearing creates financial risk for the parties to the trade

    and for their clearing FCMs. For trades that are not subject to a

    clearing mandate, the parties are not bound by any submission deadlines

    unless and until they voluntarily agree to have the trade cleared. Once

    they make that decision, however, it will reduce risk for both the

    parties, as well as their respective clearing members, to get the trade

    submitted for clearing as soon as practicable. Therefore, in most cases

    it seems likely that the parties will comply with the timing set forth

    within the rule because it is in their own best interests to do so.

    But, to leave ``all aspects'' to the parties, as ISDA suggested,

    creates the possibility that one party could expose itself, its

    counterparty, and its clearing member to unnecessary risk by delaying

    submission.\29\ In light of all the comments, the Commission believes

    that the timeframes for submission set forth in the proposed rules are

    reasonable.

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

    \29\ See ISDA.

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

    The Commission is not defining ``business day'' in this rule, in

    order to allow the entity accepting the trade for clearing, the DCO, to

    establish its own definition. The Commission understands that a DCO may

    choose to expand its business hours in order to offer a competitive

    advantage, and that this rule should not prescribe when swaps may be

    accepted for clearing. The Commission further believes that if a trade

    is submitted for clearing near the end of a business day for a

    particular DCO, but is ultimately not accepted or rejected before that

    deadline, the DCO will determine whether the trade will be accepted or

    rejected for clearing for the following day in accordance with Sec.

    39.12.

    The Commission is adopting Sec. 23.506(a)(1) with the amendment

    suggested by OCC, changing ``for purposes of risk management'' to ``for

    purposes of clearing.''

    The Commission is adopting Sec. Sec. 23.506(a)(2) and 23.506(b) as

    proposed.

    B. Swap Execution Facility and Designated Contract Market Processing of

    Trades

    1. Introduction

    For prompt and efficient clearing to occur, the rules, procedures,

    and operational systems of the trading platform and the clearinghouse

    must align. Vertically integrated trading and clearing systems

    currently process high volumes of transactions quickly and efficiently.

    The Commission believes that trading platforms and DCOs under separate

    control should be able to coordinate with one another to achieve

    similar results.

    The Commission proposed Sec. Sec. 37.700 through 37.703 to

    implement SEF Core Principle 7 (Financial Integrity of Transactions),

    pursuant to its rulemaking authority under sections 5h(h) and 8a(5) of

    the CEA.\30\ Core Principle 7 requires a SEF to ``establish and enforce

    rules and procedures for ensuring the financial integrity of swaps

    entered on or through the facilities of the swap execution facility,

    including the clearing and settlement of the swaps pursuant to section

    2(h)(1) [of the CEA].'' \31\ As originally proposed, Sec. 37.702(b)

    would require a SEF to provide for the financial integrity of its

    transactions cleared by a DCO by ensuring that the SEF has the capacity

    to route transactions to the DCO in a manner acceptable to the DCO for

    purposes of risk management.\32\ As part of the processing rulemaking,

    the Commission proposed to renumber previous Sec. 37.702(b) as

    paragraph (b)(1) and add a new paragraph (b)(2) to require the SEF to

    additionally provide for the financial integrity of cleared

    transactions by coordinating with each DCO to which it submits

    transactions for clearing, in the development of rules and procedures

    to facilitate prompt and efficient transaction processing in accordance

    with the requirements of Sec. 39.12(b)(7) of the Commission's

    regulations.\33\

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

    \30\ See Core Principles and Other Requirements for Swap

    Execution Facilities, 76 FR 1214 (Jan. 7, 2011); 7 U.S.C. 7b-3(h);

    and 7 U.S.C. 12a(5).

    \31\ See section 5h(f)(7) of the CEA, 7 U.S.C. 7b-3(f)(7).

    \32\ See 76 FR at 1248. Section 37.702(b), as originally

    proposed, referred to ``ongoing'' risk management. In renumbering

    and finalizing this provision herein, the Commission is deleting the

    term ``ongoing'' because it is superfluous and could create

    confusion when read in conjunction with other Commission regulations

    that refer to ``risk management.'' See, e.g., proposed Sec. 39.13

    relating to risk management for DCOs, 76 FR at 3720.

    \33\ See 76 FR 13101 (Mar. 10, 2011) (setting forth time frames

    for accepting or rejecting swaps for clearing).

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

    Similarly, the Commission previously proposed Sec. Sec. 38.600

    through 38.607 to implement DCM Core Principle 11 (Financial Integrity

    of Transactions) pursuant to its rulemaking authority under sections

    5(d)(1) and 8a(5) of the CEA.\34\ Core Principle 11 requires a DCM to

    ``establish and enforce-(A) rules and procedures for ensuring the

    financial integrity of transactions entered into on or through the

    facilities of the contract market (including the clearance and

    settlement of the transactions with a derivatives clearing

    organization); and (B) rules to ensure--(i) the financial integrity of

    any--(I) futures commission merchant; and (II) introducing broker; and

    (ii) the protection of customer funds.'' \35\

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

    \34\ See Core Principles and Other Requirements for Designated

    Contract Markets, 75 FR 80572 (Dec. 22, 2010); 7 U.S.C. 7(d)(1); and

    7 U.S.C. 12a(5).

    \35\ See Section 5(d)(11) of the CEA, 7 U.S.C. 7(d)(11).

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

    As originally proposed, Sec. 38.601 would require that

    transactions executed on or through a DCM, other than transactions in

    security futures products, must be cleared through a registered DCO in

    accordance with the provisions of part 39 of the Commission's

    regulations.\36\ The Commission later proposed to renumber this

    provision as paragraph (a) of proposed Sec. 38.601 and add a new

    paragraph (b) to specifically require the DCM to coordinate with each

    DCO to which it submits transactions for clearing, in the development

    of DCO rules and procedures to facilitate prompt and efficient

    transaction processing in accordance with the requirements of Sec.

    39.12(b)(7) of the Commission's regulations.\37\

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

    \36\ See 75 FR at 80618.

    \37\ See 76 FR 13101.

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

    2. Summary of Comments

    FIA supported the rules and recommended that each SEF and DCM be

    required to assure equal access to all DCOs that wish to clear trades

    executed through the facilities of the SEF or DCM. According to FIA,

    failure to grant such access would be inconsistent with section 2(h) of

    the CEA as amended by the Dodd-Frank Act, which (1) provides for the

    non-discriminatory clearing of swaps executed bilaterally or on an

    unaffiliated SEF or DCM, and (2) provides that, with respect to a swap

    that is entered into by a SD or MSP, the counterparty shall have the

    sole right to select the DCO through which the swap is cleared.

    LCH also concurred with both rules. It commented that it is of

    paramount importance that: (1) A SEF or DCM seeking access to a DCO

    must first be required to meet all regulatory requirements; (2) each

    SEF and DCM

    [[Page 21284]]

    must code to each DCO's application programming interfaces; and (3)

    each SEF and DCM must treat DCOs on a nondiscriminatory basis.

    ISDA commented that coordination among the parties subject to the

    Commission's new swap jurisdiction is critical to ensuring that the

    rulemaking process is effective without disrupting the swap markets and

    applauds this proposal. ISDA suggested that an existing standard

    managed by ISDA and used between participating companies be adopted.

    As noted above, OCC commented that the phrase ``for purpose of risk

    management'' in proposed Sec. Sec. 23.506(a)(1) and 37.702(b)(1)

    creates ambiguity because a DCO may have established routing

    requirements for reasons unrelated to risk management such as increased

    efficiency or decreased administrative costs. OCC believes that a party

    that submits transactions to a DCO for clearing should be required to

    ensure that it has the ability to route the transactions to the DCO in

    a manner that meets all of the DCO's legitimate requirements, and not

    only those that are related to risk management. OCC suggests that the

    Commission delete the phrase ``for purpose of risk management'' and

    substitute the phrase ``for clearing.''

    3. Discussion

    Rules, procedures, and operational systems, along the lines set

    forth in the rules, currently work well for many exchange-traded

    futures. Similar requirements could be applied across multiple

    exchanges and clearinghouses for swaps. The parties would need to have

    clearing arrangements in place with clearing members in advance of

    execution. In cases where more than one DCO offered clearing services,

    the parties also would need to specify in advance where the trade

    should be sent for clearing.

    The Commission concurs with OCC's comment that a DCO may have

    requirements beyond risk management. To the extent that FIA, LCH, and

    ISDA recommended that the Commission adopt additional requirements

    beyond those set forth in the rule as proposed, the Commission believes

    it is premature to adopt the additional requirements at the present

    time. However, the Commission will monitor the implementation of this

    rule and may propose amendments in the future.

    The Commission is adopting Sec. 38.601 as proposed. The Commission

    is adopting Sec. 37.702 with the amendment suggested by OCC changing

    ``for purposes of risk management'' to ``for purposes of clearing.''

    C. Clearing Member and Clearing Organization Acceptance for Clearing

    1. Introduction

    As noted above, a goal of the Dodd-Frank Act is to reduce risk by

    increasing the use of central clearing. Minimizing the time between

    trade execution and acceptance into clearing is an important risk

    mitigant.

    This time lag potentially presents credit risk to the swap

    counterparties, clearing members, and the DCO because the value of a

    position may change significantly between the time of execution and the

    time of novation, thereby allowing financial exposure to accumulate in

    the absence of daily mark-to-market. Among the purposes of clearing are

    the reduction of risk and the enhancement of financial certainty, and

    this time lag diminishes the benefits of clearing swaps that Congress

    sought to promote in the Dodd-Frank Act. A delay in clearing is also

    inconsistent with other proposed regulations concerning product

    eligibility and financial integrity of transactions insofar as the

    delay reduces liquidity and increases risk.\38\

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

    \38\ See 76 FR 1214, Jan. 7, 2011.

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

    In this rulemaking, the Commission is seeking to expand access to,

    and strengthen the financial integrity of, the swap markets subject to

    Commission oversight by providing for prompt processing, submission,

    and acceptance of swaps eligible for clearing by DCOs. This requires

    setting an appropriate time frame for the processing and submission of

    swaps for clearing, as well as a time frame for the clearing of swaps

    by the DCO.

    As originally proposed, Sec. 39.12(b)(7)(i) required DCOs to

    coordinate with DCMs and SEFs to facilitate prompt and efficient

    processing of trades. In response to a comment, the Commission later

    proposed to require ``prompt, efficient, and accurate processing of

    trades.'' \39\

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

    \39\ See letter from Robert Pickel, Executive Vice Chairman,

    International Swaps and Derivatives Association, dated April 8,

    2011.

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

    Recognizing the key role clearing members play in trade processing

    and submission of trades to central clearing, the Commission also

    proposed parallel provisions for coordination among DCOs and clearing

    members. Proposed Sec. 39.12(b)(7)(i)(B) would require DCOs to

    coordinate with clearing members to establish systems for prompt

    processing of trades. Proposed Sec. Sec. 1.74(a) and 23.610(a) would

    require reciprocal coordination with DCOs by FCMs, SDs, and MSPs that

    are clearing members.

    As originally proposed, Sec. 39.12(b)(7)(ii) required DCOs to

    accept immediately upon execution all transactions executed on a DCM or

    SEF.\40\ A number of DCOs and other commenters expressed concern that

    this requirement could expose DCOs to unwarranted risk because DCOs

    need to be able to screen trades for compliance with applicable

    clearinghouse rules related to product and credit filters.\41\ The

    Commission recognized that while immediate acceptance for clearing upon

    execution currently occurs in some futures markets, it might not be

    feasible for all cleared markets at this time. For example, where the

    same cleared product is traded on multiple execution venues, a DCO

    needs to be able to aggregate the risk of trades coming in to ensure

    that a clearing member or customer has not exceeded its credit limits.

    Accordingly, the Commission modified proposed Sec. 39.12(b)(7)(ii) to

    permit DCOs to screen trades against applicable product and credit

    criteria before accepting or rejecting them.\42\ Consistent with

    principles of open access, the proposal would require that such

    criteria be non-discriminatory with respect to trading venues and

    clearing participants.

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

    \40\ See Requirements for Processing, Clearing, and Transfer of

    Customer Positions, 76 FR 13101 (March 10, 2011).

    \41\ See letter from Craig S. Donohue, Chief Executive Officer,

    CME Group, dated April 11, 2011; letter from R. Trabue Bland, Vice

    President and Assistant General Counsel, ICE, dated April, 11, 2011;

    letter from Iona J. Levine, Group General Counsel and Managing

    Director, LCH.Clearnet, dated April, 11, 2011; letter from William

    H. Navin, Executive Vice President and General Counsel, Options

    Clearing Corporation, dated April, 11, 2011; letter from John M.

    Damgard, President, Futures Industry Association, dated April 14,

    2011.

    \42\ See 76 FR 45730, Aug. 1, 2011.

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

    Proposed Sec. 1.74(b) would set up a parallel requirement for

    clearing FCMs; proposed Sec. 23.610(b) would set up a parallel

    requirement for SDs and MSPs that are clearing members. These rules,

    again, would apply a performance standard, not a prescribed method for

    achieving it.

    As originally proposed, Sec. Sec. 39.12(b)(7)(iii) and

    39.12(b)(7)(iv) distinguished between swaps subject to mandatory

    clearing and swaps not subject to mandatory clearing.\43\ Upon review

    of the comments, the Commission concluded that this distinction was

    unnecessary with regard to processing time frames. If a DCO lists a

    product for clearing, it should be able to process it regardless of

    whether clearing is mandatory or voluntary. Accordingly, the Commission

    modified proposed Sec. 39.12(b)(7)(iii) to cover all trades not

    executed on a DCM or SEF. It would require acceptance or rejection

    [[Page 21285]]

    by the DCO as quickly after submission as would be technologically

    practicable if fully automated systems were used.

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

    \43\ See 76 FR 13101, Mar. 10, 2011.

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

    Proposed Sec. 1.74(b) would set up a parallel requirement for

    clearing FCMs; proposed Sec. 23.610(b) would set up a parallel

    requirement for SDs and MSPs that are clearing members. These rules,

    again, would apply a performance standard, not a prescribed method for

    achieving it.

    The Commission also recognized that some trades on a DCM or SEF may

    be executed non-competitively. Examples include block trades and

    exchanges of futures for physicals (``EFPs''). A DCO may not be

    notified immediately upon execution of these trades. Accordingly, the

    proposal treated these trades in the same manner as trades that are not

    executed on a DCM or SEF.

    2. Summary of Comments

    Eighteen \44\ commenters expressed support for the timing standard

    as proposed by the Commission.

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

    \44\ AIMA, AllianceBernstein, Arbor, Barnard, CIEBA, Citadel,

    DRW, Eris, FHLB, ICI, Javelin, Jeffries, MFA, SDMA, State Street,

    Spring Trading, Trading Firms, and Vizier.

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

    CME recommended that the standard be revised to ``as quickly as

    would be technologically practicable if fully automated systems and

    filters were used or as quickly as possible if automated systems or

    filters are not used.''

    MGEX requested that the Commission codify the preamble text that

    the new timing standard would require action in a matter of

    ``milliseconds or seconds or, at most, a few minutes, not hours or

    days.'' MGEX also commented that proposed Sec. 39.12(b)(7) should be a

    general acceptance and timing rule, not applicable for each specific

    contract listed to be cleared. MGEX argued that the rule only should

    apply to those swaps that a DCO has identified that it can and will

    clear, as opposed to variations of contracts listed for clearing or any

    contract not previously cleared by the DCO.

    Morgan Stanley believes that the timing standard should be intended

    to prohibit only those arrangements that prevent the use of automated

    systems that are available in the market to facilitate clearing.

    LCH suggested that the Commission modify proposed Sec. Sec.

    39.12(7)(ii) and (iii) by adding the language ``and for which

    sufficient margins have been received by the derivatives clearing

    organization'' prior to accepting and confirming a trade for clearing.

    NYPC requested clarification that in circumstances where a DCO

    automatically receives matched trade data from a DCM or SEF on a

    locked-in basis, no further systems development would be required in

    order to satisfy the above-referenced requirements of proposed

    regulations 1.74(a) and 39.12(b)(7)(i)(B).

    Better Markets stated that the timing standard must be: (1)

    Provided by the DCO or FCM; (2) capable of receiving and processing

    trade data from multiple sources in real time; (3) able to screen

    against standards such as price levels and block trade sizes as a

    threshold matter; (4) able to decrease or increase available credit

    real time; and (5) automatic push notification of acceptance or

    rejection by the DCO or FCM. Better Markets also commented that systems

    provided by a DCO or FCM must be open and require no special

    capabilities on the part of the trade execution venue, and that once

    data is input, the systems must function on a first-come-first-served

    basis using a reliable and common time stamping regime, regardless of

    affiliation or contractual relationship between the trading venue and

    DCO or FCM. Better Markets noted that confirmation of acceptance or

    rejection must not differ between trading venues based on affiliation

    or relationship.

    SG suggested that the Commission establish one or both of the

    following: (1) Credit limits of customers and FCMs are stored at the

    DCO and provided to SEFs in real time upon electronic demand; or (2) an

    industry-wide utility that stores customer and FCM limits and provides

    them to DCOs and SEFs in real time upon electronic demand.

    3. Discussion

    The Commission continues to believe that acceptance or rejection

    for clearing in close to real time is crucial both for effective risk

    management and for the efficient operation of trading venues.\45\

    Rather than prescribe a specific length of time, the Commission is

    implementing a standard that action be taken ``as quickly as would be

    technologically practicable if fully automated systems were used.''

    This standard would require action in a matter of milliseconds or

    seconds or, at most, a few minutes, not hours or days. The Commission

    recognizes that processing times may vary by product or market.

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

    \45\ See letter from James Cawley, Swaps and Derivatives Market

    Association, dated April 19, 2011.

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

    This requirement is intended to be a performance standard, not the

    prescription of a particular method of trade processing. The Commission

    expects that fully automated systems will be in place at some DCOs,

    FCMs, SDs, and MSPs. Others might have systems with some manual steps.

    The use of manual steps would be permitted so long as the process could

    operate within the same time frame as the automated systems.

    As discussed by numerous commenters, the proposed standard

    approximates real-time acceptance while providing flexibility to

    accommodate different systems and procedures. Avoiding a large gap

    between trade execution and acceptance for clearing is crucial to risk

    management for DCOs, FCMs, and market participants.

    The Commission notes that the time frame for acceptance by clearing

    members and DCOs set forth in this section is stricter than the time

    frames for submission by SDs and MSPs set forth in Section III.A.,

    above. Where execution is bilateral and clearing is voluntary, the

    delay between execution and submission to clearing is, of necessity,

    within the discretion of the parties to some degree. The Commission

    believes, however, that prudent risk management dictates that once a

    trade has been submitted to a clearing member or a DCO, the clearing

    member or DCO must accept or reject it as quickly as possible.

    Assuring prompt acceptance or rejection for clearing also

    undermines much of the stated rationale for the provisions in the

    trilateral agreements. In those unusual circumstances in which trades

    are rejected, the parties will know almost immediately and be able to

    take appropriate steps to mitigate risk.

    The Commission disagrees with CME's suggested standard of ``as

    quickly as possible.'' The Commission believes that this standard would

    introduce too much potential for delay. It could increase the very

    risks that this final rulemaking is designed to reduce or eliminate.

    In support of the final standard, the Commission notes that on

    December 13, 2011, $4.1 billion of trades were executed on a trading

    platform and cleared by a DCO within the time frame contemplated by the

    proposed rules. Specifically, 21 interest rate swaps were executed and

    cleared with an average time of 1.9 seconds and a quickest time of 1.3

    seconds.\46\

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

    \46\ Katy Burne, UPDATE: Javelin, CME Claim Record Time To Clear

    Rate Swaps, Dow Jones Newswires, Nasdaq (Dec. 14, 2011; accessed

    Jan. 3, 2012) http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201112141726dowjonesdjonline000739&title=updatejavelincme-claim-record-time-to-clear-rate-swaps.

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    [[Page 21286]]

    The Commission also disagrees with the MGEX suggestion that the

    timing standard should be codified as ``milliseconds, seconds, or

    minutes,'' because this would provide a window for trade acceptance

    that might be too wide as faster systems become available. The

    Commission believes that its proposed standard will allow for

    innovation to bring faster trade acceptance or rejection to the market

    most efficiently.

    The Commission also disagrees with LCH's proposed addition of the

    language ``and for which sufficient margins have been received by the

    derivatives clearing organization'' prior to accepting and confirming a

    trade for clearing. This standard may not be practicable for DCOs that

    are linked to high-volume automated trading systems. Currently, many

    DCOs in such circumstances calculate margin at the end of the day for

    collection the next day. Nothing in the final rules, however, precludes

    a DCO in its discretion from applying such a standard.

    The Commission confirms NYPC's belief that in circumstances where a

    DCO automatically receives matched trade data from a DCM or SEF on a

    locked-in basis, no further systems development would be required.

    The Commission believes that the comments of Better Markets and SG

    are consistent with the intent of the rules but provide a level of

    detail that the Commission believes is unnecessary at the present time,

    and in some respects goes beyond what the Commission proposed. For

    example, Better Markets recommended that DCOs and FCMs be able to

    increase available credit in real-time and to have automatic push

    notification of acceptance or rejection from clearing. The first could

    conflict with risk management procedures that some DCOs or FCMs might

    wish to use. The second is likely to be in place at many firms, but the

    Commission continues to believe that it is appropriate to have a rule

    that sets a performance standard rather than specifying a particular

    means of achieving it. Fully automated systems would of course comply

    with the performance standard. Accordingly, the Commission has decided

    not to change the rule in the manner suggested by Better Markets and

    SG. The Commission, however, will monitor the implementation of this

    rule and may propose amendments in the future.

