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2010-25322

  • FR Doc 2010-25322[Federal Register: October 14, 2010 (Volume 75, Number 198)]

    [Proposed Rules]

    [Page 63113-63120]

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

    [DOCID:fr14oc10-27]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 39 and 140

    RIN 3038-AC98, 3038-AD02

    Financial Resources Requirements for Derivatives Clearing

    Organizations

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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    SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

    is proposing rules to implement new statutory provisions enacted by

    Title VII and Title VIII of the Dodd-Frank Wall Street Reform and

    Consumer Protection Act (Dodd-Frank Act). The proposed regulations

    establish financial resources requirements for derivatives clearing

    organizations (DCOs) for the purpose of ensuring that they maintain

    sufficient financial resources to enable them to perform their

    functions in compliance with the Commodity Exchange Act and the Dodd-

    Frank Act.

    DATES: Submit comments on or before December 13, 2010.

    ADDRESSES: You may submit comments, identified by RIN number, by any of

    the following methods:

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow the instructions for submitting comments.

    Agency Web Site: http://www.cftc.gov. Follow the

    instructions for submitting comments on the Web site.

    E-mail: DCOSIDCOfinres@cftc.gov. Include the RIN number in

    the subject line of the message.

    Fax: 202-418-5521.

    Mail: David A. Stawick, Secretary of the Commission,

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

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    All comments must be submitted in English, or if not, accompanied

    by an English translation. Comments will be posted as received to

    http://www.cftc.gov. You should submit only information that you wish

    to make available publicly. If you wish the Commission to consider

    information that may be exempt from disclosure under the Freedom of

    Information Act, a petition for confidential treatment of the exempt

    information may be submitted according to the established procedures in

    CFTC Regulation 145.9.\1\

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    \1\ Commission regulations referred to herein are found at 17

    CFR Ch. 1.

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

    Chief Counsel, 202-418-5480, jlawton@cftc.gov, Phyllis P. Dietz,

    Associate Director, 202-418-5449, pdietz@cftc.gov, or Eileen A.

    Donovan, Special Counsel, 202-418-5096, edonovan@cftc.gov, Division of

    Clearing and Intermediary Oversight, Commodity Futures Trading

    Commission, Three Lafayette Centre, 1155 21 Street, NW., Washington, DC

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    20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    A. Title VII

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\2\

    Title VII of the Dodd-Frank Act \3\ amended the Commodity Exchange Act

    (CEA) \4\ to establish a comprehensive regulatory framework 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 all

    registered entities and intermediaries subject to the Commission's

    oversight.

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    \2\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

    Dodd-Frank Act may be accessed at http://www.cftc.gov./

    LawRegulation/OTCDERIVATIVES/index.htm.

    \3\ Pursuant to Section 701 of the Dodd-Frank Act, Title VII may

    be cited as the ``Wall Street Transparency and Accountability Act of

    2010.''

    \4\ 7 U.S.C. 1 et seq.

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    Section 725(c) of the Dodd-Frank Act amends Section 5b(c)(2) of the

    CEA, which sets forth core principles with which a DCO must comply to

    be registered and to maintain registration as a DCO.

    The core principles were added to the CEA by the Commodity Futures

    Modernization Act of 2000 (CFMA).\5\ Consistent with the CFMA's

    principles-based approach to regulation, the Commission did not adopt

    implementing rules and regulations, but instead promulgated guidance

    for DCOs on compliance with the core principles.\6\ However under

    Section 5b(c)(2), as amended by the Dodd-Frank Act, Congress expressly

    confirmed that the Commission may adopt implementing rules and

    regulations pursuant to its rulemaking authority under Section 8a(5) of

    the CEA.\7\

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    \5\ See Commodity Futures Modernization Act of 2000, Public Law

    106-554, 114 Stat. 2763 (2000).

    \6\ See Appendix A to Part 39, 17 CFR Part 39. The Commission

    notes that it intends to propose removal of Appendix A, in its

    entirety, as part of a future proposed rulemaking.

    \7\ 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 CEA.

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    The Commission continues to believe that, where possible, each DCO

    should be afforded an appropriate level of discretion in determining

    how to operate its business within the statutory framework. At the same

    time, the Commission recognizes that specific bright-line regulations

    may be necessary in order to facilitate DCO compliance with a given

    core principle, and ultimately, to protect the integrity of the U.S.

    clearing system. Accordingly, in developing the proposed regulation,

    the Commission has endeavored to strike an appropriate balance between

    establishing general prudential standards and prescriptive

    requirements.

