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, [email protected], and Christopher A. Hower, Attorney-Advisor,

202-418-6703, [email protected], 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, [email protected], 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.

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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).

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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\

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

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

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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.

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\29\ See ISDA.

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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\

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\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).

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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\

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\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).

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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\

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\36\ See 75 FR at 80618.

\37\ See 76 FR 13101.

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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\

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

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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\

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

International Swaps and Derivatives Association, dated April 8,

2011.

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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.

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\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.

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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.

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

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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.

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

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

Spring Trading, Trading Firms, and Vizier.

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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.

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

Association, dated April 19, 2011.

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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\

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\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).

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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.

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

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

FHLB; Jeffries; Arbor; and Javelin.

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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\

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\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).

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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.

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\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.

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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.

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\53\ See 76 FR 45730, Aug. 1, 2011.

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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\

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\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.

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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.

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\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).

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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.

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\57\ 7 U.S.C. 19(a).

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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.

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\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).

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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.

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\62\ See Sec. Sec. 1.72, 23.608, and 39.12(a).

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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.

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\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.

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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.

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\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.

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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.

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\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.

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a. Protection of Market Participants \66\ and the Public

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\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).

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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.

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\67\ See 76 FR 45730, Aug. 1, 2011.

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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.

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\68\ See MFA, Arbor, SIFMA, D. E. Shaw, AIMA, and Vizer.

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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\

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\69\ See AllianceBernstein, Citadel, D. E. Shaw, MFA, SIFMA, and

Vanguard.

\70\ See Vanguard.

\71\ See e.g., Citadel, Alliance Bernstein, and MFA.

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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.

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\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.

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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.

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\73\ See e.g., AIMA, SIFMA, Vanguard, and MFA.

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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\

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\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.

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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\

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\75\ See section 2, Timing of Acceptance of Trades for Clearing,

below.

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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.

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\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.

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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.

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\82\ See AllianceBernstein, Citadel, D. E. Shaw, MFA, SIFMA, and

Vanguard.

\83\ See also MFA, Citadel.

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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.

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\84\ See SDMA, AIMA, Trading Firms, MFA, Arbor, DRW, and

Jeffries.

\85\ See AIMA, Trading Firms, CIEBA, Citadel.

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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\

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\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.

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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.

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[[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\

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\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.

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\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.

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\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.

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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\

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\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.

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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.

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\112\ See section IV.B(2)(a), above.

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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\

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\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.

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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.

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\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).

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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.

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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.

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\117\ 47 FR 18618 (Apr. 30, 1982).

\118\ Id. at 18619.

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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.

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\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).

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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\

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\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.

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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.

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\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.

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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.

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\124\ 44 U.S.C. 3501 et seq.

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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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\125\ http://www.bls.gov/oes/current/oes113031.htm.

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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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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