    The Commission received numerous comments in the customer clearing

    documentation rulemaking emphasizing that it is imperative for

    effective risk management to have the shortest possible gap between

    execution and clearing. To permit additional time as suggested by some

    of the commenters on this rule would increase risk for DCOs, clearing

    members, and market participants.

    However, in light of commenters' concerns, the Commission is

    adopting Sec. Sec. 1.75 and 23.611, which delegate to the Director of

    the Division of Clearing and Risk the authority to establish an

    alternative compliance schedule for requirements of Sec. Sec. 1.74 and

    23.610 for swaps that are found to be technologically or economically

    impracticable for an FCM, SD, or MSP affected by Sec. Sec. 1.74 or

    23.610. The purpose of Sec. Sec. 1.75 and 23.611 is to facilitate the

    ability of the Commission to provide a technologically practicable

    compliance schedule for affected FCMs, SDs, or MSPs that seek to comply

    in good faith with the requirements of Sec. Sec. 1.74 or 23.610.

    In order to obtain an exception under Sec. Sec. 1.75 or 23.611, an

    affected FCM, SD, or MSP must submit a request to the Director of the

    Division of Clearing and Risk. FCMs, SDs, and MSPs submitting requests

    must specify the basis in fact supporting their claims that compliance

    with Sec. Sec. 1.74 or 23.610 would be technologically or economically

    impracticable. Such a request may include a recitation of the specific

    costs and technical obstacles particular to the entity seeking an

    exception and the efforts the entity intends to make in order to ensure

    compliance according to an alternative compliance schedule. An

    exception granted under Sec. Sec. 1.75 or 23.611 shall not cause a

    registrant to be out of compliance or deemed in violation of any

    registration requirements.

    Such requests for an alternative compliance schedule shall be acted

    upon by the Director of the Division of Clearing and Risk or designees

    thereto within 30 days from the time such a request is received. If not

    acted upon within the 30 day period, such request will be deemed

    approved.

    The Commission is adopting Sec. Sec. 1.74, 23.610, and 39.12(b)(7)

    as proposed.

    D. Post-Trade Allocation of Bunched Orders

    1. Introduction

    Bunched orders are orders entered by an account manager on behalf

    of multiple customers, which are executed as a block and later

    allocated among participating customer accounts for clearing. Believing

    that procedures used in the futures markets could be adapted for use in

    the swaps markets, the Commission proposed Sec. 1.35(a-1)(5)(iv).\47\

    It provided that allocations must be made as soon as practicable after

    execution but in any event no later than the following times: (1) For

    cleared transactions, sufficiently before the end of the day to ensure

    that clearing records identify the customer accounts, and (2) for

    uncleared trades, no later than the end of the day the swap was

    executed.

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    \47\ See 76 FR 33066 (Jun. 7, 2011).

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

    2. Summary of Comments

    In comments filed in connection with proposed Sec. Sec. 1.74,

    23.610, and 39.12(b)(7), BlackRock and State Street stated that the

    Commission should clarify the rules to specifically allow for post-

    trade allocation of block trades. BlackRock also commented that the

    final rule should provide that at the time of trade execution,

    confirmation of trade economics may be done at the block level, and a

    two-hour delay be allowed before the trade must be submitted to a DCO

    for clearing.

    In comments also filed in connection with proposed Sec. Sec. 1.74,

    23.610, and 39.12(b)(7), MFA and D. E. Shaw stated that it is not

    necessary to delay trades for post-execution allocation of trades to

    multiple funds. D. E. Shaw asserted that post-execution allocation is a

    ``red herring'' and should not prevent the Commission from mandating

    real-time clearing in the proposal.

    In a comment filed in connection with the proposed amendment to

    Sec. 1.35, CME asserted that bunched orders in swaps should not be

    subject to the same type of regulatory regime as bunched orders in

    futures contracts because the ``futures model'' for treatment of

    bunched orders is not a suitable model for block trades of swaps. After

    a bunched trade in the futures market is accepted for clearing, an FCM

    generally holds the positions in a suspense account while awaiting

    allocation instructions from the asset manager. In contrast, the CME

    believes that an FCM holding bunched orders for swaps in a suspense

    account, while waiting for allocation instructions, may be exposed to

    substantially greater risk considering larger transaction sizes and the

    different risk profile of cleared swaps as compared to futures. CME

    stated that a time frame of two hours should allow sufficient time for

    asset managers to allocate block trades in swaps to their individual

    customers' accounts.

    In contrast, in comments also filed in connection with proposed

    Sec. 1.35, SDMA stated that there should be no delay for bunched

    orders that are allocated after execution. According to SDMA, the

    process for swaps trade allocation

    [[Page 21287]]

    should be similar to that of the futures markets.

    The Commission received no substantive comments regarding

    allocation of uncleared trades.

    3. Discussion

    For many years in the futures markets, bunched orders have been

    executed as a block for immediate acceptance into clearing and

    allocated into individual accounts later in the day. Essentially, a

    ``stand-by'' clearing member guarantees the trades until they can be

    allocated. Consequently, there is no need for a two-hour delay.

    The proposed amendments would apply the same process to swaps. By

    allowing post-trade allocation of bunched orders, the rule is

    responsive to all the comments. By not permitting a two-hour delay the

    rule is also responsive to the comments of State Street, MFA, D. E.

    Shaw, and SDMA, but is contrary to the comments of CME and BlackRock.

    The Commission does not find persuasive the arguments that cleared

    swaps should be subject to a standard that differs in this regard from

    the standard for cleared futures. The Commission believes that a two-

    hour delay would create risk rather than mitigate it. First, the

    counterparty or counterparties to the trade would incur a delay in

    acceptance of their side into clearing because of the happenstance of

    being opposite a bunched order. This result is untenable in fast-moving

    markets. Second, the customers whose orders were being bunched would

    also suffer the same delay thereby incurring the same risks.

    The futures model has worked well for many years. In most

    instances, the orders are successfully allocated and the stand-by FCM

    ultimately is not required to clear any trades. In those cases where

    there is a misallocation, it is corrected the next day and the stand-by

    FCM is compensated by the account manager. All parties receive the

    benefits of immediate acceptance into clearing. CME and BlackRock have

    not demonstrated why these procedures would not work for swaps.

    The Commission believes that a similar analysis applies to

    uncleared swaps. Certainty of allocation by the end of the calendar day

    that a swap is executed will reduce risk for both counterparties. The

    Commission received no comments indicating otherwise.

    The Commission is adopting Sec. 1.35(a-1)(5)(iv) as proposed.

    IV. Clearing Member Risk Management

    A. Introduction

    CEA Section 3(b) provides that one of the purposes of the Act is to

    ensure the financial integrity of all transactions subject to the Act

    and to avoid systemic risk. CEA section 8a(5) authorizes the Commission

    to promulgate such regulations that it believes are reasonably

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

    the purposes of the Act. Risk management systems are critical to the

    avoidance of systemic risk, as evidenced by the statutory provisions

    cited below.

    CEA section 4s(j)(2) requires each SD and MSP to have risk

    management systems adequate for managing its business. CEA section

    4s(j)(4) requires each SD and MSP to have internal systems and

    procedures to perform any of the functions set forth in Section 4s.

    CEA section 4d requires FCMs to register with the Commission. It

    further requires FCMs to segregate customer funds. CEA section 4f

    requires FCMs to maintain certain levels of capital. CEA section 4g

    establishes reporting and recordkeeping requirements for FCMs.

    These provisions of law--and Commission regulations promulgated

    pursuant to these provisions--create a web of requirements designed to

    secure the financial integrity of the markets and the clearing system,

    to avoid systemic risk, and to protect customer funds. Effective risk

    management by SDs, MSPs, and FCMs is essential to achieving these

    goals. For example, a poorly managed position in the customer account

    may cause an FCM to become undersegregated. A poorly managed position

    in the proprietary account may cause an FCM to fall out of compliance

    with capital requirements.

    Even more significantly, a failure of risk management can cause an

    FCM to become insolvent and default to a DCO. This can disrupt the

    markets and the clearing system and harm customers. Such failures have

    been predominately attributable to failures in risk management.

    Proposed Sec. 1.73 set forth risk management requirements that

    would apply to clearing members that are FCMs; proposed Sec. 23.609

    would apply to clearing members that are SDs or MSPs. These provisions

    would require these clearing members to have procedures to limit the

    financial risks they incur as a result of clearing trades and liquid

    resources to meet the obligations that arise. The proposal required

    each clearing member to:

    (1) Establish credit and market risk-based limits based on position

    size, order size, margin requirements, or similar factors;

    (2) Use automated means to screen orders for compliance with the

    risk-based limits;

    (3) Monitor for adherence to the risk-based limits intra-day and

    overnight;

    (4) Conduct stress tests of all positions in the proprietary

    account and all positions in any customer account that could pose

    material risk to the futures commission merchant at least once per

    week;

    (5) Evaluate its ability to meet initial margin requirements at

    least once per week;

    (6) Evaluate its ability to meet variation margin requirements in

    cash at least once per week;

    (7) Evaluate its ability to liquidate the positions it clears in an

    orderly manner, and estimate the cost of the liquidation at least once

    per month; and

    (8) Test all lines of credit at least once per quarter.

    Each of these items has been observed by Commission staff as an

    element of an existing sound risk management program at a DCO or an

    FCM.

    B. Components of the Rule

    The Commission received a total of 15 comment letters directed

    specifically at the proposed risk management rules.\48\ A discussion of

    the comments received in response to each component of the rule

    follows.

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

    \48\ Barnard; Futures Industry Association (``FIA''); SDMA;

    Better Markets; ICE; CME; Freddie Mac; ISDA; MGEX; MFA; Citadel;

    FHLB; Jeffries; Arbor; and Javelin.

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

    1. Establish Credit and Market Limits and Automated Screening of Orders

    a. Summary of Comments

    FIA stated that it does not believe that ``pre-execution''

    screening of orders is feasible in all market situations. For instance,

    the FIA noted four situations wherein ``pre-execution screening'' is

    not possible given current technology. Specifically, FIA does not

    believe that ``pre-execution'' screening is possible in the case of

    floor execution, trading advisors using ``bunched'' orders, give-up

    agreements, and traders using multiple trading platforms.

    The CME also commented that automated screening is not feasible in

    a floor trading environment. The CME suggested that the Commission

    adopt the following language: ``automated or otherwise appropriate

    means to screen orders for compliance with risk-base-limits.''

    ISDA made comments consistent with CME and recommended a more

    flexible approach. ISDA noted that the

    [[Page 21288]]

    regulation may not take into account the manner in which swaps are

    executed.

    b. Discussion

    As noted previously, the Dodd-Frank Act requires the increased use

    of central clearing. In particular, Section 2(h) establishes procedures

    for the mandatory clearing of certain swaps. Central clearing will

    provide more stability to the markets, and increase transparency for

    market participants.\49\ As stated in the Committee report of the

    Senate Committee on Banking, Housing, and Urban Affairs: ``Increasing

    the use of central clearinghouses * * * will provide safeguards for

    American taxpayers and the financial system as a whole.'' \50\

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

    \49\ The Dodd-Frank Wall Street Reform and Consumer Protection

    Act: Title VII, Derivatives, Mark Jickling & Kathleen Ann Ruane, 5

    (Aug. 30, 2010).

    \50\ S. Rep. No. 111-176, at 32 (2010) (report of the Senate

    Committee on Banking, Housing, and Urban Affairs).

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

    The Commission has finalized extensive risk management standards at

    the DCO level. Given the increased importance of clearing and the

    expected entrance of new products and new participants into the

    clearing system, the Commission believes that enhancing the safeguards

    at the clearing member level is necessary as well.

    Bringing swaps into clearing will increase the magnitude of the

    risks faced by clearing members. In many cases, it will change the

    nature of those risks as well. Many types of swaps have their own

    unique set of risk characteristics. The Commission believes that the

    increased concentration of risk in the clearing system combined with

    the changing configuration of the risk warrant additional vigilance not

    only by DCOs but by clearing members as well.

    FCMs generally have extensive experience managing the risk of

    futures. They generally have less experience managing the risks of

    swaps. The Commission believes that it is a reasonable precaution to

    require that certain safeguards be in place. It would ensure that FCMs,

    who clear on behalf of customers, are subject to standards at least as

    stringent as those applicable to SDs and MSPs, who clear only for

    themselves. Failure to require SDs, MSPs, and FCMs that are clearing

    members to maintain such safeguards would frustrate the regulatory

    regime established in the CEA, as amended by the Dodd-Frank Act.

    Accordingly, the Commission believes that applying the risk-management

    requirements in the proposed rules to SDs, MSPs, and FCMs that are

    clearing members are reasonably necessary to effectuate the provisions,

    and to accomplish the purposes, of the CEA.

    The Commission does not intend to prescribe the particular means of

    fulfilling these obligations. As is the case with DCOs, clearing

    members will have flexibility in developing procedures that meet their

    needs. For example, items (1) and (2) could be addressed through simple

    numerical limits on order or position size, or through more complex

    margin-based limits. Further examples could include price limits that

    would reject orders that are too far away from the market, or limits on

    the number of orders that could be placed in a short time.

    These proposals are consistent with international standards. In

    August 2010, the International Organization of Securities Commissions

    issued a report entitled ``Direct Electronic Access to Markets.'' \51\

    The report set out a number of principles to guide markets, regulators,

    and intermediaries. Principle 6 states that:

    \51\ The report can be found at www.iosco.org.

    A market should not permit DEA [direct electronic access] unless

    there are in place effective systems and controls reasonably

    designed to enable the management of risk with regard to fair and

    orderly trading including, in particular, automated pre-trade

    controls that enable intermediaries to implement appropriate trading

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

    limits.

    Principle 7 states that:

    Intermediaries (including, as appropriate, clearing firms)

    should use controls, including automated pre-trade controls, which

    can limit or prevent a DEA Customer from placing an order that

    exceeds a relevant intermediary's existing position or credit

    limits.

    Over the years, ``rogue'' traders have caused substantial financial

    damage to both small and large firms. The size or sophistication of the

    firm has not provided comprehensive protection. Traders have found ways

    to exploit gaps in internal controls. Automated screening procedures,

    such as Globex Credit Controls, are already in place in many markets

    and have proven to be effective tools for reducing risk. Therefore, the

    Commission believes that as proposed, the rule should require clearing

    members to use automated means for screening orders executed on

    automated trading systems.

    In response to the comments, the Commission has determined that,

    for non-automated markets such as open outcry exchanges or voice

    brokers, the rules would permit other forms of internal controls. For

    example, a clearing member cannot use an automated system to screen the

    orders of a floor trader. Proprietary or customer orders executed by

    open outcry or voice broker can be screened automatically if they are

    routed automatically. Many orders, however, continue to be placed by

    telephone. It is not practicable at this time to use automated means to

    screen such orders. A clearing member, however, can actively monitor a

    trader's activities and be in communication if the trader approaches a

    limit. To incorporate this approach, the Commission is revising

    Sec. Sec. 1.73(a)(2)(ii), 1.73(a)(2)(iii), and 23.609(a)(2)(ii) using

    language suggested by ISDA. Specifically, as amended, these rules

    provide that clearing members must ``establish and maintain systems of

    risk controls reasonably designed to ensure compliance.''

    The Commission believes that, as amended, the rules will be

    responsive to the comments of FIA, CME, and ISDA. They will continue to

    emphasize the key role that order screening can play in managing risk

    while making accommodation for certain circumstances where automated

    screening may not be possible or practicable at this time.

    In response to the comments, the Commission has also determined to

    make changes with regard to give-ups and bunched orders. Give-ups are

    trades where the execution function and the clearing function are

    performed by different firms. Revised paragraph (2)(iv) requires the

    clearing firm, which bears the financial risk of the trade, to set

    limits and communicate them to the executing firm, which would apply

    them. This arrangement is consistent with current practice. The uniform

    give-up contract contains a provision allowing a clearing firm to

    establish limits on the trades it will accept from the executing firm.

    To the extent the executing firm is an SD or MSP, and the clearing

    firm is an affiliated FCM, the firms will also have to comply with the

    conflict of interest rules for SD/MSPs and the conflict of interest

    rules for FCMs.\52\ Those rules address appropriate partitions between

    the trading units of an SD/MSP and the clearing units of an affiliated

    FCM. For example, recently-promulgated Sec. 23.605(d)(1)(iv) prohibits

    an SD/MSP

    [[Page 21289]]

    from interfering with the setting of risk tolerance levels by an

    affiliated FCM.

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

    \52\ See ``Swap Dealer and Major Swap Participant Recordkeeping

    and Reporting, Duties, and Conflicts of Interest Policies and

    Procedures; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Policies and Procedures; Swap Dealer, Major

    Swap Participant, and Futures Commission Merchant Chief Compliance

    Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

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

    As noted above, for bunched orders, typically one firm acts as a

    ``stand-by'' clearing firm for purposes of getting the trade executed,

    but before the end of the day, the block is broken up and assigned

    among multiple clearing members, each of whom is acting on behalf of a

    particular customer.

    Revised paragraph (2)(v)(A) requires the stand-by clearing firm to

    establish limits for the block account and screen the order. Revised

    paragraph (2)(v)(B) requires each ultimate clearing firm to establish

    limits for each of its customers and enter an agreement with the

    account manager under which the account manager would screen orders for

    compliance. Revised paragraph (2)(v)(C) requires each ultimate clearing

    firm to establish controls to enforce its limits. The revisions adjust

    the rule to take into account the more complex procedures entailed in

    processing bunched orders. They narrow the scope of the screening

    required by various clearing participants from what was originally

    proposed.

    To the extent the account manager or one of the customers is an SD/

    MSP and one of the clearing firms is an affiliated FCM, the firms also

    will have to comply with the conflict of interest rules for SD/MSPs and

    the conflict of interest rules for FCMs. As noted above, those rules

    address appropriate partitions between the trading units of an SD/MSP

    and the clearing units of an affiliated FCM.

    2. Stress Tests

    a. Summary of Comments

    Chris Barnard and Better Markets both recommended that the

    Commission require specific stress tests. Barnard recommended that the

    Commission adopt a minimum standard and Better Markets recommended an

    ``extreme but plausible'' standard for stress tests. In addition,

    Better Markets believes that stress test results should be reported to

    the Commission and the relevant DCO. FHLB recommended that stress test

    results be publicly disclosed. FHLB believes that public disclosure of

    stress test results would allow customers to mitigate risk.

    b. Discussion

    Stress tests are an essential risk management tool. The purpose in

    conducting stress tests is to determine the potential for significant

    losses in the event of extreme market events and the ability of traders

    and clearing members to absorb the losses.

    The Commission intentionally refrained from setting specific stress

    tests levels or a minimum threshold. The Commission believes that

    clearing members are in the best position to design stress tests based

    on their knowledge of markets and the types of customers they carry. In

    addition, the Commission believes that specifying certain stress tests

    might stifle innovation or cause firms to use minimum levels to meet

    regulatory compliance rather than implementing a vigorous risk

    management program. This approach is consistent with the approach

    recently adopted by the Commission for DCO stress tests. The Commission

    intends to monitor the implementation of this rule to determine whether

    clearing members are routinely conducting stress tests reasonably

    designed for the types of risk the clearing members and their customers

    face.

    The Commission believes that the concept of ``extreme but

    plausible'' conditions is commonly used and was implicit in the

    proposal. The Commission is adding the phrase to the rule text for

    clarity.

    The Commission believes that public disclosure of stress test

    results could be a disincentive to aggressive stress testing. Moreover,

    disclosure of results could have the effect of improper disclosure of

    confidential position information.

    The Commission is adopting the provisions as proposed, with

    amendments to Sec. Sec. 1.73(a)(4) and 23.609(a)(4) to incorporate the

    phrase ``extreme but plausible market conditions.''

    3. Margin Evaluation

    a. Summary of Comments

    ISDA and FIA believe that the requirement to evaluate initial

    margin once per week is unclear. ISDA pointed out that a clearing

    member generally knows the amount of initial margin and collects it

    promptly.

    The Commission received no comments regarding Sec. Sec. 1.73(a)(6)

    and 23.609(a)(6) regarding variation margin.

    b. Discussion

    The purpose of this provision is to require clearing firms to

    evaluate their ability to deal with certain contingencies on a routine

    basis. For example, a DCO might raise margin requirements, or option

    positions might be exercised, or a customer might default on a margin

    call. The clearing firm should make sure that it has resources

    available to meet its continuing obligations under such circumstances.

    The Commission is adopting Sec. Sec. 1.73(a)(5), 1.73(a)(6),

    23.609(a)(5), and 23.609(a)(6) as proposed.

    4. Estimated Cost of Liquidation

    a. Summary of Comments

    FIA commented that ``even in normal markets, estimating the costs

    of liquidating such positions in an orderly manner will be difficult at

    best. In times of market stress, such estimates will be impossible.''

    b. Discussion

    The Commission recognizes that estimating the cost of liquidation

    is at times difficult. But the inevitable imprecision of any estimate

    does not justify abandoning efforts to quantify potential losses.