    Core Principle B, as amended by the Dodd-Frank Act, requires a DCO

    to possess financial resources that, at a minimum, exceed the total

    amount that would enable the DCO to meet its financial obligations to

    its clearing members \8\ notwithstanding a default by

    [[Page 63114]]

    the clearing member creating the largest financial exposure for the DCO

    in extreme but plausible market conditions; and enable the DCO to cover

    its operating costs for a period of 1 year, as calculated on a rolling

    basis. The Commission is proposing to adopt Regulation 39.11 to

    establish requirements that a DCO will have to meet in order to comply

    with Core Principle B.

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    \8\ The term ``clearing members'' refers to entities that have a

    direct financial relationship to a DCO, regardless of the DCO's

    organizational structure, i.e., whether or not the DCO is a

    membership organization. Clearing members include futures commission

    merchants (FCMs) that clear on behalf of customers or themselves,

    and non-FCMs that clear solely on behalf of themselves. See also the

    definition of the term ``clearing member'' in CFTC Regulation

    1.3(c).

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    B. Title VIII

    Section 802(b) of the Dodd-Frank Act states that the purpose of

    Title VIII is to mitigate systemic risk in the financial system and to

    promote financial stability. Section 804 authorizes the Financial

    Stability Oversight Council (Council) to designate entities involved in

    clearing and settlement as systemically important.\9\

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    \9\ Commission staff has been engaged in discussions with staff

    of other members of the Council concerning which entities might

    qualify.

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    Section 805(a) of the Dodd-Frank Act allows the Commission to

    prescribe regulations for those DCOs that the Council has determined

    are systemically important. The Commission is also proposing to adopt

    some additional or enhanced requirements for systemically important

    DCOs (SIDCOs).

    The Commission requests comment on all aspects of the proposed

    rules, as well as comment on the specific provisions and issues

    highlighted in the discussion below. The Commission further requests

    comment on an appropriate effective date for final rules, once adopted.

    II. Proposed Regulations

    A. DCOs

    1. Amount of Financial Resources Required

    As a central counterparty, a DCO must have sufficient financial

    resources to be able to withstand a potential default by one of its

    clearing members.\10\ In the event of a default, a DCO would continue

    to have obligations to the clearing members that are owed variation

    settlement payments and, therefore, the DCO must have sufficient liquid

    resources to meet those obligations in a timely fashion. Proposed

    Regulation 39.11(a)(1) would require a DCO to maintain sufficient

    financial resources to meet its financial obligations to its clearing

    members notwithstanding a default by the clearing member creating the

    largest financial exposure for the DCO in extreme but plausible market

    conditions. This standard is consistent with the standard set forth in

    Core Principle B, and is also consistent with current international

    standards.\11\

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    \10\ Each DCO determines for itself what constitutes a

    ``default,'' but generally a clearing member is considered to be in

    default when it fails to fulfill any obligation to the DCO.

    \11\ In November 2004, the Task Force on Securities Settlement

    Systems, jointly established by the Committee on Payment and

    Settlement Systems (CPSS) of the central banks of the Group of Ten

    countries and the Technical Committee of the International

    Organization of Securities Commissions (IOSCO), issued its

    Recommendations for Central Counterparties. Under Recommendation 5,

    a central counterparty must maintain sufficient financial resources

    to withstand, at a minimum, a default by the participant to which it

    has the largest exposure in extreme but plausible market conditions.

    However, the Commission notes that CPSS and IOSCO are currently

    reviewing this standard and it may be revised.

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    There may be some instances in which one clearing member controls

    another clearing member or in which a clearing member is under common

    control with another clearing member. The Commission proposes to treat

    such affiliated clearing members as a single entity for purposes of

    determining the largest financial exposure because the default of one

    affiliate could have an impact on the ability of the other to meet its

    financial obligations to the DCO.\12\ However, to the extent that each

    affiliated clearing member is treated as a separate entity by the DCO,

    with separate capital requirements, separate guaranty fund obligations,

    and separate potential assessment liability, the Commission requests

    comment on whether a different approach might be warranted.

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    \12\ For example, the positions of each clearing member would be

    margined separately and would be stress tested separately. However,

    losses of each would be aggregated and gains would not offset

    losses.