    The purpose of the calculation is to alert the clearing firm to

    potential risks that might otherwise go undetected. This exercise could

    lead a clearing firm to decide: (1) To arrange for additional financing

    to cover a potential loss; or (2) to reduce the positions prior to a

    period of market stress. Commission staff perform stress tests of FCM

    positions and have alerted FCMs about potential losses. Based on

    Commission staff's experience in this area, the Commission believes

    that this is a topic that has not been fully addressed by some clearing

    members in recent years.

    In response to commenters, the Commission has decided to modify

    Sec. 1.73(a)(7) to require estimation of liquidation costs once per

    quarter, rather than once per month.

    Additionally, the Commission is re-numbering Sec. 23.609(a)(7) to

    Sec. 23.609(a)(8), and renumbering Sec. 23.609(a)(8) to Sec.

    23.609(a)(7), in order to follow the parallel structure in Sec. 1.73.

    The Commission is adopting Sec. Sec. 1.73(a)(8) and 23.609(a)(7)

    with the modifications discussed above.

    5. Testing Lines of Credit

    a. Summary of Comments

    The CME commented that the requirement to test lines of credit

    should only be done on an annual basis rather than a quarterly basis.

    The CME believes that quarterly testing is not cost efficient. ISDA

    sought clarification on whether the test requires an actual drawing of

    funds or an assessment of conditions precedent to drawing.

    b. Discussion

    The Commission accepts that quarterly testing might not be cost

    efficient under all circumstances. Nonetheless, the Commission

    encourages clearing members to test lines of credit more frequently

    based on

    [[Page 21290]]

    market and credit events. For instance, if a line of credit is in place

    with a bank that has recently suffered a credit rating downgrade, a

    test may be appropriate.

    The Commission believes that the actual drawing of funds is

    essential to testing a line of credit. Among other things, the test

    should ensure the ability of the bank or other institution to move the

    funds in a timely fashion and that the clearing member can assess its

    ability to approve the drawing and properly make accounting entries.

    This approach is consistent with the approach the Commission recently

    adopted for DCOs.

    The Commission is adopting Sec. Sec. 1.73(a)(8) and 23.609(a)(7)

    as proposed, but with an amendment to provide for annual--rather than

    quarterly--testing of lines of credit.

    6. Vagueness, Conflict, and/or Overlap Among Regulations

    a. Summary of Comments

    FIA expressed concern that paragraphs (a)(1) and (a)(4) through (6)

    of Sec. 1.73 are too vague. FIA also expressed concern that the limits

    required by Sec. 1.73 ``may conflict with the provisions of proposed

    Rule 1.72(c), which provides that an FCM may set only `an overall limit

    for all positions held by the customer' at the FCM. Further, such

    limits may indirectly `limit' the number of counterparties with whom a

    customer may enter into a trade, in apparent violation of proposed Rule

    1.72(b).'' Regulation 1.72 was proposed in the customer clearing

    documentation rules \53\ and is discussed in Part II, above.

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

    \53\ See 76 FR 45730, Aug. 1, 2011.

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

    ISDA commented that the then-proposed Sec. 23.600 imposes a risk

    management program for SDs and MSPs that must include ``policies and

    procedures to monitor and manage, market, credit, liquidity, foreign

    currency, legal, operational, and settlement risk, as well as controls

    on business trading.'' ISDA believes that the broad requirements of

    Sec. 23.600 that pertain to liquidity and funding make proposed Sec.

    23.609(a)(5)-(8) redundant. The Commission recently promulgated Sec.

    23.600 as a final rule.\54\

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

    \54\ ``Swap Dealer and Major Swap Participant Recordkeeping and

    Reporting, Duties, and Conflicts of Interest Policies and

    Procedures; Futures Commission Merchant and Introducing Broker

    Conflicts of Interest Policies and Procedures; Swap Dealer, Major

    Swap Participant, and Futures Commission Merchant Chief Compliance

    Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

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

    b. Discussion

    The Commission does not believe that Sec. 1.73 is too vague.

    Paragraph (a)(1) addresses risk-based limits, paragraph (a)(4)

    addresses stress tests, and paragraphs (a)(5) and (6) address margin.

    While FIA asserts that these requirements are vague, it provides no

    additional detail on the issue.

    The regulation was intentionally drafted in a non-prescriptive

    manner. Risk management is a complex process that requires firms to

    make judgment calls on a daily basis. Moreover, each firm has a

    different customer base, different resources, and a different risk

    appetite. The Commission envisions that each clearing member will

    comply with Sec. 1.73 using procedures and technology appropriate to

    its business model and customer base. As drafted, these provisions

    allow flexibility and innovation in complying with the regulation.

    The Commission does not believe that Sec. Sec. 1.73 and 1.72

    conflict. As proposed, Sec. 1.72(b) would prohibit limits as to the

    number of counterparties, whereas Sec. 1.73 would require limits set

    according to criteria such as position size or margin amount. FIA

    asserts that the regulations could conflict because Sec. 1.73 may

    ``indirectly'' limit the number of counterparties. A position limit, of

    course, can have the effect of limiting the number of counterparties in

    the sense that if a trader can only execute 100 lots, the trader cannot

    have more than 100 counterparties. But such an indirect result is

    distinguishable from the conduct prohibited by Sec. 1.72(b)--the

    deliberate setting of limits on the number of counterparties. The first

    is a legitimate risk management tool; the second is an unnecessary

    impediment to the free and open trading that would promote liquidity.

    Section 1.72(c) would prohibit only limits on the size of positions

    with specific counterparties. It does not prohibit limits tied to

    executing firms. Moreover, it specifically provides that overall

    position limits are permissible. Thus, there is no conflict between

    Sec. 1.72(c) and Sec. 1.73.

    The Commission also does not believe that the broad requirements of

    the recently-promulgated Sec. 23.600 make proposed Sec. 1.73

    redundant. Section 23.600 sets out broad principles applicable to all

    SDs and MSPs. As proposed, Sec. 23.609 would apply only to those SDs

    and MSPs that are clearing members of a DCO. The Commission believes

    that if an SD or MSP takes on the additional risks and responsibilities

    of clearing, it should undertake risk management procedures similar to

    those undertaken by clearing FCMs for their proprietary accounts.

    Clearing members pose risks to DCOs and users of DCOs that are not

    posed by SDs and MSPs that are not clearing members.

    V. Effective Dates

    A. Summary of Comments

    Arbor, Citadel, and Eris urged the Commission to prioritize the

    entire rule in the final rulemaking process.

    The Banks, DB, EEI, and ISDA commented that the Commission should

    not rush this proposal.

    Wells Fargo commented that the Commission should delay compliance

    until most industry systems meet the real-time acceptance standard. LCH

    requested that the Commission delay compliance for 9 months, if the

    rules are adopted as proposed. AllianceBernstein commented that the

    Commission's recently proposed phased implementation provides ample

    time for the market to make final preparations, and no ``interim''

    execution documentation arrangements are necessary. Morgan Stanley

    stated that real-time clearing and risk limit compliance verification

    cannot be developed quickly enough to abandon trilateral agreements.

    B. Discussion

    This rulemaking includes rules applicable to FCMs, SDs, MSPs, DCMs,

    SEFs, and DCOs. In addressing implementation, it is important to

    distinguish between FCMs, DCMs, and DCOs, on the one hand, and SDs,

    MSPs, and SEFs, on the other.

    FCMs, DCMs, and DCOs are currently involved in clearing swaps.

    Entity definitions are not necessary for them. Product definitions are

    not necessary for the implementation of the rules applicable to them.

    The products currently being cleared as swaps by DCOs are commonly

    characterized as such by market participants. To delay implementation

    of these rules pending implementation of the further product definition

    rules would be to deny market participants pricing, operational, and

    risk-management benefits unnecessarily.

    No firms are currently registered as SDs, MSPs, or SEFs. Therefore,

    the rules applicable to these entities will have no practical effect

    until other rulemakings are completed, such as the further entity

    definition rulemaking. Nevertheless, many entities currently expect to

    operate as SDs, MSPs, or SEFs, regardless of the precise contours of

    the entity definitions. It would be more efficient for such entities,

    particularly those that are currently active in the

    [[Page 21291]]

    markets, to develop their systems and procedures in anticipation of

    being subject to these rules as soon as they become applicable. Indeed,

    failing to take such measures would disadvantage those that did not

    prepare for the imminent regulatory framework. This approach would also

    avoid temporary gaps or discrepancies in the system of rules addressing

    client clearing documentation, trade processing, and clearing member

    risk management resulting from differing implementation schedules for

    various entities.

    As discussed above, the Commission believes that implementation of

    these rules is essential to effective clearing of swaps. The Commission

    has determined that for FCMs, DCMs, and DCOs, these rules shall become

    effective October 1, 2012. For SDs and MSPs, these rules shall become

    effective on the later of October 1, 2012, or the date that the

    registration rules become effective.\55\ For SEFs, these rules shall

    become effective on the later of October 1, 2012, or the date that the

    rules implementing the core principles for SEFs become effective.\56\

    The Commission believes that this approach strikes an appropriate

    balance between those commenters who urged implementation as quickly as

    possible and those who urged delayed implementation.

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

    \55\ Registration of Swap Dealers and Major Swap Participants,

    77 FR 2613 (Jan. 19, 2012).

    \56\ Core Principles and Other Requirements for Swap Execution

    Facilities, 76 FR 1214 (Jan. 7, 2011).

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

    VI. Consideration of Costs and Benefits

    Introduction

    CEA Section 15(a) requires the CFTC to consider the costs and

    benefits of its action before promulgating a regulation under the CEA,

    specifying that the costs and benefits shall be evaluated in light of

    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.\57\ To the extent that these final regulations repeat

    the statutory requirements of the Dodd-Frank Act, they will not create

    costs and benefits beyond those resulting from Congress's statutory

    mandates in the Dodd-Frank Act. However, to the extent that the

    regulations reflect the Commission's own determinations regarding

    implementation of the Dodd-Frank Act's provisions, such Commission

    determinations may result in other costs and benefits. It is these

    other costs and benefits resulting from the Commission's determinations

    pursuant to and in accordance with the Dodd-Frank Act that the

    Commission considers with respect to the Section 15(a) factors.

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

    \57\ 7 U.S.C. 19(a).

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

    The regulations contained in this Adopting Release were proposed in

    four separate notices of proposed rulemaking (``NPRMs''). Sections

    1.72, 1.74, 23.608, 23.610, 39.12(a)(1)(iv), and 39.12(b)(7) were

    proposed in Customer Clearing Documentation and Timing of Acceptance

    for Clearing,\58\ sections 23.506, 37.702(b), and 38.601(b) were

    proposed in Requirements for Processing, Clearing, and Transfer of

    Customer Positions,\59\ sections 1.73 and 23.609 were proposed in

    Clearing Futures Commission Merchant Risk Management,\60\ and 1.35(a-

    1)(5)(iv) was proposed in Adaptation of Regulations to Incorporate

    Swaps.\61\ The Commission is finalizing the rules contained in this

    Adopting Release together because they address three overarching,

    closely-connected aims: (1) Non-discriminatory access to counterparties

    and clearing; (2) straight-through processing; and (3) effective risk

    management among clearing members. Each of these provides substantial

    benefits for the markets and market participants.

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

    \58\ See 76 FR 45730 (Aug. 1, 2011).

    \59\ See 76 FR 13101 (Mar. 10, 2011).

    \60\ See 76 FR 45724 (Aug. 1 2011).

    \61\ See 76 FR 33066 (Jun. 6, 2011).

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

    The regulations related to non-discriminatory access concern

    customer clearing documentation. Specifically, they prohibit FCMs, SDs,

    MSPs, and DCOs from entering into agreements, including those known in

    the industry as ``trilateral agreements,'' with terms restricting an

    FCM's customer's ability to access all willing counterparties in the

    market and obtain a swap on reasonably competitive terms.\62\ Open

    access, unrestrained by contractual terms of this type, is critical to

    the efficiency and financial integrity of the swap markets.

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

    \62\ See Sec. Sec. 1.72, 23.608, and 39.12(a).

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

    This first set of rules is designed to avoid the undesirable

    consequences likely to result from trilateral agreements, which include

    limits on the range of eligible counterparties with whom market

    participants can transact, reduced competition for customers' business,

    fragmentation of customers' trading limits at the FCM, and distorted

    price discovery.\63\ Reduced competition in this context may lead to

    wider spreads, higher transaction fees (i.e., increased costs for

    customers), and reduced market efficiency. Moreover, limiting a market

    participant's access to less than all willing counterparties, including

    those offering trades on terms approximating the best available in the

    market could undermine price discovery, and market efficiency. The

    first cluster of rules seeks to mitigate these problems through

    provisions fostering open access to all available counterparties and

    democratized access to clearing services. To that end, it prevents

    FCMs, SDs, MSPs, and DCOs from entering into any agreement that would:

    (a) Disclose the identity of a customer's original executing

    counterparty to the FCM, SD, or MSP; (b) limit the number of

    counterparties available to the customer; (c) set any limits on the

    size of position a customer may take (other than the general limit

    established by their FCM); (d) impede a customer's access to trades

    that approximate the best terms available; or (e) prevent compliance

    with timeframes for processing swaps that are required by other parts

    of these rules.

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

    \63\ Trilateral agreements were introduced in June 2011. On

    August 1, 2011 the Commission issued the NPRM of this rule

    prohibiting certain terms that are central to the trilateral

    agreements and as a consequence, adoption of the agreements thus far

    has been extremely limited.

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

    A second group of regulations mandates straight-through

    processing--rapid processing of swap transactions, including rapid

    submission to the DCO for acceptance or rejection from clearing--for

    swaps required to be cleared or that the counterparties elect to clear.

    In this regard, the regulations impose requirements on FCMs, SDs, MSPs,

    DCMs, SEFs, and DCOs that, taken together, are designed to ensure that

    counterparties know whether a swap will be accepted for clearing at, or

    soon after, the time of execution which is a critical condition for

    eliminating counterparty risk that undermines democratized access to

    the swap markets.\64\ When two parties enter into a bilateral swap

    transaction with the intention of clearing a swap, each party bears

    counterparty risk with respect to the other until the swap enters

    clearing. Once the swap enters clearing, the clearinghouse becomes the

    counterparty to each side of the trade, which minimizes and

    standardizes counterparty risk.To the extent that there is a period of

    time between execution and clearing, counterparty risk may develop as

    post-execution market movements impact the swap's value and each party

    could face significant costs if the swap is

    [[Page 21292]]

    eventually rejected from clearing and subsequently broken. Both

    counterparties run the risk that they may have to replace the swap

    under different, less desirable terms if the market has moved against

    them during the intervening time. In addition, SDs, whether providing

    liquidity to a non-SD or SD counterparty, may have to unwind or offset

    any positions they have taken on to hedge the original swap; this can

    also be costly, again, particularly if the market has moved against

    them since the execution of the original swap. Bilateral agreements

    typically address such ``breakage'' costs, but the effectiveness of

    those provisions could be compromised if either counterparty is

    unwilling or unable to make the other whole for losses. Such costs are

    potentially significant, particularly when the markets are volatile and

    the latency period is long, giving SDs an incentive to discriminate

    among counterparties on the basis of their credit quality. To mitigate

    those costs and promote more democratized access to the markets, it is

    critical that executed swap transactions be accepted or rejected from

    clearing quickly.

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

    \64\ See Sec. Sec. 1.35, 1.74, 23.506, 23.610, 37.702, 38.601,

    and 39.12(b) of the Commission's regulations.

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

    These rules contain several requirements that are designed to

    ensure that swaps are processed and accepted or rejected promptly from

    clearing, including requirements that FCMs, SDs, MSPs, SEFs, DCMs, and

    DCOs coordinate with one another to ensure they have the capacity to

    accept or reject trades ``as quickly as technologically practicable if

    fully automated systems were used.'' For trades executed on a DCM or

    SEF, the Commission anticipates that processing and submitting a trade

    for clearing would be near real-time, thus substantially eliminating

    the potential for significant counterparty risk accumulation during the

    latency period. For trades that are not executed on an exchange, but

    are required to be cleared, the rules require submission for clearing

    ``as soon as is technologically practicable after execution'' but no

    later than by the close of business on the day of execution. Similarly,

    swaps not executed on an exchange and for which clearing is elected by

    the counterparties (but not required by law) must also be submitted for

    clearing as soon as technologically practicable, but not later than the

    day following the latter of execution or the decision to clear.

    The Commission expects that these rules requiring coordination to

    ensure rapid processing and acceptance or rejection of swaps for

    clearing will be beneficial in several respects. First, they will

    promote rapid adoption in the market of currently existing technologies

    that will make possible near real-time processing of exchange traded

    swaps. For trades that are pre-screened, or executed on an exchange,

    this will virtually eliminate counterparty credit risks associated with

    clearing rejection. The rules will also significantly reduce the amount

    of time needed to process swaps that are not traded on an exchange;

    although costs associated with latency-period counterparty credit risk

    cannot be completely eliminated in this context, the rules will

    substantially reduce the need to discriminate among potential

    counterparties in off-exchange trades, as well as the potential costs

    associated with rejected trades. By reducing or eliminating the

    counterparty risk that could otherwise develop during the latency

    period, these rules promote a market in which all eligible market

    participants have access to counterparties willing to trade on terms

    that approximate the best available terms in the market. This rule may

    improve price discovery and promote market integrity.

    The third set of rules in this Adopting Release requires that FCMs,

    SDs, and MSPs who are clearing members of a DCO implement sound risk

    management practices that help ensure their financial strength. A DCO's

    financial strength depends on the continued financial strength of its

    clearing members. The Commission believes that requiring clearing

    members to engage in certain risk management procedures will provide

    additional assurance of their ability to meet their financial

    obligations to their respective DCOs, particularly in times of market

    stress.

    The third group of rules in this Adopting Release therefore

    requires clearing members to establish overall risk-based position

    limits for their proprietary trading accounts and each of their

    customer accounts, and to screen trades for compliance with those

    limits. The rules also require clearing members to monitor for

    adherence to such risk-based position limits, both intra-day and

    overnight; to conduct rigorous stress tests on significant accounts at

    least once per week; to evaluate their ability to meet initial and

    variation margin requirements at least once per week; to evaluate the

    probable cost of liquidating various accounts at least once per month;

    to test all lines of credit at least once per year; and to establish

    procedures and records that ensure and verify their compliance with

    these requirements. Many of these requirements reflect common practices

    for clearing members. These rules promote consistent use of risk

    management best practices among clearing members, while also allowing

    flexibility to encourage innovation and adaptation to the specific

    operating requirements of diverse clearing members. The Commission

    anticipates that the requirements themselves will help to ensure that

    clearing members and their respective DCOs remain financially sound

    during periods of market stress. Moreover, the Commission believes that

    the flexibility these requirements allow will minimize attendant costs

    and enable members to adapt their risk management practices to new

    market demands and develop more effective strategies for monitoring and

    managing risk.

    In the sections that follow, the Commission evaluates the costs and

    benefits relevant to each of the three groups of rules pursuant to

    Section 15(a) of the CEA. Each section specifically addresses the

    individual Section 15(a) factors with respect to the rule group and

    responds to comments pertaining to that group. In its analysis, the

    Commission has endeavored, where possible, to quantify costs and

    benefits. However, the costs and benefits are either indirect, highly

    variable, or both and therefore are not subject to reliable

    quantification at this time. Nevertheless, the Commission has

    considered all the comments received, a broad range of costs and

    benefits pertaining to democratized swap market access, improvements

    and challenges in risk management, development and implementation of

    necessary technology, market liquidity, and several others as detailed

    below.

    Cost Benefit Consideration by Rule Group

    1. Customer Clearing Documentation

    Sections 1.72, 23.608, and 39.12(a)(1)(vi) restrict FCMs, SDs and

    MSPs, and DCOs, respectively, from entering into any arrangements that

    would (a) disclose the identity of a customer's original executing

    counterparty to any FCM, SD, or MSP; (b) limit the number of

    counterparties with whom a customer may trade; (c) restrict the size of

    a position that the customer may take with any individual counterparty

    apart from the overall limit for all positions held by the customer at

    the FCM; (d) limit a customer's access to trades on terms that have a

    reasonable relationship to the best terms available; or (e) prevents

    compliance with other regulations requiring rapid processing and

    acceptance or rejection from clearing.

    The Commission believes that these rules proscribe certain terms in

    trilateral agreements that were proposed by some

    [[Page 21293]]

    SDs and FCMs. However, the Commission notes that trilateral agreements

    were not used in swap markets prior to June 2011. SDs historically have

    provided liquidity and managed risk without the use of trilateral

    agreements, and the Commission understands that such agreements have

    not yet been widely adopted. Therefore, it is unlikely that these

    rules, by preventing certain terms in trilateral agreements, will cause

    widespread changes in current market practices for managing

    counterparty risk or for negotiating bilateral agreements.\65\

    Moreover, the rules adopted in this Adopting Release will enhance risk

    management in other ways, obviating any perceived need for terms in

    trilateral agreements that can harm market competitiveness, efficiency,

    and price discovery. In that context, the Commission concludes that

    these changes are justified.

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

    \65\ To the extent that changes will occur, the costs attendant

    to them are indirect and cannot be estimated without data that is

    not available at this time.

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

    a. Protection of Market Participants \66\ and the Public

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

    \66\ The term ``market participants'' as it is used throughout

    the cost benefit considerations section includes SDs, MSPs, FCMs,

    and the customers of FCMs (i.e., SD, MSP, and non-SD/MSP swap

    counterparties).

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

    The Commission is concerned that by giving FCMs the ability to

    establish and communicate sub-limits on the positions a specific SD may

    clear with a specific customer, the trilateral agreements may allow

    FCMs to influence the amount of business that a customer conducts with

    specific counterparties, or to constrain the number or choice of

    counterparties with whom a customer is able to trade. This concern is

    amplified because a number of FCMs have affiliated SDs who (along with

    other SDs with whom the FCM-affiliated SD competes for swap transaction

    business) are potential counterparties to the FCM's customers. To the

    extent that FCMs could use terms in trilateral agreements to influence

    a customer's choice from among potential SD counterparties, the

    agreements could provide a means for FCMs to direct business toward an

    associated SD (or to raise the cost of doing business with an

    unassociated SD) to the diminution of competition to provide swap

    liquidity generally; in this way, the agreement may work to the

    disadvantage of those market participants that might benefit from

    better competition. Moreover, by limiting a customer's range of

    potential counterparties and the size of positions that may be entered

    with specific counterparties, the FCM establishes a condition that in

    some circumstances could preclude matching of the customer's order with

    the counterparty that is willing to provide the best available terms in

    the market at that time. This sub-optimal outcome increases costs for

    the customer, and any systematic increases in costs to the customer

    will indirectly impact prices that the public ultimately pays for

    related goods and services.

    In addition, such limitations also impose costs on potential

    counterparties who are prevented from trading with customers by

    restrictions in the trilateral agreements. If those counterparties are

    dealers, they lose the opportunity to win that customer's business. If

    those counterparties are non-dealers, they lose the liquidity that

    would have otherwise been available to them as a consequence of the

    customer's need to execute a swap. Last, an FCM could, intentionally or

    unintentionally, signal to the market information about the customer

    through designation notices. For example, clearing members may be more

    likely to reduce a customer's limits during a time of market stress.

    Communicating reductions on various sub-limits to potential SD

    counterparties may signal (perhaps wrongly) that the credit quality of

    the customer is deteriorating. This signal could make it more difficult

    for the customer to transact at a time when their ability to transact

    is particularly critical.

    These potential costs to customers and the public will be

    forestalled or altogether eliminated by these rules. These benefits,

    however, are unquantifiable for several reasons. First, many of the

    potential costs and benefits associated with trilateral agreements are

    indirect and dispersed to a degree that they would be difficult to

    estimate even if there were ample data available. Second, ample data is

    not available. The Commission does not have any data that characterizes

    pricing, liquidity, or other important variables in the presence and

    absence of trilateral agreements. Last, trilateral agreements were

    introduced in mid-June 2011, and the Commission believes that adoption

    of trilateral agreements thus far has been extremely limited. Further,

    the Commission believes that the NPRM of this rule, which was released

    a few weeks after trilateral agreements were introduced, may be a

    primary factor deterring rapid adoption of these agreements.\67\ To the

    extent that this is correct, the current rate of adoption and impact on

    the market is unlikely to be a reflection of what the impact of

    trilateral agreements would be in the absence of this rule. In other

    words, even if the Commission had the data necessary to estimate the

    current impact of trilateral agreements (which it does not), those

    estimates would not accurately reflect the potential impact of these

    agreements. However, by prohibiting contractual terms that would limit

    the number of potential counterparties, set sub-limits on a customer's

    positions, or restrict a customer's access to terms reasonably related

    to the best terms available in the market, these rules provide

    significant protection to market participants.

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

    \67\ See 76 FR 45730, Aug. 1, 2011.

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

    With respect to the customer-identity nondisclosure requirement,

    several commenters stated that protecting anonymity is critical as a

    condition for open, efficient, and competitive swap markets.\68\

    Maintaining the anonymity of a customer's counterparty prevents the

    clearing member from sharing with any affiliated SDs competitively

    sensitive information about its customers' counterparties--who may be

    competitors and/or subsequent swap counterparties to the affiliated

    SD--that affiliated SDs can use for their own gain (and that of the SD/

    FCM affiliate group). This rule, together with the rule that prevents

    FCMs from establishing sub-limits, prohibits arrangements that allow

    FCMs to share competitively sensitive information that could undermine

    competition to provide swap liquidity--including information that

    provides transparency into customer swap positions and exposures. In so

    doing, the rules better protect those swap counterparty market

    participants that benefit from greater competition (e.g., as may be

    reflected in improved bid/ask spreads) to provide the desired swaps.

    The value of such protection would vary depending on the specific type

    and timing of information that is communicated as well as the role and

    incentives of the entity receiving that information relative to the

    entity about which the information is disclosed. These factors are

    highly variable and impracticable to quantify, and, as a consequence,

    the Commission does not have adequate information to reasonably

    estimate the additional costs that might be caused by such disclosures,

    or the value of preventing such costs.

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

    \68\ See MFA, Arbor, SIFMA, D. E. Shaw, AIMA, and Vizer.

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

    In addition, SDs, FCMs, and FCM customers may soon expend resources

    negotiating trilateral agreements. By prohibiting certain provisions

    from inclusion in trilateral agreements, these rules reduce the

    likelihood that SDs, FCMs, and customers will enter into them. To the

    extent that this occurs,

    [[Page 21294]]

    SDs, FCMs, and customers will save the substantial costs that otherwise

    would be required to negotiate such agreements.\69\ Vanguard, for

    example, estimates that, if it was forced by SDs to implement

    trilateral agreements, it may have to negotiate and enter into

    approximately 4,800 new trilateral agreements per year.\70\ In

    addition, those agreements would create significant administrative and

    ongoing legal costs associated with review, periodic update, and, for

    customers, compliance to monitor their own activities. Some commenters

    suggested that the resources necessary to create and administer

    trilateral agreements would divert resources from implementing market

    infrastructure that is necessary to facilitate straight through

    processing.\71\

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

    \69\ See AllianceBernstein, Citadel, D. E. Shaw, MFA, SIFMA, and

    Vanguard.

    \70\ See Vanguard.

    \71\ See e.g., Citadel, Alliance Bernstein, and MFA.

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

    The Commission recognizes that prohibiting certain arrangements

    that are currently in trilateral agreements may increase counterparty

    risks (costs) that SDs face due to the possibility that swaps they

    enter could be rejected from clearing. Trilateral agreements are

    intended to increase the degree of the SD's certainty that trades with

    certain customers and within certain limits will be accepted for

    clearing. The prohibitions contained in the first group of rules are

    likely to prevent SDs from using trilateral agreements in this way,

    creating certain potential costs for the SDs who have established

    trilateral agreements with some of their customers and the customers'

    FCMs.\72\ However, as noted above, there are also significant costs

    associated with trilateral agreements. Moreover, in the Commission's

    judgment, provisions contained within the second cluster of rules

    (i.e., rules pertaining to straight-through processing) will mitigate

    the potential costs to SDs and other market participants substantially.

    More specifically, as discussed below, the second group of rules

    mitigates costs associated with pre-clearing-approval counterparty risk

    through straight-through-processing requirements; the Commission

    anticipates these rules will drive rapid implementation of existing

    market technology to substantially narrow the window of counterparty

    risk for SDs between execution and clearing acceptance/rejection.

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

    \72\ These costs, if compared against the baseline of current

    market practice, depend on the extent to which trilateral agreements

    containing terms proscribed in these rules are currently being used.

    Based on anecdotal feedback from market participants, the Commission

    believes that trilateral agreements have not yet been widely

    adopted. Moreover, as suggested above, the Commission believes that

    requiring more rapid swap processing and clearing determinations

    will offset these costs, diminishing them significantly over time.

    However, the Commission does not have sufficient data regarding the

    number of trilateral agreements currently in place, or the number

    and terms of swap transactions that they impact, to estimate these

    costs.

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

    Moreover, commenters have suggested that in certain circumstances,

    the sub-limits associated with trilateral agreements may actually

    exacerbate the counterparty risk problem by delaying processing and

    increasing the latency period during which counterparty exposure

    develops.\73\ If a customer enters a swap with an SD without a

    trilateral agreement in place, the FCM may need to check with and

    adjust the limits of various SDs who do have trilateral agreements set

    up with that customer before making a clearing determination. The

    administrative requirements of these steps could delay clearing. By

    prohibiting agreements that create such delays, the rules reduce the

    latency period for some transactions, which also reduces the amount of

    counterparty risk that can develop during that period.

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

    \73\ See e.g., AIMA, SIFMA, Vanguard, and MFA.

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

    Notwithstanding the inability to quantify in dollar terms the costs

    of this change in risk avoidance and mitigation practice, in the

    Commission's judgment the change is justified by the critical benefits

    that the rules provide regarding open access to, and democratization

    of, swap markets.

    b. Efficiency, Competitiveness and Financial Integrity of Markets

    These rules specifically prohibit any agreement that would limit a

    customer's potential available counterparties. This prohibition

    encourages competition among SD counterparties for the customer's

    business, which is likely to reduce spreads and promote the customer's

    ability to obtain swap positions on terms approaching or equaling the

    best available terms in the market at that time. Accordingly, the

    Commission expects the spreads and terms under which customers are able

    to obtain swaps to improve when compared with a situation in which

    customers' range of potential counterparties is constrained by

    counterparty-specific sub-limits established by the FCM. It is possible

    that the effect of greater competition on spreads and terms may be

    mitigated by the impact of increased risk to the dealers, which is also

    likely to impact spreads and terms. However, the Commission believes

    that the latter effects will be minimized and diminish over time as the

    processing of trades becomes more rapid.

    As suggested above, counterparty-specific sub-limits increase

    expenses related to monitoring and administrative requirements, and

    commenters have stated that in some circumstances trilateral agreements

    may actually slow swap processing. The prohibitions contained in these

    rules will prevent such arrangements, thereby leading to greater swap

    processing speed in those circumstances.

    c. Price Discovery

    If certain customers are prevented from accessing swaps on terms

    that approximate the best available terms in the market at that time,

    and then the terms of that trade are reported in real time, it risks

    sending misleading signals to the market about the price at which

    certain swaps are available. This result has the potential to undermine

    price discovery. The prohibitions in these rules will help ensure that

    customers in the market can access trades on approximately the best

    terms available in the market, both in general by prohibiting

    agreements that would prevent such an outcome, and more specifically by

    prohibiting any (1) agreements that would limit the number of

    counterparties with whom a customer may trade, and (2) counterparty-

    specific sub-limits on the customer's positions.

    d. Sound Risk Management Practices

    By ensuring that customers are able to trade with all willing

    counterparties in the market, the rules promote greater liquidity

    available to the customer and to potential counterparties, which makes

    it more likely they will be able to enter swaps and offset positions as

    needed. This result is important for maintaining effective offsetting

    positions as underlying positions change. Moreover, greater liquidity

    may push transaction costs downward, which enables market participants

    to execute their risk management strategies in a more cost-effective

    manner.

    To the extent that prohibiting certain terms typical of trilateral

    agreements will reduce an SD's certainty about whether the swap will be

    cleared, it may increase the SD's risk management costs. However, as

    noted above, trilateral agreements did not appear until June 2011,

    which suggests that SDs are capable of managing their risks effectively

    in the absence of certain terms contained in those agreements. For

    example, SDs conduct due diligence in order to evaluate their

    counterparty's credit-worthiness, and may choose to negotiate terms in

    the bilateral agreement that determine what

    [[Page 21295]]

    obligations each counterparty has in the event that a swap should be

    rejected from clearing. SDs may have to adjust their risk management

    strategies for the possibility that their counterparty may not be able

    to meet the terms of the bilateral agreement if the trade is rejected.

    If such bilateral agreements provide that the swap will be terminated

    when rejected from clearing, the dealer may have to unwind or offset

    certain aspects of positions that they have taken to offset the

    original position. The Commission anticipates that SDs will account for

    these potential additional costs in the terms and pricing of the swaps

    they offer. In most cases, however, the risk management strategies

    described above reflect current market practice. Therefore, much of the

    costs associated with those practices are not a function of these

    rules. Last, these potential costs will be mitigated by faster

    processing, and, in cases where prescreening or near real-time post-

    execution screening are possible, eliminated.\74\

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

    \74\ Several commenters pointed out that in an environment where

    real-time clearing determinations are made, bilateral execution

    agreements are not necessary. As evidence, commenters pointed to

    Clearport, Globex, and WebICE. Each of these platforms facilitate

    real-time clearing determinations, and each does so without

    bilateral execution agreements. See e.g., SDMA and Javelin.

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

    Some SDs have posited that market liquidity for some customers may

    decrease because SDs will not provide swaps to counterparties whose

    credit quality is lower unless a trilateral agreement is executed. The

    Commission recognizes that any factor that undermines SDs' confidence

    that swaps will be cleared may cause them to avoid certain trades or to

    increase the price at which they are willing to offer swaps to certain

    counterparties. However, because SDs have been providing liquidity to

    market participants for years in the absence of trilateral agreements,

    and adoption of such agreements is not yet widespread, the Commission

    does not believe that preventing certain provisions of these agreements

    will significantly reduce liquidity in swap markets. Moreover, certain

    aspects of these rules, such as requirements for rapid swap processing

    and clearing determinations, are likely to promote additional liquidity

    by reducing the counterparty risk that could develop for SDs between

    the time of execution and clearing.\75\

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

    \75\ See section 2, Timing of Acceptance of Trades for Clearing,

    below.

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

    e. Other Public Interest Considerations

    The Commission has not identified additional public interest

    considerations beyond those discussed above.

    f. Response to Comments

    Several commenters noted that the benefits of the proposed rules

    include: reduced systemic risk; \76\ reduced barriers to entry and

    greater competition among liquidity providers, clearing members, and

    execution venues; \77\ enhanced market depth and liquidity; \78\

    substantially reduced transaction costs; \79\ narrower bid-ask spreads;

    \80\ and increased access to best execution via the freedom to execute

    with any counterparty in the market.\81\ D. E. Shaw and MFA commented

    that the proposed rules would preserve anonymity among trading

    participants, and facilitate the development of electronic trading and

    central limit order books.

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

    \76\ See AllianceBernstein, Arbor, CBA, CIEBA, Citadel, D. E.

    Shaw, and MFA.

    \77\ See AllianceBernstein, Arbor, Citadel, D. E. Shaw, and MFA.

    \78\ Id.

    \79\ See AllianceBernstein, Arbor, and CIEBA.

    \80\ See AllianceBernstein, Citadel, D. E. Shaw, and MFA.

    \81\ See AllianceBernstein, Citadel, D. E. Shaw, and MFA.

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

    Additionally, several commenters remarked that without the final

    rules, the framework for trilateral agreements would substantially

    increase costs for market participants.\82\ AllianceBernstein suggested

    that without the proposed rules, resources would be diverted from

    forward-looking technological solutions for clearing certainty, and

    instead used to prop-up legacy systems for credit intermediation.\83\

    Vanguard stated that the trilateral agreement will introduce

    significant costs and delays to the timeline for swaps clearing

    implementation because parties will be forced to execute a myriad of

    documents as a pre-condition to clearing and trading.

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

    \82\ See AllianceBernstein, Citadel, D. E. Shaw, MFA, SIFMA, and

    Vanguard.

    \83\ See also MFA, Citadel.

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

    Moreover, multiple commenters stated that while they are generally

    loathe to encourage regulations that interfere with private contracts

    between two parties, they believe that the undesirable consequences of

    trilateral agreements, such as limiting a customer's choice of

    counterparties and trading venues, impairing their access to the best

    terms available, the potential for anticompetitive effects, creating

    barriers to entry for new liquidity providers, delaying adoption of

    technology that will enable real time processing and clearing

    determinations, and precluding anonymity that is a necessary condition

    for trading on central limit order books, justify these rules.\84\ In

    this vein commenters maintained that the largest SDs have sufficient

    power deriving from their role as swap liquidity providers to coerce at

    least some market participants into signing ``optional'' trilateral

    agreements, and expressed concern that the agreement could rapidly

    become an industry standard despite the resistance of buy-side

    firms.\85\ The Commission agrees that it is necessary, in this case, to

    establish rules that prevent trilateral agreements from being used to

    limit open and competitive swap markets.

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

    \84\ See SDMA, AIMA, Trading Firms, MFA, Arbor, DRW, and

    Jeffries.

    \85\ See AIMA, Trading Firms, CIEBA, Citadel.

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

    In supporting the use of trilateral agreements some commenters have

    suggested that they are analogous to the FIA/FOA sponsored

    International Uniform Brokerage Execution Services (``Give-Up'')

    Agreement (``Futures Give-Up Agreement''), which is used in the futures

    markets. The Futures Give-Up Agreement is between an executing broker,

    clearing broker, and customer, and allows the clearing broker to

    ``place limits or conditions on the positions it will accept for the

    give-up for customer's account.'' \86\ Commenters expressed the opinion

    that the risks faced by executing brokers and clearing firms in futures

    markets are substantially similar to the risks faced by SDs and

    clearing members in the swap markets, and therefore the use of

    trilateral agreements should be acceptable.\87\

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

    \86\ See Morgan Stanley, FIA/ISDA, Banks.

    \87\ See Morgan Stanley.

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

    However, the Commission is not persuaded that the points of

    similarity between Futures Give-Up Agreements and trilateral agreements

    provide sufficient evidence to demonstrate that the latter may be used

    in swap markets without adverse effects on market participants as

    discussed above. The two types of agreements are distinguishable in

    important respects. The parties to a Futures Give-Up Agreement include

    a customer and two brokers acting on behalf of the customer. The

    parties do not include the customer's trading counterparty in the

    relevant transaction. Moreover, Futures Give-Up Agreements do not: (a)

    Disclose the identity of a customer's original executing counterparty

    to any FCM, SD, or MSP; (b) limit the number of counterparties with

    whom a customer may trade; (c) restrict the size of a position that the

    customer may take with any individual counterparty apart

    [[Page 21296]]

    from the overall limit for all positions held by the customer at the

    FCM; (d) limit a customer's access to execution of trades on terms that

    have a reasonable relationship to the best terms available; or (e)

    prevent compliance with other regulations requiring rapid processing

    and acceptance or rejection from clearing.

    Some commenters suggested that by specifying the types, size, and

    volume of trades that they are willing to engage in with certain

    customers, trilateral agreements help increase the range of

    counterparties with whom SDs are willing to trade.\88\ There is not

    sufficient data available to the Commission to evaluate these

    assertions, and commenters did not provide any data to support them.

    The Commission acknowledges that factors reducing an SD's certainty

    about whether a swap will be cleared could prompt it to limit its

    business with certain counterparties or to change the terms under which

    it offers swaps to certain counterparties, but the trilateral

    agreements could also constrain either the range of counterparties with

    whom an SD is willing to trade, the size of positions it is willing to

    offer to certain counterparties, or both.\89\ In other words, while

    some commenters are concerned that prohibiting certain terms in

    trilateral agreements may constrain liquidity, the Commission

    recognizes that trilateral agreements also constrain liquidity. It is

    not knowable at this time which force is likely to have the greater

    constrictive effect on the liquidity that an SD is willing to provide

    to certain counterparties. Moreover, as stated above, some aspects of

    these rules, including the straight-through-processing and risk

    management provisions, are likely to substantially reduce, if not

    eliminate, SD latency exposure and encourage SDs to provide greater

    liquidity. Accordingly, in the Commission's judgment, proscribing

    certain terms of trilateral agreements (with their negative

    implications for competition, efficiency and price discovery) is the

    preferable approach from a systemic standpoint to promote liquidity.

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

    \88\ See Morgan Stanley, UBS, and EEI.

    \89\ The first page of the FIA-ISDA Cleared Derivatives

    Execution Agreement states that ``EXECUTION PARTIES MAY REQUEST THAT

    A FORM OF THIS AGREEMENT (OR THE ANNEXES HERETO) BE EXECUTED AS A

    CONDITION TO ENTERING INTO TRANSACTIONS INTENDED TO BE CLEARED.''

    See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf.

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

    Commenters opposed to the rules stated that prohibiting trilateral

    agreements would require buy-side and sell-side firms to subject

    themselves to risks that they do not face today and would make it

    necessary for dealers to expend resources negotiating bilateral

    agreements with customers and evaluating the customer's credit prior to

    executing a transaction.\90\ However, this would only be true to the

    extent that trilateral agreements are (1) being used today to mitigate

    certain risks, and (2) make it unnecessary to negotiate bilateral

    agreements and evaluate a customer's counterparty risk. As stated

    above, the Commission believes that trilateral agreements are not

    widely used at this time and, thus, are providing dealers risk

    protection only to a limited extent. Moreover, it does not appear that

    trilateral agreements obviate the need to negotiate what might happen

    in the event of breakage; the Commission, therefore, does not believe

    that prohibiting certain provisions of trilateral agreements is likely

    to significantly impact the expenses associated with bilateral

    agreements.\91\

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

    \90\ See Banks, Morgan Stanley.

    \91\ See http://www.futuresindustry.org/downloads/ClearedDerivativesExecutionAgreement_June142001.pdf. The trilateral

    agreement template includes terms dictating what happens in the

    event that a swap is rejected from clearing. The CFTC believes,

    therefore, that these terms are likely negotiated and addressed even

    where trilateral agreements are used.