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    Separately, proposed Regulation 39.11(a)(2) would require a DCO to

    maintain sufficient financial resources to cover its operating costs

    for at least one year, calculated on a rolling basis. This standard is

    consistent with the standard set forth in amended Core Principle B. It

    is also consistent with established accounting standards, under which

    an entity's ability to continue as a going concern comes into question

    if there is evidence that the entity may be unable to continue to meet

    its obligations in the next 12 months without substantial disposition

    of assets outside the ordinary course of business, restructuring of

    debt, externally forced revisions of its operations, or similar

    actions.\13\

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    \13\ See American Institute of Certified Public Accountants

    Auditing Standards Board Statement of Auditing Standards No. 59, The

    Auditor's Consideration of an Entity's Ability to Continue as a

    Going Concern, as amended.

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    2. Types of Financial Resources

    a. Default Resources

    Proposed Regulation 39.11(b)(1) lists the types of financial

    resources that would be available to a DCO to satisfy the requirements

    of proposed Regulation 39.11(a)(1): (1) The margin of the defaulting

    clearing member; (2) the DCO's own capital; (3) the guaranty fund

    deposits of the defaulting clearing member and non-defaulting clearing

    members; (4) default insurance; (5) if permitted by the DCO's rules,

    potential assessments for additional guaranty fund contributions on

    non-defaulting clearing members; and (6) any other financial resource

    deemed acceptable by the Commission. A DCO would be able to request an

    informal interpretation from CFTC staff on whether or not a particular

    financial resource may be acceptable to the Commission.

    In the event of a default by one of its clearing members, a DCO

    would first seize the margin of the defaulting clearing member. If the

    margin were insufficient to cure the default, the DCO might use its own

    capital to cover the shortfall. Currently, Commission regulations do

    not prescribe capital requirements for DCOs. The Commission invites

    comment on whether it should consider adopting such requirements and if

    so, what those requirements should be.

    Clearing members also are typically required to maintain a deposit,

    in the form of cash and/or securities, in a guaranty fund, which may be

    used by the DCO to cover any loss sustained as a result of the failure

    of a clearing member to discharge its obligations to the DCO. In the

    event of a default, the DCO may draw on the defaulting clearing

    member's deposit to satisfy its counterparty obligations. If the

    deposit is insufficient, the DCO may draw on the guaranty fund deposits

    of non-defaulting clearing members.

    In addition, a DCO may have an assessment power that allows it to

    demand additional funds from non-defaulting clearing members, up to a

    specified amount, if the guaranty fund has been exhausted. The size of

    a clearing member's potential assessment obligation is usually

    established by a formula set forth in the DCO's rules.

    Unlike margin or a guaranty fund, assessment powers are not

    resources on

    [[Page 63115]]

    hand but a promise to pay. A clearing member, however, may have a

    strong financial incentive to pay an assessment. If a clearing member

    failed to pay its assessment obligation, that failure would be treated

    as a default and the clearing member would be subject to liquidation of

    its positions and forfeiture of the margin in its proprietary account.

    Thus, in addition to a potential general interest in maintaining the

    viability of the DCO going forward, a non-defaulting clearing member

    may have a specific incentive to pay an assessment depending on the

    size and profitability of its positions and the margin on deposit

    relative to the size of the assessment.

    No U.S. futures clearinghouse has ever had to exercise its

    assessment power. In light of the apparent low probability of a default

    of such magnitude as to require assessments, the use of assessment

    power as a backstop rather than increasing the size of guaranty funds

    seems to have been an efficient allocation of capital. The growth in

    clearing of swaps, however, creates new risks that the Commission must

    evaluate.

    The Commission is proposing that DCOs put rules and procedures in

    place to ensure timely payment of assessments by clearing members.

    First, each DCO must require its clearing members to have the ability

    to meet an assessment within the time frame of a normal variation

    settlement cycle. Second, each DCO must monitor, on a continual basis,

    each clearing member's financial and operational capacity to pay

    potential assessments.