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

    Furthermore, commenters opposed to the rules stressed that the

    trilateral agreements are optional.\92\ They also noted that the

    trilateral agreements ``do not affirmatively limit'' a customer's

    ability to trade with willing counterparties or prohibit dealers and

    customers from entering positions greater than the sub-limit

    established by the FCM.\93\ However, even in the absence of

    ``affirmative'' limitations, the agreement may have much the same

    effect. Some commenters stated that certain dealers have expressed

    unwillingness to continue providing swaps to certain customers if they

    did not sign a trilateral agreement; the agreement itself contemplates

    this possibility.\94\ The Commission's concern with conduct of this

    type is heightened by information suggesting that a relatively small

    number of dealers provide a significant amount of swap liquidity

    available.\95\ Under these circumstances, each dealer that refuses to

    offer swaps in the absence of a trilateral agreement may significantly

    reduce liquidity available to a customer. Absent sufficient competition

    to provide liquidity, dealers may be able to impose restrictive,

    undesirable trilateral agreement terms on customers.

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

    \92\ See FIA/ISDA.

    \93\ See Morgan Stanley. See also FIA/ISDA, Banks.

    \94\ See n.71, above.

    \95\ See the OCC's Quarterly Report on Bank Trading and

    Derivatives Activities Third Quarter 2011, available at http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq311.pdf, which states, ``Derivatives activity in the

    U.S. banking system continues to be dominated by a small group of

    large financial institutions. Five large commercial banks represent

    96% of the total banking industry notional amounts and 85% of

    industry net current credit exposure.'' While the report only

    includes data related to positions held by U.S. banks, and

    incorporates derivatives that are not swaps, anecdotal evidence also

    supports the likelihood that a relatively small dealer population

    accounts for significant portions of swap liquidity.

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

    Commenters in favor of trilateral agreements suggested that concern

    about anti-competitive behavior could be addressed by allowing the

    customer to determine how their overall limit at the clearinghouse is

    allocated across potential counterparties. The Commission agrees that

    such an approach would mitigate the concern that FCMs could use

    trilateral agreements to influence a customer's choice of

    counterparties in an anti-competitive manner. However, it would not

    allow customers to take positions in excess of previously established

    sub-limits with certain counterparties without walking through the

    process of reallocating sub-limits, a process that could be time

    consuming. This result risks delay of swap processing and clearing

    determinations, or inducement of market participants to select

    suboptimal offers that comply with pre-established limits to avoid the

    delay. Such a delay could be particularly problematic in volatile

    market situations, where the ability to enter into positions quickly

    may be necessary in order to manage risk effectively.

    2. Timing of Acceptance of Trades for Clearing

    Taken as a whole, the regulations in this cluster require SEFs,

    DCMs, SDs, MSPs, and DCOs to coordinate in order to facilitate real-

    time acceptance or rejection of trades for clearing, including through

    development of the technology necessary to do so. In the case of

    cleared trades, the swaps must be processed and submitted to the DCO as

    soon as technologically practicable using fully automated systems. In

    the case of non-cleared trades, the swaps will be processed and

    submitted to the DCO as soon as is technologically practicable, but

    allows for processing to take slightly longer. More specifically:

    Regarding Clearing Members

    Sections 1.74 and 23.610 require that FCMs, and SDs and MSPs,

    respectively, coordinate with the DCO to accept or reject trades for

    clearing ``as quickly as

    [[Page 21297]]

    would be technologically practicable if fully automated systems were

    used'' and do so by one of the following methods: (1) Pre-screening

    orders; (2) enabling the DCO to screen orders using criteria

    established by the FCM, SD or MSP; or (3) setting up systems that

    enable the DCO to communicate with and receive a reply from the FCM,

    SD, or MSP as soon as would be practicable if fully automated systems

    were used.

    Section 23.506 requires SDs and MSPs to: (1) Have the capacity to

    submit swaps that are not executed on a DCM or SEF (``OTC swaps'') to

    the DCO for clearing in a way that is acceptable to the DCO; (2) work

    with the DCO to process swaps in a manner that is ``prompt and

    efficient'' and that complies with 39.12(b)(7); (3) submit bilateral

    swaps to the DCO as soon as is technologically practicable but no

    later, if it is a swap subject to mandatory clearing, than the close of

    business on the day of execution, or, if it is a swap not subject to

    mandatory clearing, no later than the end of the following business day

    from the later of execution or the date when the parties decide to

    clear.

    Section 1.35 requires that for bunched trades that are cleared,

    post-trade allocations must occur on the day of execution, so that

    clearing records properly reflect the ultimate customers. (Bunched

    trades that are cleared are not given a delay for post-trade allocation

    before being submitted for clearing.) For bunched trades that are not

    cleared, post-trade allocations must happen by the end of the day they

    are executed.

    Regarding Execution Platforms

    Section 38.601 requires that transactions executed on or through a

    DCM, other than transactions in security futures products, must be

    cleared on a DCO, and the DCM must work with DCOs to ensure ``prompt

    and efficient'' transaction processing such that the DCO can comply

    with Sec. 39.12(b)(7). Section 37.702(b) requires that SEFs coordinate

    with DCOs in order to route transactions to the DCO in a manner

    acceptable to the DCO, and to develop rules and procedures that

    facilitate prompt transaction processing in accordance with Sec.

    39.12(b)(7).

    Regarding DCOs

    Section 39.12(b)(7) requires DCOs: (1) To coordinate with SEFs and

    DCMs to develop rules and procedures that facilitate ``prompt,

    efficient, and accurate'' processing of transactions received by the

    DCO; (2) to coordinate with FCMs, SDs, and MSPs to set up systems that

    enable the clearing member or the DCO acting on its behalf to accept or

    reject trades for clearing as swiftly as if fully automated systems

    were used; (3) for trades executed on SEFs or DCMs, to establish rules

    to accept or reject trades for clearing as fast as if fully automated

    systems were used, and to accept all trades for which both executing

    parties have a clearing member, and that satisfy the criteria of the

    DCO; and (4) for trades that are not executed on SEFs or DCMs, but that

    are for contracts listed by the DCO, to satisfy requirements similar to

    those applicable to trades that are executed on SEFs or DCMs.

    a. Protection of Market Participants and the Public

    The Commission anticipates that this group of rules will provide

    significant benefits to market participants. First, by requiring that

    SEFs, DCMs, SDs, and MSPs coordinate in ways that will lead to faster

    processing and acceptance or rejection of swaps for clearing, the rules

    reduce the latency period during which counterparty risk can accumulate

    for parties who have executed a swap that they intend to clear. If,

    following a long latency period, the swap is rejected from clearing and

    is cancelled as a consequence, the SD will be forced to recoup breakage

    costs from their counterparty to the extent that their bilateral

    agreement provides and their counterparty is able to meet the terms of

    that agreement; the SD also may need to unwind or offset any position

    it has established, potentially at a loss. SDs have pointed out that

    the size of many swap transactions, as well as the illiquidity and

    volatility of these markets, create the potential for these risks to be

    substantial,\96\ so by reducing the time between execution and

    clearing, these rules provide considerable benefits to SDs. Moreover,

    for swaps where real-time acceptance or rejection from clearing occurs,

    the latency period, and the potential for post-execution termination

    costs, is eliminated.

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

    \96\ SDs, however, did not provide estimates of or seek to

    quantify such risks.

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

    Likewise, non-SD market participants will be able to better judge

    their counterparty risk and hedging strategies. The possibility exists

    that a non-SD market participant could have to unwind or offset other

    positions at a loss if a swap position is cancelled unexpectedly, or

    need to create the same position but on less favorable terms if the

    market has moved against them. It is also possible that the non-SD

    market participant may not be able to negotiate terms with the SD that

    would allow it to recoup much or all of the costs associated with the

    cancelled swap. Reducing or eliminating the latency period through more

    rapid processing and acceptance or rejection of swaps from clearing

    will reduce those costs to the benefit of both SD and non-SD market

    participants. If there is less time between execution and clearing,

    there will be less time for counterparty exposure to develop, which

    mitigates the need for extensive due diligence or for elaborate

    procedures to address breakage costs.

    With respect to costs, some capital investment will be necessary to

    develop the processes and implement the technology necessary to meet

    the requirements specified in these rules. However, in the case of

    DCMs, SDs, MSPs, and DCOs, the Commission believes that many entities

    are already using procedures and technology that comply with the

    standards in some measure. The necessary investments, therefore, will

    be incremental and will depend significantly on the current processes

    and technology in place at each of these institutions. Moreover, many

    of these entities may have to modify or upgrade their systems in order

    to comply with other aspects of the Dodd-Frank Act. The costs necessary

    to adjust technology platforms to meet these other requirements are

    being considered in each of those rules, and so the costs attributable

    to these rules are only those that create improvements that would not

    otherwise be made pursuant to those other rules. The incremental costs

    attributable to these rules cannot be quantified, due to the

    flexibility the rules provide regulated entities to meet the applicable

    standards and to the differing technology already in use by those

    entities, but the Commission anticipates that the necessary capital

    expenditures by some entities may be significant. However, as discussed

    above, the benefits of such technology and procedures are substantial

    as well, and, based on comments, the Commission believes potentially of

    a magnitude to offset the costs of implementing such systems. Citadel

    believes the rules will save enough resources to benefit the economy as

    a whole, and SDMA estimates that the total benefits for corporate

    America will have a value of approximately $15 billion annually.\97\

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

    \97\ See Citadel and SDMA. Neither commenter provided

    calculations to substantiate their estimates, so the Commission is

    not able to verify their accuracy. However, as stated above, the

    Commission does believe that the benefits of such systems and

    procedures will be substantial.

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

    [[Page 21298]]

    b. Efficiency, Competitiveness, and Financial Integrity of the Markets

    The general requirement that processing and acceptance or rejection

    from clearing must occur ``as quickly as is technologically

    practicable'' or ``as quickly as is technologically practicable if

    fully automated systems are used'' creates an enforceable standard that

    provides SEFs, DCMs, SDs, MSPs, and DCOs the freedom to establish

    systems that meet their unique operational needs and that is, in their

    judgment, most cost effective. By accommodating innovation, and further

    system improvements, this approach will promote continued improvements

    in the reliability and efficiency of these systems that, indirectly,

    may benefit financial market efficiency generally.

    Rapid processing and acceptance or rejection from clearing will

    help to ensure that eligible counterparties are not exposed in

    transactions that are ultimately rejected from clearing and broken.

    With respect to dealers, this helps to ensure that they will be

    available to other eligible customers by reducing the amount of their

    balance sheet that is ``tied up'' supporting transactions that are

    eventually rejected from clearing and broken. By limiting the duration

    of transactional exposure, the rules' rapid processing requirements

    serve to help protect market liquidity that dealers in significant part

    provide.\98\

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

    \98\ See n. 77, above.

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

    Required coordination among SEFs, DCMs, SDs, MSPs, and DCOs,

    together with the requirements for rapid processing and acceptance or

    rejection from clearing, is likely to promote broad adoption of

    standardized technologies and processes. The rules, in this respect,

    will provide an incentive to further improvements in the speed of

    processing, and may reduce switching costs for customers by ensuring

    that their technology platforms are able to interface with a wide array

    of FCMs and counterparties without significant modifications. Lower

    switching costs, in turn, are conducive to greater competition among SD

    counterparties and lower bid-ask spreads may result.

    Limit order books \99\ cannot exist in an environment where there

    is uncertainty about clearing because each participant will want to

    identify its potential counterparty and evaluate its creditworthiness

    in order to manage risks that could develop if the trade is rejected

    from clearing. Enabling clearing members and exchanges to pre-screen

    orders in real time for compliance with clearing member limits for each

    customer facilitates the development of a central limit order book and

    the pure price competition it affords by ensuring that each trade

    executed on the exchange will proceed to clearing. This certainty, and

    the central limit order book that it makes possible, enables anonymous,

    exchange-based execution. This execution method is an effective

    mechanism for providing all-to-all market access, placing all eligible

    market participants on equal footing when bidding on or offering

    positions; the only distinguishing characteristic among them is the

    price they bid or offer. Participants do not need to know the identity

    of entities on the other side of the trade or to concern themselves

    with the creditworthiness of those entities because each participant

    knows they will be facing the clearinghouse as their counterparty.

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

    \99\ A Central Limit Order Book (CLOB) is a system used by many

    exchanges to consolidate and match orders. An open CLOB exposes

    available pricing and market depth for listed products. Market

    participants are allowed to see limit orders that have been placed

    but have not yet been executed or cancelled. Usually, exchanges use

    open CLOBs to match customer trade orders with a ``price time

    priority.''

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

    Efficiency, certainty of clearing, and liquidity in the U.S. based

    swap markets are attractive characteristics that may prompt additional

    customers and dealers to send business to U.S.-based exchanges. To the

    extent that this occurs, it will promote greater liquidity and

    competition.

    c. Price Discovery

    Pre-trade price transparency is enhanced by central limit order

    books, where market participants can view the prices at which market

    participants are willing to ``buy'' or ``sell'' certain positions. Pre-

    screening capabilities help to ensure that only bids and offers from

    parties whose transactions will be accepted for clearing are

    represented in the central limit order book. This promotes the

    integrity of the order book, and the informational value of the bids

    and offers contained within it, which promotes effective price

    discovery.

    To the extent that a swap moves from execution to acceptance or

    rejection from clearing and receives an answer in real time that speed

    eliminates the need for SDs to price idiosyncratic counterparty risk

    (i.e. risk that is different than that posed by the clearinghouse as a

    counterparty) into the swap. This result means that the price at which

    a swap is transacted more accurately reflects the price that other

    market participants would receive for the same product at that time.

    Therefore, the prices reported in real time have greater informational

    value for all market participants.

    d. Sound Risk Management Practices

    If an SD is uncertain whether a trade will clear, it will not know

    whether it should account for idiosyncratic counterparty risk because

    it will not know whether the clearinghouse or their counterparty will

    face them for the life of the swap.\100\ Or, if the agreement between

    the SD and the customer counterparty calls for the trade to be

    cancelled in the event of clearing rejection, the SD's hedging

    strategies will be complicated by uncertainty until the clearing

    outcome is known. Faster processing and acceptance or rejection of

    trades from clearing facilitates sound risk management by eliminating

    these uncertainties, or at least by reducing the period of time during

    which they are relevant. This result makes it easier and potentially

    less costly for dealers to develop and execute sound risk management

    strategies.

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

    \100\ See DB.

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

    Similarly, faster processing and acceptance or rejection from

    clearing makes it easier and potentially less costly for other non-SD

    market participants to manage their risk effectively. The more

    certainty SDs have that a trade will clear, the less they need to

    charge for clearing-acceptance risk. This result makes it less

    expensive for non-SD market participants to acquire the positions they

    need to execute their risk management strategies. It also obviates the

    need that an SD would otherwise have to evaluate counterparty credit-

    worthiness, which may decrease the amount of time required for a market

    participant to execute a needed trade. In volatile markets, this

    increased speed can be valuable, if not essential, when managing

    complex risks.

    On the other hand, some processes will still be manual even after

    these rules are adopted. This result may be true particularly for swap

    transactions that are executed bilaterally and then communicated to

    clearing members. Speed requirements may increase the possibility of

    errors in manual processes. The potential range of mistakes and range

    of costs associated with those mistakes is broad, and impossible to

    estimate. However, market participants have an incentive to avoid such

    mistakes, and the Commission anticipates that the requirements related

    to the timing of acceptance or rejection from clearing will encourage

    automated, straight-through processing, which over time is likely to

    reduce the number of manual processes and therefore the number of

    opportunities for errors.

    Also, while these rules require clearing members, SEFs, DCMs, and

    [[Page 21299]]

    DCOs to develop the ability to process swaps and make clearing

    determinations in a timeframe that is likely to be a matter of

    milliseconds, seconds, or at most, a few minutes, bilateral

    transactions will still take some amount of time to submit to the

    appropriate clearing member. The rules require SDs and MSPs to submit

    OTC swaps for clearing as soon as is technologically practicable and in

    no case later than the close of business on the date of execution for

    swaps that are required to be cleared, and in no case later than the

    end of the business day following execution or the decision to clear

    (whichever is later) for swaps that are not required to be cleared.

    Moreover, until the mandatory clearing regime becomes effective, all

    OTC swaps will be subject to the requirement that they be submitted for

    clearing as soon as is technologically practicable but in no case later

    than the day following execution or the decision to clear (whichever is

    later). Therefore, some time lapse between execution and clearing as

    well as some breakage risk will remain for OTC swaps and that risk may

    be greater prior to the mandatory clearing regime becoming effective.

    However, the Commission notes that these rules establish timelines

    for submission to clearing that are considerably shorter than what some

    market participants practice today. Moreover, the close of business on

    the date of execution and the end of the business day following

    execution or the decision to clear (whichever is later) are outer

    bounds on the timeline for submitting swaps to clearing. The rules

    still require these swaps to be submitted ``as soon as is

    technologically practicable,'' which in many cases will likely be

    sooner than these outer limits. Last, to the extent that market

    participants bear breakage cost risk, they have an incentive to submit

    OTC swaps for clearing promptly and to implement and promote

    technological improvements that will allow them to do so. Each of these

    considerations are likely to significantly reduce the amount of time

    between execution and submission for clearing for OTC swaps, and

    therefore, are likely to mitigate the breakage risks that

    counterparties face when engaging in OTC transactions.

    e. Other Public Interest Considerations

    As described above, rapid and predictable clearing provides

    substantial benefits for both SDs and other market participants. As

    market entities come into compliance with these rules, the Commission

    anticipates that rapid processing and clearing determinations will make

    the U.S. markets more attractive to foreign entities, which could

    further increase liquidity and reduce spreads.

    Also, the Commission observes that much of the technology that will

    be necessary to meet these requirements has been implemented in certain

    venues with marked success.\101\ This circumstance, together with the

    fact that many market participants already may have systems capable of

    at least partial compliance, will serve to limit the overall outlay

    necessary to bring regulated entities into compliance.

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

    \101\ See e.g., Arbor, Eris, CME, SDMA, Vanguard, and Javelin.

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

    f. Response to Comments

    Many commenters agreed that the technology for real time acceptance

    or rejection already exists in other cleared derivatives markets and is

    currently being rolled out for cleared OTC swaps.\102\ Commenters also

    noted that the benefits of the rules far exceed any incremental costs

    in upgrading infrastructure, and that any required infrastructure

    upgrades would be minimal due to existing industry capabilities.\103\

    Furthermore, Citadel stated that any costs to upgrade existing

    infrastructure have already been factored into industry investment

    plans, because many SDs, FCMs, DCOs, and SEFs are already launching

    real-time acceptance.

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

    \102\ See AllianceBernstein, Arbor, Citadel, D.E. Shaw, Eris,

    Javelin, MFA, SDMA, and State Street.

    \103\ See AllianceBernstein, Arbor, D.E. Shaw, MFA, and SDMA.

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

    Eris noted that it is currently able to execute and clear interest

    rate swaps. Arbor stated that it supports both the Globex and Clearport

    solutions for swaps because they are proven, work well, and would be

    inexpensive alternatives for market participants to implement. Arbor

    continued to state that because such workflow and technology are

    currently used by clearinghouses and clearing members today, these

    technologies could be ported quickly into the cleared swaps context.

    Finally, Arbor remarked that by compelling market adoption of workflow

    and systems currently deployed in other cleared markets, implementation

    will be less costly and more rapid.

    Javelin calculated that Clearport's daily trade volume increased

    from 139,177 contracts in 2005 to over 450,000 contracts today. Javelin

    also noted that Clearport covers multiple asset classes including

    credit and interest rates, and is interfacing with over 16,000

    registered users, and Globex had average daily volume of 6,368,000

    contracts in interest rates during August 2011 and total exchange

    average daily volume of 14,420,000 contracts during the same period.

    Commenters opposed to the rules doubted that ``market-wide real-

    time'' clearing and risk limit compliance verification can be developed

    quickly enough or provided with sufficient reliability to eliminate the

    ``functional benefits'' of trilateral agreements.\104\ One commenter

    posited that to provide real-time clearing on a broad basis would

    require systems that have the capacity to share information, calculate

    risk metrics on a portfolio basis, adjust limits accordingly, and

    disseminate information in ways that are not currently possible and

    that are unlikely to be possible in the near future.\105\

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

    \104\ See Morgan Stanley, and Banks.

    \105\ See Morgan Stanley.

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

    However, the Commission is not persuaded by these opposing

    commenters' arguments, which pivot on an assumption that the

    Commission's determination to prohibit certain provisions commonly

    contained in trilateral agreements is premised on a faulty belief that

    the functional benefits of trilateral agreements will be entirely

    eliminated in the near term. Such a belief, however, is not the premise

    for the Commission's determination. Rather, after careful consideration

    of costs and benefits associated with trilateral agreements, the

    Commission believes that certain provisions common to these agreements

    generate unacceptable costs and, thus, should be prohibited. In

    reaching this determination, the Commission has not concluded, and need

    not conclude, that the trilateral agreements, judged in isolation, are

    devoid of value.

    Moreover, the Commission believes that significant improvements in

    straight through processing and in the speed of processing and clearing

    determinations can be achieved even when the ideal is not yet

    attainable. In that regard, the Commission notes that the system

    requirements delineated by commenters opposed to the rules describe

    ``requirements'' that the Commission does not believe are necessary to

    straight through processing or real time clearing determinations.\106\

    Several commenters noted that some technologies existing today provide

    near real-time clearing determinations with respect to certain

    swaps.\107\ Those

    [[Page 21300]]

    systems function effectively despite the fact that they do not achieve

    the ideal system requirements described by other commenters. The

    Commission, therefore, believes that while many of the ``requirements''

    described by some commenters are desirable, they are not essential to

    swap processing and clearing determinations that comply with these

    rules. Furthermore, the Commission believes that improvements that

    significantly mitigate the risks associated with counterparty exposure

    that trilateral agreements seek to address are possible with existing

    technology.

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

    \106\ Id.

    \107\ See SDMA, Vanguard, State Street, Arbor, Eris, CME, and

    Javelin. Multiple commenters cited Clearport as an example of

    immediate post-trade (or ''low latency'') solution that is already

    providing clearing acceptance/rejection decisions within

    milliseconds of execution in some markets. Similarly, commenters

    cited Globex and WebICE as examples of platforms that provide pre-

    trade screens against customer limits set by FCMs, which enables

    ``perfect settlement'' (i.e. every trade that is executed is

    accepted immediately for clearing) for the markets in which they

    operate. Commenters generally cited these examples as evidence that

    the requisite technology for real time clearing determinations

    already exists, and could be applied more broadly in order to

    facilitate compliance with the rules adopted in this release.

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

    One commenter suggested that sub-limits with individual dealers

    need not delay clearing of swaps because the same technology that is

    used to satisfy the Commission's requirements for clearing in real time

    could be used to automate the sub-limits.\108\ However, commenters

    generally agreed that real-time clearing determinations would mitigate

    or eliminate any legitimate need for sub-limits or the agreements

    necessary to establish them, a perspective that the Commission finds

    persuasive.\109\ Once the technology necessary for straight through

    processing and real time clearing determinations is in place, the

    economic rationale that commenters have advanced in favor of sub-limits

    will no longer be relevant, and therefore the elements of trilateral

    agreements that are prohibited in the first part of these rules will

    not assist SDs with risk management.

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

    \108\ See Morgan Stanley.

    \109\ See e.g., SDMA, AIMA, Vanguard, AllianceBernstein, Trading

    Firms, and MFA. In addition, Morgan Stanley, ISDA/FIA, Banks, and

    EEI implicitly acknowledge that real-time clearing determinations

    mitigate the need for trilateral agreements by arguing that

    trilateral agreements are a useful risk management tool because

    real-time clearing determinations are not yet possible in all parts

    of the market.

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

    3. Clearing Member Risk Management

    This cluster of rules establishes risk management requirements for

    FCMs, SDs, and MSPs who are clearing members. Section 1.73 of the

    Commission's regulations requires FCMs who are clearing members to: (1)

    Establish limits for proprietary accounts and customer accounts based

    on position size, order size, margin requirements, etc.; (2) ensure

    that trades received by the FCM for automated or non-automated

    execution, that are executed bilaterally then delivered to the FCM, or

    that are executed by a broker and then delivered to the FCM, are

    screened by either the FCM or the broker (whichever encounters the

    transaction first) for compliance with overall position limits at the

    FCM for each customer; (3) monitor for compliance with overall position

    limits at the FCM for each customer both intraday and overnight; (4)

    conduct stringent stress tests for all positions that could impact its

    financial strength at least once per week; (5) evaluate its ability to

    meet initial margin requirements at least once per week; (6) evaluate

    its ability to, and the cost of, liquidating positions in its

    proprietary and customer accounts at least once per month; (7) test all

    lines of credit at least once per year; and (8) establish procedures

    and maintain records to ensure and document compliance with these

    requirements.

    Section 23.609 requires SDs and MSPs who are clearing members to do

    all the same things to manage risk, with the exception that bilateral

    execution, ``give up'' agreements, and bunched orders are not addressed

    in this section, because SDs and MSPs may only clear customer trades if

    they are also registered as FCMs.

    a. Protection of Market Participants

    Several reported incidents over the last 15 years involving so

    called ``rogue traders''\110\ highlight the protective import of these

    rules. The rules in the second group require FCMs to establish overall

    position limits for each of their customers and promote the

    establishment of systems capable of more effectively pre-screening

    orders for compliance with these overall position limits. Automated

    screening mechanisms that are external to those of an FCM's customer

    provide a second layer of defense against evasion by rogue traders

    within the customer's organization. The Commission believes that these

    measures will help protect against rogue trading, thereby protecting

    market participants, who past events have shown to be vulnerable to

    harm from such conduct.\111\

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

    \110\ See e.g., Report of the Board of Banking Supervision

    Inquiry Into the Circumstances of the Collapse of Barings, (Jul. 18,

    1995), available at: http://www.prmia.org/pdf/Case_Studies/Barings_Case_Study.pdf; Factbox: Rise and Fall of the SocGen Rogue

    Trader, Reuters (Jan. 27, 2008), available at http://www.reuters.com/article/2008/01/27/us-socgen-factbox-idUSL2733740320080127.

    \111\ A key purpose of risk management procedures is to minimize

    the chance of a firm incurring losses that exceed its risk appetite.

    For example, in 1999, a CFTC-regulated futures commission merchant

    filed bankruptcy after a trader exceeded his trading limits. This

    event highlights the potential damage that occurs from a poorly

    designed risk management program or from a lack internal controls.

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

    With respect to the risk management requirement that each clearing

    member establish overall position limits for each customer, the rules

    promote restrictions that help prevent individual customers from

    establishing positions sufficiently large to jeopardize the financial

    health of their clearing member if they were to default. This is a

    critical safeguard that, due to its importance and relative simplicity,

    the Commission anticipates many clearing members may already have in

    place. But, by implementing these rules, the Commission is ensuring

    that every clearing member uses such safeguards to help ensure that

    they, and the DCOs on which they clear trades, remain financially sound

    even during times of financial market turbulence.

    The risk management requirements do prescribe certain timelines for

    regular testing and evaluation; however, they do not dictate (1)

    specific levels for position limits set by clearing members, or (2)

    specific methodologies of testing with respect to the clearing member's

    ability to meet margin requirements, the cost of liquidating positions,

    or stress testing positions that could have a material impact on the

    entity's financial strength. This flexibility gives market participants

    the opportunity to implement the requirements in ways that are suited

    to their operational patterns and minimize costs associated with

    changes and upgrades to existing technology systems. Moreover, it

    allows market participants ample room to innovate and adapt the most

    effective procedures as the market continues to evolve. This

    flexibility for innovation and adaptation is critical to the long term

    success of risk management practices. Over time the markets will

    continue to evolve with changes in products, connections among

    institutions, regulatory requirements, and broader economic realities.

    Each of these dynamic realities has the potential to impact the

    effectiveness of specific risk management strategies, making it

    essential for firms to continue adapting their approaches. The rules

    benefit FCMs, their counterparties, and the public by giving FCMs the

    flexibility they need to continue developing effective risk management

    strategies that address current market realities.

    Clearing members that do not currently practice one or more of the

    requirements established by this cluster of rules will incur some

    incremental costs to comply with them. Some initial investment will be

    required to develop

    [[Page 21301]]

    and implement processes necessary for compliance, and ongoing costs

    will be incurred as such entities engage in repeated testing. The

    incremental cost for each entity will depend on the degree to which its

    current practices are or are not in compliance, as well as the

    procedures they select and implement in order to comply. The Commission

    does not have, and has not been provided by commenters with, the

    information required to estimate those costs either on a per-entity or

    aggregate basis. However, the Commission expects that while the costs

    may be material for a small number of entities, most clearing members

    are currently using risk management strategies that are largely

    compliant with these requirements and, therefore, the incremental cost

    for most entities and for the market as a whole is likely to be

    relatively low.

    b. Efficiency, Competitiveness, and Financial Integrity of the Markets

    With clearing mandates in place, the financial integrity of swap

    markets will depend significantly on the financial strength of DCOs.

    Moreover, the financial health of a DCO is dependent upon the strength

    of its clearing members and those members' ability to meet any

    obligations pursuant to the terms of their agreement with the DCO. By

    requiring clearing members to implement sound risk management

    practices, the rules mitigate the risk that those members could

    experience financial strain that could undermine the financial strength

    of the DCO.

    In addition, by requiring that DCOs coordinate with clearing

    members and that clearing members coordinate with account managers who

    execute trades before submitting them to the clearing member, the rules

    promote market integrity by making it more difficult for market

    participants to circumvent the overall position limit established by

    their clearing member.

    c. Price Discovery

    The Commission does not expect these rules to materially affect

    price discovery.

    d. Sound Risk Management Practices

    As mentioned above, prescreening of trades for compliance with

    overall position limits set by the clearing member will help guard

    against the activities of rogue traders, particularly those that may be

    operating within one of the clearing members' customers. Intraday and

    overnight monitoring of compliance with overall position limits is an

    additional line of defense against the same risk, but also serves to

    help protect the clearing member against any such activities within its

    own ranks. In this way, the rules mandate processes that provide a

    deterrent against and a screen for rogue trading, and help to protect

    market participants from these relatively infrequent, but potentially

    catastrophic, risks.

    Moreover, in situations where automated screening may not be

    possible, such as with bunched trades and give-up trades, the rules

    still specify requirements that should effect pre-screening of trades

    against overall position limits with the clearing member. Non-automated

    systems may be slightly slower, but the manual screens still provide

    some measure of protection against the activities of rogue traders.

    Even in situations where non-automated screening occurs post-execution,

    as is the case with screens on floor traders, manual systems--if

    carefully and rigorously practiced--can provide effective protection

    against excessive exposure. In the case of floor traders, the clearing

    member may monitor the trader's positions throughout the day and

    intervene in person when the trader exceeds allowable limits, forcing

    him to close out positions immediately in order to come under such

    limits, even if he must close out those positions at a loss. Such

    monitoring reduces the opportunity that the trader has to exceed

    appropriate limits, and the amount of time that such excesses can last,

    thus limiting the associated potential risk for his firm and the

    clearing member.

    Also, as stated above, the flexibility that is implicit in these

    requirements is particularly critical as a precondition to innovation

    regarding testing methodologies. Clearing members might develop many

    different approaches to stress tests, one or more of which may be

    particularly well suited to a particular firm and set of market

    conditions, but which may not be well suited to other firms and market

    conditions. Flexibility is critical to enabling continued development

    and testing of new methodologies. It is likely to benefit the

    individual entities that engage in such innovation and testing, as well

    as a broader array of market participants introduced to developments at

    industry gatherings and through informal transfer of intellectual

    capital as personnel move between firms.

    The requirement for each clearing member to evaluate its ability to

    meet margin requirements at least once per week is a valuable tool to

    help clearing firms avoid liquidity crises, which could jeopardize the

    solvency of otherwise healthy clearing members. Margin calls can come

    as a result of significant movements in the price of the underlying

    commodity, or as a consequence of changes in price volatility.

    Counterparties may choose to exercise options at unanticipated times,

    which may have significant repercussions for a clearing member's margin

    requirements. Additionally, a clearing member's cash position may be

    negatively impacted if one of its customers becomes unable to meet

    margin calls on large positions. Clearing members must have sufficient

    liquidity to meet margin calls from the DCO, even at a time when the

    clearing member may have a depleted cash position due to the failure of

    its customers to meet margin requirements. Such stress tests may help

    to ensure that the clearing member has a clear sense for how much

    liquidity may be necessary in such circumstances, and may encourage

    them to preserve ample liquidity.

    Testing lines of credit also helps clearing members to ensure that

    (1) the credit provider is able to honor its commitment, and (2) the

    clearing member can access the line in a timely fashion. Liquidity

    crises seldom play out in slow motion, and time is likely to be of the

    essence when a clearing member needs to access its credit line.

    Therefore, it is important for the clearing member's staff to know how

    to access the line quickly and reliably when it is needed. By requiring

    annual testing, the rules guard against the danger that an episode of

    financial strain for the member could be exacerbated by an inability to

    access its credit line in a timely manner. Such preventable problems

    could be fatal for the firm in the midst of a liquidity crisis.

    e. Other Public Interest Considerations

    The Commission understands that the past several years' events in

    the financial markets have tested and strained the public's confidence

    in financial institutions' management of risks. To the extent that

    these regulations promote broader implementation of sound risk-

    management practices, they may serve to strengthen such public

    confidence in the integrity of the affected markets. Such public

    confidence, if justified by improved risk-management practices, is

    critical to the overall health and functioning of the swaps and

    commodity markets.

    To the extent that sound risk management practices are broadened,

    these regulations will help to promote such confidence, and as such

    will benefit the financial markets and the American public who

    ultimately

    [[Page 21302]]

    benefits from the health of these markets.

    f. Response to comments

    Chris Barnard and Better Markets both recommend that the Commission

    require specific stress tests, and FHLB recommends that stress test

    results be publicly disclosed.\112\ FHLB believes that public

    disclosure of stress test results would allow customers to mitigate

    risk.

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

    \112\ See section IV.B(2)(a), above.

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

    The purpose of stress tests is for clearing members to monitor the

    potential losses they would face in the event of extreme market events

    as well as their ability to absorb such losses.

    The Commission has chosen not to set specific thresholds or

    specifying methodologies for stress tests for three reasons. First,

    appropriate thresholds and methodologies depend, at least in part, on

    the types of customers and positions that characterize each clearing

    member's business. The clearing member is best positioned to account

    for these factors when developing an appropriate test. Second, the

    Commission believes that specifying certain stress test thresholds

    could prompt firms to focus tests on those minimum levels in order to

    meet regulatory requirements rather than establishing thresholds that

    further achieve the goal of maintaining a vigorous risk management

    program. Third, the Commission believes that specifying particular

    methodologies for stress testing would stifle innovation, which would

    undermine the effectiveness of stress tests as the swap markets and

    their clearing members continue to evolve.\113\

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

    \113\ The Commission also notes that the approach taken in this

    rule is consistent with the approach recently adopted by the

    Commission for DCO stress tests. The Commission intends to monitor

    to determine whether the tests conducted by clearing members are

    reasonably designed for the types of risk the clearing members and

    their customers face.

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

    The Commission considered FHLB's recommendation but believes that

    public disclosure of stress test results could be a disincentive to

    aggressive stress testing, which would undermine the intent of this

    rule and the strength of the FCM's risk management program, and in so

    doing, increase risk to the DCO. Moreover, disclosure of results could

    have the effect of improper disclosure of confidential position

    information. Last, additional rules have been enacted limiting the

    range of assets in which FCMs can invest customer funds,\114\ and

    requiring careful segregation of customer funds,\115\ both of which are

    designed to protect customers in the event that an FCM should become

    insolvent. With these considerations in view, the Commission has chosen

    not to require FCMs to make the results of their stress tests public.

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

    \114\ See Investment of Customer Funds and Funds Held in an

    Account for Foreign Futures and Foreign Options Transactions, 76 FR

    78776 (Dec. 19, 2011).

    \115\ See Protection of Cleared Swaps Customer Contracts and

    Collateral; Conforming Amendments to the Commodity Broker Bankruptcy

    Provisions, 77 FR 6336 (Feb. 7, 2012).

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

    The CME commented that clearing members should only be required to

    test lines of credit on an annual basis rather than a quarterly basis

    because they believe that more frequent testing is not cost efficient.

    ISDA inquired as to whether an institution must actually draw funds in

    order to properly test a line of credit.

    The Commission agrees that quarterly testing might not be cost

    efficient in every situation, and therefore has established an annual

    testing requirement in the Adopting Release. However, the Commission

    encourages clearing members to test lines of credit more frequently

    based on any developments that might impact the ability of the lender

    to provide the line of credit, or the clearing member's ability to

    access it in a timely manner. Various market events, credit events, and

    operational changes could lead to a situation where testing lines of

    credit would be appropriate. For example, if, the clearing member

    changes personnel or reorganizes in a manner that changes the

    individuals who would be responsible for accessing the credit line, the

    Commission believes that it would be beneficial to test lines of

    credit.

    The Commission believes that the actual drawing of funds is

    essential to testing a line of credit. Among other things, the test

    should ensure the ability of the bank or other institution to move the

    funds in a timely fashion, which is likely to be particularly important

    at times when the firm most needs the additional liquidity provided by

    the line of credit.

    VII. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies

    consider whether the regulations they propose will have a significant

    economic impact on a substantial number of small entities.\116\ The

    final rules set forth in this release would affect FCMs, SDs, MSPs,

    DCOs, DCMs, and SEFs. The Commission has already established certain

    definitions of ``small entities'' to be used in evaluating the impact

    of its rules on such entities in accordance with the RFA.

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

    \116\ 5 U.S.C. 601 et seq.

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

    In the Commission's ``Policy Statement and Establishment of

    Definitions of `Small Entities' for Purposes of the Regulatory

    Flexibility Act,'' \117\ the Commission concluded that registered FCMs

    should not be considered to be small entities for purposes of the RFA.

    The Commission's determination in this regard was based, in part, upon

    the obligation of registered FCMs to meet the capital requirements

    established by the Commission. Likewise, the Commission determined

    ``that, for the basic purpose of protection of the financial integrity

    of futures trading, Commission regulations can make no size distinction

    among registered FCMs.'' \118\ Thus, with respect to registered FCMs,

    the Commission believes that the final rules will not have a

    significant economic impact on a substantial number of small entities.

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

    \117\ 47 FR 18618 (Apr. 30, 1982).

    \118\ Id. at 18619.

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

    Like FCMs, SDs will be subject to minimum capital and margin

    requirements, and are expected to comprise the largest global firms.

    Moreover, the Commission is required to exempt from designation as an

    SD any entity that engages in a de minimis level of swaps dealing in

    connection with transactions with or on behalf of customers. Based, in

    part, on that rationale, the Commission previously has determined that

    SDs should not be considered to be ``small entities'' for purposes of

    the RFA.\119\ Thus, with respect to SDs, the Commission believes that

    the final rules will not have a significant economic impact on a

    substantial number of small entities.

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

    \119\ See ``Registration of Swap Dealers and Major Swap

    Participants,'' 77 FR 2613, 2620 (Jan. 19, 2012); ``Business Conduct

    Standards for Swap Dealers and Major Swap Participants with

    Counterparties,'' 77 FR 9734, 9803-04 (Feb. 17, 2012).

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

    Further, the Commission previously has determined that large

    traders are not ``small entities'' for RFA purposes, with the

    Commission considering the size of a trader's position to be the only

    appropriate test for the purpose of large trader reporting. The

    Commission similarly has noted that MSPs, by definition, will maintain

    substantial positions in swaps, creating substantial counterparty

    exposure that could have serious adverse effects on the financial

    stability of the United States banking system or financial markets.

    Based, in part, on those facts, the Commission previously has

    determined that MSPs should not be considered to be ``small entities''

    for purposes of the RFA.\120\

    [[Page 21303]]

    Thus, with respect to MSPs, the Commission believes that the final

    rules will not have a significant economic impact on a substantial

    number of small entities.\121\

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

    \120\ Id.

    \121\ In a recent rulemaking, the Commission discussed the

    applicability of the RFA with respect to SDs and MSPs as follows:

    ``The Commission is carrying out Congressional mandates by proposing

    these rules. The Commission is incorporating registration of SDs and

    MSPs into the existing registration structure applicable to other

    registrants. In so doing, the Commission has attempted to accomplish

    registration of SDs and MSPs in the manner that is least disruptive

    to ongoing business and most efficient and expeditious, consistent

    with the public interest, and accordingly believes that these

    registration rules will not present a significant economic burden on

    any entity subject thereto.'' ``Swap Dealer and Major Swap

    Participant Recordkeeping and Reporting, Duties, and Conflicts of

    Interest Policies and Procedures; Futures Commission Merchant and

    Introducing Broker Conflicts of Interest Policies and Procedures;

    Swap Dealer, Major Swap Participant, and Futures Commission Merchant

    Chief Compliance Officer,'' available at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_4_BusConductStandardsInternal/ssLINK/federalregister022312b.

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

    Certain of the final rules set forth in this release will affect

    DCMs, SEFs, and DCOs, some of which will be designated as systemically

    important DCOs. The Commission previously has determined that DCMs,

    SEFs, and DCOs are not ``small entities'' for purposes of the RFA.\122\

    In determining that these registered entities are not ``small

    entities,'' the Commission reasoned that it designates a contract

    market, or registers a DCO or SEF, only if the entity meets a number of

    specific criteria, including the expenditure of sufficient resources to

    establish and maintain an adequate self-regulatory program.\123\

    Because DCMs, SEFs, and DCOs are required to demonstrate compliance

    with Core Principles, including principles concerning the maintenance

    or expenditure of financial resources, the Commission determined that

    such registered entities are not ``small entities'' for the purposes of

    the RFA. Thus, with respect to DCMs, SEFs, and DCOs, the Commission

    believes that the final rules will not have a significant economic

    impact on a substantial number of small entities.

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

    \122\ 76 FR 44776, 44789 (July 27, 2011) (``Provisions Common to

    Registered Entities''); see 66 FR 45604, 45609 (Aug. 29, 2001); 47

    FR 18618, 18619 (Apr. 30, 1982).

    \123\ See, e.g., Core Principle 2 applicable to SEFs under

    Section 733 of the Dodd-Frank Act.

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

    Accordingly, pursuant to Section 605(b) of the RFA, 5 U.S.C.

    605(b), the Chairman, on behalf of the Commission, certifies that these

    rules and rule amendments will not have a significant economic impact

    on a substantial number of small entities.

    B. Paperwork Reduction Act

    1. Customer Clearing Documentation

    Pursuant to the Paperwork Reduction Act (``PRA''),\124\ the

    Commission may not conduct or sponsor, and a registrant is not required

    to respond to, a collection of information unless it displays a

    currently valid Office of Management and Budget (``OMB'') control

    number. The final rules set forth in this Adopting Release relating to

    Customer Clearing Documentation will result in new collection of

    information requirements within the meaning of the PRA.

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

    \124\ 44 U.S.C. 3501 et seq.

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

    Accordingly, the Commission requested control numbers for the

    required collection of information. The Commission has submitted this

    notice of final rulemaking along with supporting documentation for

    OMB's review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.

    The title for this collection of information is ``Customer Clearing

    Documentation and Timing of Acceptance for Clearing.'' The OMB has

    assigned this collection control number 3038-0092.

    The collection of information under these regulations is necessary

    to implement certain provisions of the CEA, as amended by the Dodd-

    Frank Act. Specifically, it is essential to reducing risk and fostering

    open access to clearing and execution of customer transactions on a DCM

    or SEF on terms that have a reasonable relationship to the best terms

    available by prohibiting restrictions in customer clearing

    documentation of SDs, MSPs, FCMs, or DCOs that could delay or block

    access to clearing, increase costs, and reduce market efficiency by

    limiting the number of counterparties available for trading. These

    regulations are also crucial both for effective risk management and for

    the efficient operation of trading venues among SDs, MSPs, FCMs, and

    DCOs.

    Many responses to this collection of information will be mandatory.

    The Commission protects proprietary information according to the

    Freedom of Information Act and 17 CFR part 145, ``Commission Records

    and Information.'' In addition, section 8(a)(1) of the CEA strictly

    prohibits the Commission, unless specifically authorized by the CEA,

    from making public ``data and information that would separately

    disclose the business transactions or market positions of any person

    and trade secrets or names of customers.'' The Commission is also

    required to protect certain information contained in a government

    system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.

    a. Information Provided by Reporting Entities/Persons

    SDs, MSPs, FCMs, and DCOs will be required to develop and maintain

    written customer clearing documentation in compliance with Sec. Sec.

    1.72, 23.608, and 39.12. Section 39.12(b)(7)(i)(B) requires DCOs to

    coordinate with clearing members to establish systems for prompt

    processing of trades. Sections 1.74(a) and 23.610(a) require reciprocal

    coordination with DCOs by FCMs, SDs, and MSPs that are clearing

    members.

    The annual burden associated with these regulations is estimated to

    be 16 hours, at an annual cost of $1,600 for each FCM, SD, and MSP.

    Burden means the total time, effort, or financial resources expended by

    persons to generate, maintain, retain, disclose, or provide information

    to or for a federal agency. The Commission has characterized the annual

    costs as initial costs because the Commission anticipates that the cost

    burdens will be reduced dramatically over time as the documentation and

    procedures required by these regulations become increasingly

    standardized within the industry.

    Sections 1.72 and 23.608 require each FCM, SD, and MSP to ensure

    compliance with these regulations. Maintenance of contracts is prudent

    business practice and the Commission anticipates that SDs and MSPs

    already maintain some form of this documentation. Additionally, the

    Commission believes that much of the existing customer clearing

    documentation already complies with these rules, and therefore that

    compliance will require a minimal burden.

    In addition to the above, the Commission anticipates that FCMs,

    SDs, and MSPs will spend an average of another 16 hours per year

    drafting and, as needed, updating customer clearing documentation to

    ensure compliance required by Sec. Sec. 1.72 and 23.608.

    For each DCO, the annual burden associated with these regulations

    is estimated to be 40 hours, at an annual cost of $4,000. Burden means

    the total time, effort, or financial resources expended by persons to

    generate, maintain, retain, disclose, or provide information to or for

    a federal agency. The Commission has characterized the annual costs as

    initial costs because the Commission anticipates that the cost burdens

    will be reduced dramatically over time as the documentation and

    procedures required by the regulations

    [[Page 21304]]

    are implemented. Any additional expenditure related to Sec. 39.12

    likely would be limited to the time required to review--and, as needed,

    amend--existing documentation and procedures.

    Section 39.12(b)(7) requires each DCO to coordinate with clearing

    members to establish systems for prompt processing of trades. The

    Commission believes that this is currently a practice of DCOs.

    Accordingly, any additional expenditure related to Sec. 39.12(b)(7)

    likely would be limited to the time initially required to review--and,

    as needed, amend--existing trade processing procedures to ensure that

    they conform to all of the required elements and to coordinate with

    FCMs, SDs, and MSPs to establish reciprocal procedures.

    The Commission anticipates that DCOs will spend an average of 20

    hours per year drafting--and, as needed, updating--the written policies

    and procedures to ensure compliance required by Sec. 39.12, and 20

    hours per year coordinating with FCMs, SDs, and MSPs on reciprocal

    procedures.

    The hour burden calculations below are based upon a number of

    variables such as the number of FCMs, SDs, MSPs, and DCOs in the

    marketplace and the average hourly wage of the employees of these

    registrants that would be responsible for satisfying the obligations

    established by the proposed regulation.

    There are currently 134 FCMs and 14 DCOs based on industry data.

    SDs and MSPs are new categories of registrants. Accordingly, it is not

    currently known how many SDs and MSPs will become subject to these

    rules, and this will not be known to the Commission until the

    registration requirements for these entities become effective. The

    Commission believes there will be approximately 125 SDs and MSPs who

    will be required to comply with the recordkeeping requirements of the

    proposed rules. The Commission estimated the number of affected

    entities based on industry data.

    According to recent Bureau of Labor Statistics, the mean hourly

    wage of an employee under occupation code 11-3031, ``Financial

    Managers,'' (which includes operations managers) that is employed by

    the ``Securities and Commodity Contracts Intermediation and Brokerage''

    industry is $74.41.\125\ Because SDs, MSPs, FCMs, and DCOs include

    large financial institutions whose operations management employees'

    salaries may exceed the mean wage, the Commission has estimated the

    cost burden of these proposed regulations based upon an average salary

    of $100 per hour.

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

    Accordingly, the estimated hour burden was calculated as follows:

    Developing Written Procedures for Compliance, and Maintaining

    Records Documenting Compliance for SDs and MSPs. This hourly burden

    arises from the requirement that SDs and MSPs make and maintain records

    documenting compliance related to client clearing documentation.

    Number of registrants: 125.

    Frequency of collection: As needed.

    Estimated number of annual responses per registrant: 1.

    Estimated aggregate number of annual responses: 125.

    Estimated annual hour burden per registrant: 16 hours.

    Estimated aggregate annual hour burden: 2,000 burden hours [125

    registrants x 16 hours per registrant].

    Developing Written Procedures for Compliance, and Maintaining

    Records Documenting Compliance for FCMs. This hourly burden arises from

    the requirement that FCMs make and maintain records documenting

    compliance related to client clearing documentation.

    Number of registrants: 134.

    Frequency of collection: As needed.

    Estimated number of annual responses per registrant: 1.

    Estimated aggregate number of annual responses: 134.

    Estimated annual hour burden per registrant: 16 hours.

    Estimated aggregate annual hour burden: 2,144 burden hours [134

    registrants x 16 hours per registrant].

    Drafting and Updating Trade Processing Procedures for DCOs. This

    hour burden arises from the time necessary to develop and periodically

    update the trade processing procedures required by the regulations.

    Number of registrants: 14.

    Frequency of collection: Initial drafting, updating as needed.

    Estimated number of annual responses per registrant: 1.

    Estimated aggregate number of annual responses: 14.

    Estimated annual hour burden per registrant: 40 hours.

    Estimated aggregate annual hour burden: 560 burden hours [14

    registrants x 40 hours per registrant].

    Based upon the above, the aggregate hour burden cost for all

    registrants is 4,704 burden hours and $470,400 [4,704 x $100 per hour].

    2. Time Frames for Acceptance into Clearing

    The Commission believes that the final rules set forth in this

    Adopting Release relating to the Time Frames for Acceptance into

    Clearing will not impose any new information collection requirements

    that require approval of OMB under the PRA.

    3. Clearing Member Risk Management

    The final rules contained in this Adopting Release relating to

    Clearing Member Risk Management will result in new collection of

    information requirements within the meaning of the PRA. Accordingly,

    the Commission requested control numbers for the required collection of

    information. The Commission has submitted this notice of final

    rulemaking along with supporting documentation for OMB's review in

    accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for this

    collection of information is ``Clearing Member Risk Management.'' An

    agency may not conduct or sponsor, and a person is not required to

    respond to, a collection of information unless it displays a currently

    valid control number. The OMB has assigned this collection control

    number 3038-0094.

    The collection of information under these regulations is necessary

    to implement certain provisions of the CEA, as amended by the Dodd-

    Frank Act. Specifically, it is essential both for effective risk

    management and for the efficient operation of trading venues on which

    SDs, MSPs, and FCMs participate. The position risk management

    requirement established by the rules diminishes the chance for a

    default, thus ensuring the financial integrity of markets as well as

    customer protection.

    Responses to this collection of information will be mandatory. The

    Commission protects proprietary information according to the Freedom of

    Information Act and 17 CFR part 145, ``Commission Records and

    Information.'' In addition, section 8(a)(1) of the CEA strictly

    prohibits the Commission, unless specifically authorized by the CEA,

    from making public ``data and information that would separately

    disclose the business transactions or market positions of any person

    and trade secrets or names of customers.'' The Commission is also

    required to protect certain information contained in a government

    system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.

    a. Information Provided by Reporting Entities/Persons

    SDs, MSPs, and FCMs will be required to develop and monitor

    procedures for position risk management in accordance with Sec. Sec.

    1.73 and 23.609.

    [[Page 21305]]

    The annual burden associated with these regulations is estimated to

    be 524 hours, at an annual cost of $52,400 for each FCM, SD, and MSP.

    Burden means the total time, effort, or financial resources expended by

    persons to generate, maintain, retain, disclose, or provide information

    to or for a federal agency. The Commission has characterized the annual

    costs as initial costs because the Commission anticipates that the cost

    burdens will be reduced dramatically over time as the documentation and

    procedures required by the regulations become increasingly standardized

    within the industry.

    This hourly burden primarily results from the position risk

    management obligations that will be imposed by Sec. Sec. 1.73 and

    23.609. Sections 1.73 and 23.609 will require each FCM, SD, and MSP to

    establish and enforce procedures to establish risk-based limits,

    conduct stress testing, evaluate the ability to meet initial and

    variation margin, test lines of credit, and evaluate the ability to

    liquidate, in an orderly manner, the positions in the proprietary and

    customer accounts and estimate the cost of the liquidation. The

    Commission believes that each of these items is currently an element of

    existing risk management programs at a DCO or an FCM. Accordingly, any

    additional expenditure related to Sec. Sec. 1.73 and 23.609 likely

    will be limited to the time initially required to review and, as

    needed, amend, existing risk management procedures to ensure that they

    encompass all of the required elements and to develop a system for

    performing these functions as often as required.

    In addition, Sec. Sec. 1.73 and 23.609 will require each FCM, SD,

    and MSP to establish written procedures to comply, and maintain records

    documenting compliance. Maintenance of compliance procedures and

    records of compliance is prudent business practice and the Commission

    anticipates that FCMs, SDs, and MSPs already maintain some form of this

    documentation.

    With respect to the required position risk management, the

    Commission estimates that FCMs, SDs, and MSPs will spend an average of

    2 hours per trading day, or 504 hours per year, performing the required

    tests. The Commission notes that the specific information required for

    these tests is of the type that would be performed in a prudent market

    participant's ordinary course of business.

    In addition to the above, the Commission anticipates that FCMs,

    SDs, and MSPs will spend an average of 16 hours per year drafting and,

    as needed, updating the written policies and procedures to ensure

    compliance required by Sec. Sec. 1.73 and 23.609, and 4 hours per year

    maintaining records of the compliance.

    The hour burden calculations below are based upon a number of

    variables such as the number of FCMs, SDs, and MSPs in the marketplace

    and the average hourly wage of the employees of these registrants that

    will be responsible for satisfying the obligations established by the

    regulations.

    There are currently 134 FCMs based on industry data. SDs and MSPs

    are new categories of registrants. Accordingly, it is not currently

    known how many SDs and MSPs will become subject to these rules, and

    this will not be known to the Commission until the registration

    requirements for these entities become effective. The Commission

    believes there will be approximately 125 SDs and MSPs who will be

    required to comply with the recordkeeping requirements of the proposed

    rules. The Commission estimated the number of affected entities based

    on industry data.

    According to recent Bureau of Labor Statistics, the mean hourly

    wage of an employee under occupation code 11-3031, ``Financial

    Managers,'' (which includes operations managers) that is employed by

    the ``Securities and Commodity Contracts Intermediation and Brokerage''

    industry is $74.41.\126\ Because SDs, MSPs, and FCMs include large

    financial institutions whose operations management employees' salaries

    may exceed the mean wage, the Commission has estimated the cost burden

    of these regulations based upon an average salary of $100 per hour.

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    \126\ http://www.bls.gov/oes/current/oes113031.htm.

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

    Accordingly, the estimated hour burden was calculated as follows:

    Developing and Conducting Position Risk Management Procedures for

    SDs and MSPs. This hourly burden arises from the requirement that SDs

    and MSPs establish and perform testing of clearing member risk

    management procedures.

    Number of registrants: 125.

    Frequency of collection: Daily.

    Estimated number of responses per registrant: 252 [252 trading

    days].

    Estimated aggregate number of responses: 31,500 [125 registrants x

    252 trading days].

    Estimated annual burden per registrant: 504 hours [252 trading days

    x 2 hours per record].

    Estimated aggregate annual hour burden: 63,000 hours [125

    registrants x 252 trading days x 2 hours per record].

    Developing Written Procedures for Compliance, and Maintaining

    Records Documenting Compliance for SDs and MSPs. This hourly burden

    arises from the requirement that SDs and MSPs make and maintain records

    documenting compliance related to clearing member risk management.

    Number of registrants: 125.

    Frequency of collection: As needed.

    Estimated number of annual responses per registrant: 1.

    Estimated aggregate number of annual responses: 125.

    Estimated annual hour burden per registrant: 20 hours.

    Estimated aggregate annual hour burden: 2,500 burden hours [125

    registrants x 20 hours per registrant].

    Developing and Conducting Position Risk Management Procedures for

    FCMs. This hourly burden arises from the requirement that FCMs

    establish and perform testing of clearing member risk management

    procedures.

    Number of registrants: 134.

    Frequency of collection: Daily.

    Estimated number of responses per registrant: 252 [252 trading

    days].

    Estimated aggregate number of responses: 33,768 [134 registrants x

    252 trading days].

    Estimated annual burden per registrant: 504 hours [252 trading days

    x 2 hours per record].

    Estimated aggregate annual hour burden: 67,536 hours [134

    registrants x 252 trading days x 2 hours per record].

    Developing Written Procedures for Compliance, and Maintaining

    Records Documenting Compliance for FCMs. This hourly burden arises from

    the requirement that FCMs make and maintain records documenting

    compliance related to clearing member risk management.

    Number of registrants: 134.

    Frequency of collection: As needed.

    Estimated number of annual responses per registrant: 1.

    Estimated aggregate number of annual responses: 134.

    Estimated annual hour burden per registrant: 20 hours.

    Estimated aggregate annual hour burden: 2,680 burden hours [134

    registrants x 20 hours per registrant].

    Based upon the above, the aggregate hour burden cost for all

    registrants is 135,716 burden hours and $13,571,600 [227,416 x $100 per

    hour].

    In addition to the per hour burden discussed above, the Commission

    anticipates that SDs, MSPs, and FCMs may incur certain start-up costs

    in connection with the recordkeeping obligations. Such costs may

    include the expenditures related to re-programming or updating existing

    recordkeeping technology and systems to enable the SD, MSP, or FCM to

    collect, capture,

    [[Page 21306]]

    process, maintain, and re-produce any newly required records. The

    Commission believes that SDs, MSPs, and FCMs generally could adapt

    their current infrastructure to accommodate the new or amended

    technology and thus no significant infrastructure expenditures would be

    needed. The Commission estimates the programming burden hours

    associated with technology improvements to be 60 hours.

    According to recent Bureau of Labor Statistics, the mean hourly

    wages of computer programmers under occupation code 15-1021 and

    computer software engineers under program codes 15-1031 and 1032 are

    between $34.10 and $44.94.\127\ Because SDs, MSPs, and FCMs generally

    will be large entities that may engage employees with wages above the

    mean, the Commission has conservatively chosen to use a mean hourly

    programming wage of $60 per hour. Accordingly, the start-up burden

    associated with the required technological improvements is $3,600 [$60

    x 60 hours] per affected registrant or $932,400 [$3,600 x 259

    registrants] in the aggregate.

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    List of Subjects

    17 CFR Part 1

    Conflicts of interest, Futures commission merchants, Major swap

    participants, Swap dealers.

    17 CFR Part 23

    Conflicts of interests, Futures commission merchants, Major swap

    participants, Swap dealers.

    17 CFR Part 37

    Swaps, Swap execution facilities.

    17 CFR Part 38

    Block transaction, Commodity futures, Designated contract markets,

    Transactions off the centralized market.

    17 CFR Part 39

    Derivatives clearing organizations, Risk management, Swaps.

    For the reasons stated in the preamble, amend 17 CFR parts 1, 23,

    37, 38, and 39 as follows:

    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    0

    1. Revise the authority citation for part 1 to read as follows:

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

    6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,

    9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as

    amended by Title VII of the Dodd-Frank Wall Street Reform and

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

    0

    2. Amend Sec. 1.35 by revising paragraph (a-1)(5)(iv) to read as

    follows:

    Sec. 1.35 Records of commodity interest and cash commodity

    transactions.

    * * * * *

    (a-1) * * *

    (5) * * *

    (iv) Allocation. Orders eligible for post-execution allocation must

    be allocated by an eligible account manager in accordance with the

    following:

    (A) Allocations must be made as soon as practicable after the

    entire transaction is executed, but in any event no later than the

    following times: For cleared trades, account managers must provide

    allocation information to futures commission merchants no later than a

    time sufficiently before the end of the day the order is executed to

    ensure that clearing records identify the ultimate customer for each

    trade. For uncleared trades, account managers must provide allocation

    information to the counterparty no later than the end of the calendar

    day that the swap was executed.

    (B) Allocations must be fair and equitable. No account or group of

    accounts may receive consistently favorable or unfavorable treatment.

    (C) The allocation methodology must be sufficiently objective and

    specific to permit independent verification of the fairness of the

    allocations using that methodology by appropriate regulatory and self-

    regulatory authorities and by outside auditors.

    * * * * *

    0

    3. Add Sec. 1.72 to read as follows:

    Sec. 1.72 Restrictions on customer clearing arrangements.

    No futures commission merchant providing clearing services to

    customers shall enter into an arrangement that:

    (a) Discloses to the futures commission merchant or any swap dealer

    or major swap participant the identity of a customer's original

    executing counterparty;

    (b) Limits the number of counterparties with whom a customer may

    enter into a trade;

    (c) Restricts the size of the position a customer may take with any

    individual counterparty, apart from an overall limit for all positions

    held by the customer at the futures commission merchant;

    (d) Impairs a customer's access to execution of a trade on terms

    that have a reasonable relationship to the best terms available; or

    (e) Prevents compliance with the timeframes set forth in Sec.

    1.74(b), Sec. 23.610(b), or Sec. 39.12(b)(7) of this chapter.

    0

    4. Add Sec. 1.73 to read as follows:

    Sec. 1.73 Clearing futures commission merchant risk management.

    (a) Each futures commission merchant that is a clearing member of a

    derivatives clearing organization shall:

    (1) Establish risk-based limits in the proprietary account and in

    each customer account based on position size, order size, margin

    requirements, or similar factors;

    (2) Screen orders for compliance with the risk-based limits in

    accordance with the following:

    (i) When a clearing futures commission merchant provides electronic

    market access or accepts orders for automated execution, it shall use

    automated means to screen orders for compliance with the limits;

    (ii) When a clearing futures commission merchant accepts orders for

    non-automated execution, it shall establish and maintain systems of

    risk controls reasonably designed to ensure compliance with the limits;

    (iii) When a clearing futures commission merchant accepts

    transactions that were executed bilaterally and then submitted for

    clearing, it shall establish and maintain systems of risk management

    controls reasonably designed to ensure compliance with the limits;

    (iv) When a firm executes an order on behalf of a customer but

    gives it up to another firm for clearing,

    (A) The clearing futures commission merchant shall establish risk-

    based limits for the customer, and enter into an agreement in advance

    with the executing firm that requires the executing firm to screen

    orders for compliance with those limits in accordance with paragraph

    (a)(2)(i) or (ii) as applicable; and

    (B) The clearing futures commission merchant shall establish and

    maintain systems of risk management controls reasonably designed to

    ensure compliance with the limits.

    (v) When an account manager bunches orders on behalf of multiple

    customers for execution as a block and post-trade allocation to

    individual accounts for clearing:

    (A) The futures commission merchant that initially clears the block

    shall establish risk-based limits for the block account and screen the

    order in accordance with paragraph (a)(2)(i) or (ii) as applicable;

    (B) The futures commission merchants that clear the allocated

    trades

    [[Page 21307]]

    on behalf of customers shall establish risk-based limits for each

    customer and enter into an agreement in advance with the account

    manager that requires the account manager to screen orders for

    compliance with those limits; and

    (C) The futures commission merchants that clear the allocated

    trades on behalf of customers shall establish and maintain systems of

    risk management controls reasonably designed to ensure compliance with

    the limits.

    (3) Monitor for adherence to the risk-based limits intra-day and

    overnight;

    (4) Conduct stress tests under extreme but plausible conditions of

    all positions in the proprietary account and in each customer account

    that could pose material risk to the futures commission merchant at

    least once per week;

    (5) Evaluate its ability to meet initial margin requirements at

    least once per week;

    (6) Evaluate its ability to meet variation margin requirements in

    cash at least once per week;

    (7) Evaluate its ability to liquidate, in an orderly manner, the

    positions in the proprietary and customer accounts and estimate the

    cost of the liquidation at least once per quarter; and

    (8) Test all lines of credit at least once per year.

    (b) Each futures commission merchant that is a clearing member of a

    derivatives clearing organization shall:

    (1) Establish written procedures to comply with this regulation;

    and

    (2) Keep full, complete, and systematic records documenting its

    compliance with this regulation.

    (3) All records required to be maintained pursuant to these

    regulations shall be maintained in accordance with Commission

    Regulation 1.31 (17 CFR 1.31) and shall be made available promptly upon

    request to representatives of the Commission and to representatives of

    applicable prudential regulators.

    0

    5. Add Sec. 1.74 to read as follows:

    Sec. 1.74 Futures commission merchant acceptance for clearing.

    (a) Each futures commission merchant that is a clearing member of a

    derivatives clearing organization shall coordinate with each

    derivatives clearing organization on which it clears to establish

    systems that enable the futures commission merchant, or the derivatives

    clearing organization acting on its behalf, to accept or reject each

    trade submitted to the derivatives clearing organization for clearing

    by or for the futures commission merchant or a customer of the futures

    commission merchant as quickly as would be technologically practicable

    if fully automated systems were used; and

    (b) Each futures commission merchant that is a clearing member of a

    derivatives clearing organization shall accept or reject each trade

    submitted by or for it or its customers as quickly as would be

    technologically practicable if fully automated systems were used; a

    clearing futures commission merchant may meet this requirement by:

    (1) Establishing systems to pre-screen orders for compliance with

    criteria specified by the clearing futures commission merchant;

    (2) Establishing systems that authorize a derivatives clearing

    organization to accept or reject on its behalf trades that meet, or

    fail to meet, criteria specified by the clearing futures commission

    merchant; or

    (3) Establishing systems that enable the clearing futures

    commission merchant to communicate to the derivatives clearing

    organization acceptance or rejection of each trade as quickly as would

    be technologically practicable if fully automated systems were used.

    0

    6. Add Sec. 1.75 to read as follows:

    Sec. 1.75 Delegation of authority to the Director of the Division of

    Clearing and Risk to establish an alternative compliance schedule to

    comply with futures commission merchant acceptance for clearing.

    (a) The Commission hereby delegates to the Director of the Division

    of Clearing and Risk or such other employee or employees as the

    Director may designate from time to time, the authority to establish an

    alternative compliance schedule for requirements of Sec. 1.74 for

    swaps that are found to be technologically or economically

    impracticable for an affected futures commission merchant that seeks,

    in good faith, to comply with the requirements of Sec. 1.74 within a

    reasonable time period beyond the date on which compliance by such

    futures commission merchant is otherwise required.

    (b) A request for an alternative compliance schedule under this

    section shall be acted upon by the Director of the Division of Clearing

    and Risk within 30 days from the time such a request is received, or it

    shall be deemed approved.

    (c) An exception granted under this section shall not cause a

    registrant to be out of compliance or deemed in violation of any

    registration requirements.

    (d) Notwithstanding any other provision of this section, in any

    case in which a Commission employee delegated authority under this

    section believes it appropriate, he or she may submit to the Commission

    for its consideration the question of whether an alternative compliance

    schedule should be established. Nothing in this section shall be deemed

    to prohibit the Commission, at its election, from exercising the

    authority delegated in this section.

    PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

    0

    7. Revise the authority citation for part 23 to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,

    9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

    0

    8. Add subpart I to read as follows:

    Subpart I--Swap Documentation

    Sec.

    23.500-23.505 [Reserved]

    23.506 Swap processing and clearing.

    Subpart I--Swap Documentation

    Sec. Sec. 23.500-23.505 [Reserved]

    Sec. 23.506 Swap processing and clearing.

    (a) Swap processing. (1) Each swap dealer and major swap

    participant shall ensure that it has the capacity to route swap

    transactions not executed on a swap execution facility or designated

    contract market to a derivatives clearing organization in a manner

    acceptable to the derivatives clearing organization for the purposes of

    clearing; and

    (2) Each swap dealer and major swap participant shall coordinate

    with each derivatives clearing organization to which the swap dealer,

    major swap participant, or its clearing member submits transactions for

    clearing, to facilitate prompt and efficient swap transaction

    processing in accordance with the requirements of Sec. 39.12(b)(7) of

    this chapter.

    (b) Swap clearing. With respect to each swap that is not executed

    on a swap execution facility or a designated contract market, each swap

    dealer and major swap participant shall:

    (1) If such swap is subject to a mandatory clearing requirement

    pursuant to section 2(h)(1) of the Act and an exception pursuant to

    2(h)(7) is not applicable, submit such swap for clearing to a

    derivatives clearing organization as soon as technologically

    practicable after execution of the swap, but no later than the close of

    business on the day of execution; or

    (2) If such swap is not subject to a mandatory clearing requirement

    pursuant to section 2(h)(1) of the Act but is accepted for clearing by

    any derivatives clearing organization and

    [[Page 21308]]

    the swap dealer or major swap participant and its counterparty agree

    that such swap will be submitted for clearing, submit such swap for

    clearing not later than the next business day after execution of the

    swap, or the agreement to clear, if later than execution.

    0

    9. Add Sec. 23.608 to subpart J, as added at 77 FR 20128, April 3,

    2012, effective June 4, 2012, to read as follows:

    Sec. 23.608 Restrictions on counterparty clearing relationships.

    No swap dealer or major swap participant entering into a swap to be

    submitted for clearing with a counterparty that is a customer of a

    futures commission merchant shall enter into an arrangement that:

    (a) Discloses to the futures commission merchant or any swap dealer

    or major swap participant the identity of a customer's original

    executing counterparty;

    (b) Limits the number of counterparties with whom a customer may

    enter into a trade;

    (c) Restricts the size of the position a customer may take with any

    individual counterparty, apart from an overall limit for all positions

    held by the customer with the swap dealer or major swap participant;

    (d) Impairs a customer's access to execution of a trade on terms

    that have a reasonable relationship to the best terms available; or

    (e) Prevents compliance with the timeframes set forth in Sec.

    1.74(b), Sec. 23.610(b), or Sec. 39.12(b)(7) of this chapter.

    0

    10. Add Sec. 23.609 to subpart J, as added at 77 FR 20128, April 3,

    2012, effective June 4, 2012, to read as follows:

    Sec. 23.609 Clearing member risk management.

    (a) With respect to clearing activities in futures, security

    futures products, swaps, agreements, contracts, or transactions

    described in section 2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act,

    commodity options authorized under section 4c of the Act, or leveraged

    transactions authorized under section 19 of the Act, each swap dealer

    or major swap participant that is a clearing member of a derivatives

    clearing organization shall:

    (1) Establish risk-based limits based on position size, order size,

    margin requirements, or similar factors;

    (2) Screen orders for compliance with the risk-based limits in

    accordance with the following:

    (i) For transactions subject to automated execution, the clearing

    member shall use automated means to screen orders for compliance with

    the risk-based limits; and

    (ii) For transactions subject to non-automated execution, the

    clearing member shall establish and maintain systems of risk controls

    reasonably designed to ensure compliance with the limits.

    (3) Monitor for adherence to the risk-based limits intra-day and

    overnight;

    (4) Conduct stress tests under extreme but plausible conditions of

    all positions at least once per week;

    (5) Evaluate its ability to meet initial margin requirements at

    least once per week;

    (6) Evaluate its ability to meet variation margin requirements in

    cash at least once per week;

    (7) Evaluate its ability to liquidate the positions it clears in an

    orderly manner, and estimate the cost of the liquidation; and

    (8) Test all lines of credit at least once per year.

    (b) Each swap dealer or major swap participant that is a clearing

    member of a derivatives clearing organization shall:

    (1) Establish written procedures to comply with this regulation;

    and

    (2) Keep full, complete, and systematic records documenting its

    compliance with this regulation.

    (3) All records required to be maintained pursuant to these

    regulations shall be maintained in accordance with Commission

    Regulation Sec. 1.31 and shall be made available promptly upon request

    to representatives of the Commission and to representatives of

    applicable prudential regulators.

    0

    11. Add Sec. 23.610 to subpart J, as added at 77 FR 20128, April 3,

    2012, effective June 4, 2012, to read as follows:

    Sec. 23.610 Clearing member acceptance for clearing.

    (a) Each swap dealer or major swap participant that is a clearing

    member of a derivatives clearing organization shall coordinate with

    each derivatives clearing organization on which it clears to establish

    systems that enable the clearing member, or the derivatives clearing

    organization acting on its behalf, to accept or reject each trade

    submitted to the derivatives clearing organization for clearing by or

    for the clearing member as quickly as would be technologically

    practicable if fully automated systems were used; and

    (b) Each swap dealer or major swap participant that is a clearing

    member of a derivatives clearing organization shall accept or reject

    each trade submitted by or for it as quickly as would be

    technologically practicable if fully automated systems were used; a

    clearing member may meet this requirement by:

    (1) Establishing systems to pre-screen orders for compliance with

    criteria specified by the clearing member;

    (2) Establishing systems that authorize a derivatives clearing

    organization to accept or reject on its behalf trades that meet, or

    fail to meet, criteria specified by the clearing member; or

    (3) Establishing systems that enable the clearing member to

    communicate to the derivatives clearing organization acceptance or

    rejection of each trade as quickly as would be technologically

    practicable if fully automated systems were used.

    0

    12. Add Sec. 23.611 to subpart J, as added at 77 FR 20128, April 3,

    2012, effective June 4, 2012, to read as follows:

    Sec. 23.611 Delegation of authority to the Director of the Division

    of Clearing and Risk to establish an alternative compliance schedule to

    comply with clearing member acceptance for clearing.

    (a) The Commission hereby delegates to the Director of the Division

    of Clearing and Risk or such other employee or employees as the

    Director may designate from time to time, the authority to establish an

    alternative compliance schedule for requirements of Sec. 23.610 for

    swaps that are found to be technologically or economically

    impracticable for an affected swap dealer or major swap participant

    that seeks, in good faith, to comply with the requirements of Sec.

    23.610 within a reasonable time period beyond the date on which

    compliance by such swap dealer or major swap participant is otherwise

    required.

    (b) A request for an alternative compliance schedule under this

    section shall be acted upon by the Director of the Division of Clearing

    and Risk within 30 days from the time such a request is received, or it

    shall be deemed approved.

    (c) An exception granted under this section shall not cause a

    registrant to be out of compliance or deemed in violation of any

    registration requirements.

    (d) Notwithstanding any other provision of this section, in any

    case in which a Commission employee delegated authority under this

    section believes it appropriate, he or she may submit to the Commission

    for its consideration the question of whether an alternative compliance

    schedule should be established. Nothing in this section shall be deemed

    to prohibit the Commission, at its election, from exercising the

    authority delegated in this section.

    [[Page 21309]]

    0

    13-14. Revise part 37 to read as follows:

    PART 37--SWAP EXECUTION FACILITIES

    Sec.

    Subparts A-G [Reserved]

    Subpart H--Financial Integrity of Transactions

    37.700 [Reserved]

    37.701 [Reserved]

    37.702 General financial integrity.

    37.703 [Reserved]

    Subparts I-K [Reserved]

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3 and 12a, as

    amended by the Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Pub. L. 111-203, 124 Stat. 1376.

    Subparts A-G [Reserved]

    Subpart H--Financial Integrity of Transactions

    Sec. 37.700 [Reserved]

    Sec. 37.701 [Reserved]

    Sec. 37.702 General financial integrity.

    (a) [Reserved]

    (b) For transactions cleared by a derivatives clearing

    organization:

    (1) By ensuring that the swap execution facility has the capacity

    to route transactions to the derivatives clearing organization in a

    manner acceptable to the derivatives clearing organization for purposes

    of clearing; and

    (2) By coordinating with each derivatives clearing organization to

    which it submits transactions for clearing, in the development of rules

    and procedures to facilitate prompt and efficient transaction

    processing in accordance with the requirements of Sec. 39.12(b)(7) of

    this chapter.

    Sec. 37.703 [Reserved]

    Subparts I-K [Reserved]

    PART 38--DESIGNATED CONTRACT MARKETS

    0

    15. Revise the authority citation for part 38 to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,

    6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as

    amended by the Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Pub. L. 111-203, 124 Stat. 1376.

    0

    16. Designate existing Sec. Sec. 38.1 through 38.6 as the contents of

    added subpart A under the following heading:

    Subpart A--General Provisions

    * * * * *

    0

    17. Add subpart L to read as follows:

    Subpart L--Financial Integrity of Transactions

    Sec.

    38.600 [Reserved]

    38.601 Mandatory clearing.

    38.602-38.606 [Reserved]

    Subpart L--Financial Integrity of Transactions

    Sec. 38.601 [Reserved]

    Sec. 38.601 Mandatory clearing.

    (a) Transactions executed on or through the designated contract

    market, other than transactions in security futures products, must be

    cleared through a registered derivatives clearing organization, in

    accordance with the provisions of part 39 of this chapter.

    (b) A designated contract market must coordinate with each

    derivatives clearing organization to which it submits transactions for

    clearing, in the development of rules and procedures to facilitate

    prompt and efficient transaction processing in accordance with the

    requirements of Sec. 39.12(b)(7) of this chapter.

    Sec. Sec. 38.602-38.606 [Reserved]

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    0

    18. Revise the authority citation for part 39 to read as follows:

    Authority: 7 U.S.C. 2, and 7a-1 as amended by the Dodd-Frank

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

    Stat. 1376.

    Subpart B--Compliance With Core Principles

    0

    19. In Sec. 39.12, add paragraphs (a)(1)(vi) and (b)(7) to read as

    follows:

    Sec. 39.12 Participant and product eligibility.

    (a) * * *

    (1) * * *

    (vi) No derivatives clearing organization shall require as a

    condition of accepting a swap for clearing that a futures commission

    merchant enter into an arrangement with a customer that:

    (A) Discloses to the futures commission merchant or any swap dealer

    or major swap participant the identity of a customer's original

    executing counterparty;

    (B) Limits the number of counterparties with whom a customer may

    enter into trades;

    (C) Restricts the size of the position a customer may take with any

    individual counterparty, apart from an overall limit for all positions

    held by the customer at the futures commission merchant;

    (D) Impairs a customer's access to execution of a trade on terms

    that have a reasonable relationship to the best terms available; or

    (E) Prevents compliance with the time frames set forth in Sec.

    1.74(b), Sec. 23.610(b), or Sec. 39.12(b)(7) of this chapter.

    * * * * *

    (b) * * *

    (7) Time frame for clearing. (i) Coordination with markets and

    clearing members.

    (A) Each derivatives clearing organization shall coordinate with

    each designated contract market and swap execution facility that lists

    for trading a product that is cleared by the derivatives clearing

    organization in developing rules and procedures to facilitate prompt,

    efficient, and accurate processing of all transactions submitted to the

    derivatives clearing organization for clearing.

    (B) Each derivatives clearing organization shall coordinate with

    each clearing member that is a futures commission merchant, swap

    dealer, or major swap participant to establish systems that enable the

    clearing member, or the derivatives clearing organization acting on its

    behalf, to accept or reject each trade submitted to the derivatives

    clearing organization for clearing by or for the clearing member or a

    customer of the clearing member as quickly as would be technologically

    practicable if fully automated systems were used.

    (ii) Transactions executed competitively on or subject to the rules

    of a designated contract market or swap execution facility. A

    derivatives clearing organization shall have rules that provide that

    the derivatives clearing organization will accept or reject for

    clearing as quickly after execution as would be technologically

    practicable if fully automated systems were used, all contracts that

    are listed for clearing by the derivatives clearing organization and

    are executed competitively on or subject to the rules of a designated

    contract market or a swap execution facility. The derivatives clearing

    organization shall accept all trades:

    (A) For which the executing parties have clearing arrangements in

    place with clearing members of the derivatives clearing organization;

    (B) For which the executing parties identify the derivatives

    clearing organization as the intended clearinghouse; and

    (C) That satisfy the criteria of the derivatives clearing

    organization, including but not limited to applicable

    [[Page 21310]]

    risk filters; provided that such criteria are non-discriminatory across

    trading venues and are applied as quickly as would be technologically

    practicable if fully automated systems were used.

    (iii) Swaps not executed on or subject to the rules of a designated

    contract market or a swap execution facility or executed non-

    competitively on or subject to the rules of a designated contract

    market or a swap execution facility. A derivatives clearing

    organization shall have rules that provide that the derivatives

    clearing organization will accept or reject for clearing as quickly

    after submission to the derivatives clearing organization as would be

    technologically practicable if fully automated systems were used, all

    swaps that are listed for clearing by the derivatives clearing

    organization and are not executed on or subject to the rules of a

    designated contract market or a swap execution facility or executed

    non-competitively on or subject to the rules of a designated contract

    market or a swap execution facility. The derivatives clearing

    organization shall accept all trades:

    (A) That are submitted by the parties to the derivatives clearing

    organization, in accordance with Sec. 23.506 of this chapter;

    (B) For which the executing parties have clearing arrangements in

    place with clearing members of the derivatives clearing organization;

    (C) For which the executing parties identify the derivatives

    clearing organization as the intended clearinghouse; and

    (D) That satisfy the criteria of the derivatives clearing

    organization, including but not limited to applicable risk filters;

    provided that such criteria are non-discriminatory across trading

    venues and are applied as quickly as would be technologically

    practicable if fully automated systems were used.

    * * * * *

    Issued in Washington, DC, on March 20, 2012, by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    Appendices to Customer Clearing Documentation, Timing of Acceptance for

    Clearing, and Clearing Member Risk Management--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 Sommers,

    Chilton, and Wetjen voted in the affirmative; Commissioner O'Malia

    voted in the negative.

    Appendix 2--Statement of Chairman Gensler

    I support today's final rulemaking on clearing which will

    promote market participants' access to central clearing, increase

    market transparency, foster competition, support market efficiency,

    and bolster risk management. These rules include provisions on

    client clearing documentation, so-called `straight-through'

    processing, bunched orders, and clearing member risk management.

    These final rules have all benefited from broad public comment.

    One of the primary goals of the Dodd-Frank Wall Street Reform

    and Consumer Protection Act (Dodd-Frank Act) is to lower risks to

    the public by increasing the use of central clearing and to promote

    the financial integrity of the markets and the clearing system.

    These rules are an important step in furtherance of these goals.

    First, the final rule does so by establishing requirements for

    the documentation between a Futures Commission Merchant (FCM) and

    its customers and between a Swap Dealer and its counterparties. This

    rule will foster bilateral clearing arrangements between customers

    and their FCM. The rule will promote competition in the provision of

    clearing services and swap liquidity to the broad public by limiting

    one FCM or Swap Dealer from restricting a customer or counterparty

    access to other market participants.

    Second, the final rule does so by setting standards for the

    timely processing of trades through so-called `straight-through'

    processing or sending transactions promptly to the clearinghouse

    upon execution. This lowers risk to the markets by minimizing the

    time between submission and acceptance or rejection of trades for

    clearing. These regulations would require and establish uniform

    standards for prompt processing, submission and acceptance for

    clearing of swaps eligible for clearing. Such uniform standards,

    similar to the practices in the futures markets, lower risk because

    they allow market participants to get the prompt benefit of clearing

    rather than having to first enter into a bilateral transaction that

    would subsequently be moved into a clearinghouse.

    Third, the final rule does so by allowing asset managers to

    allocate bunched orders for swaps consistent with long established

    rules for allocating bunched orders for futures. This will help

    promote access to clearing of swaps for pension funds, mutual funds

    and other clients of asset managers.

    Lastly, the final rule does so by strengthening the risk

    management procedures of clearing members. One of the primary goals

    of the Dodd-Frank Act was to reduce the risk that swaps pose to the

    economy. The final rule would require clearing members that are

    FCMs, Swap Dealers, and major swap participants to establish risk-

    based limits on their customer and house accounts. The rule also

    would require clearing members to establish procedures to, amongst

    other provisions, evaluate their ability to meet margin

    requirements, as well as liquidate positions as needed. These risk

    filters and procedures would help secure the financial integrity of

    the markets and the clearing system.

    [FR Doc. 2012-7477 Filed 4-6-12; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: April 9, 2012



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