    As discussed below, the Commission is proposing to limit the degree

    to which assessment powers may be considered to be an available

    financial resource. The Commission invites comment on whether these

    limits and requirements are appropriate. More generally, the Commission

    is also seeking comment on whether assessment powers should be

    considered to be a financial resource available to satisfy the

    requirements of proposed Regulation 39.11(a)(1).

    b. Operating Resources

    Proposed Regulation 39.11(b)(2) lists the types of financial

    resources that would be available to a DCO to satisfy the requirements

    of proposed Regulation 39.11(a)(2): (1) The DCO's own capital; and (2)

    any other financial resource deemed acceptable by the Commission. A DCO

    would be able to request an informal interpretation from CFTC staff on

    whether or not a particular financial resource may be acceptable to the

    Commission. The Commission invites commenters to recommend particular

    financial resources, and explain the basis, for inclusion in the final

    regulation. In this regard, the Commission notes that the proposed rule

    does not specify that a DCO must hold equity capital. The Commission

    requests comment on whether such a provision would be appropriate.

    c. Allocation of Resources

    Proposed Regulation 39.11(b)(3) would allow a DCO to allocate a

    financial resource, in whole or in part, to satisfy the requirements of

    either proposed Regulation 39.11(a)(1) (default risk) or proposed

    Regulation 39.11(a)(2) (operating costs), but not both, and only to the

    extent the use of that financial resource is not otherwise limited by

    the CEA, Commission regulations, the DCO's rules, or any contractual

    arrangements to which the DCO is a party. In the event that a default

    would force a DCO to cease operations, the DCO would need sufficient

    financial resources to cover the default and conduct an orderly wind

    down of its business.

    3. Computation of the Financial Resources Requirement

    Proposed Regulation 39.11(c)(1) would require a DCO to perform

    stress testing on a monthly basis in order to make a reasonable

    calculation of the financial resources it needs to meet the

    requirements of proposed Regulation 39.11(a)(1). In the first instance,

    the DCO would have reasonable discretion in determining the methodology

    it uses to make the calculation.\14\ Because effective stress testing

    involves a great deal of judgment, the Commission is not proposing that

    DCOs test a particular scenario. Rather, the proposed regulation

    requires DCOs to take into account both historical data and

    hypothetical situations. (By definition, a stress test using only

    historical data would never cover a market move setting a new record.)

    Within those guidelines, DCOs would have discretion in selecting

    scenarios, subject to Commission review.

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    \14\ This is consistent with DCO Core Principle A, which gives a

    DCO ``reasonable discretion in establishing the manner in which it

    complies with the core principles.'' See Section 5b(c)(2)(A) of the

    CEA, 7 U.S.C. 7a-1(c)(2)(A).

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    The Commission would review the methodology and require changes as

    appropriate. The methodology must address any unique risks associated

    with particular products, such as the jump to default risk and

    compounding effects of credit default swaps.

    Because of the comprehensive nature of the stress tests required

    for determining the size of the financial resources package, the

    Commission is proposing that these tests be conducted monthly. As will

    be discussed in a later rulemaking,\15\ the Commission is likely to

    require more frequent stress testing in connection with DCO risk

    management programs. Such tests would be conducted for different

    purposes and might use different inputs. The Commission requests

    comment on whether monthly tests are appropriate for purposes of

    calculating required financial resources.

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    \15\ The Commission will propose, at a later time, additional

    regulations to implement Core Principle D (risk management).

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    Proposed Regulation 39.11(c)(2) would require a DCO to make a

    reasonable calculation each month of the financial resources it needs

    to meet the requirements of proposed Regulation 39.11(a)(2). In the

    first instance, the DCO would have reasonable discretion in determining

    the methodology it uses to make the calculation. However, the

    Commission may review the methodology and require changes as

    appropriate.

    4. Valuation of Financial Resources

    Proposed Regulation 39.11(d)(1) would require a DCO, no less

    frequently than monthly, to calculate the current market value of each

    financial resource used to meet its obligations under proposed

    Regulation 39.11(a). A DCO would be required to perform the valuation

    at other times as appropriate, because market values may fluctuate and

    proposed Regulation 39.11(a) requires the DCO to be able to meet its

    obligations on a rolling basis. When valuing a financial resource, a

    DCO would be required to reduce the value, as appropriate, to reflect

    any market or credit risk specific to that particular resource, i.e.,

    apply a haircut. The Commission would permit each DCO to exercise its

    discretion in determining the applicable haircuts. However, such

    haircuts would have to be evaluated on a quarterly basis, would be

    subject to Commission review, and would have to be acceptable to the

    Commission.

    Notwithstanding a DCO's general discretion in applying haircuts,

    proposed Regulation 39.11(d)(2)(i) would require a 30 percent haircut

    on the value of a DCO's assessment power. This is because in the event

    of a default, the defaulting clearing member would not be able to pay

    its assessment and other clearing members might also be unable or

    unwilling to pay. Based on the significant percentage of total margin

    that may be attributable to a few of the largest clearing members,

    failure to pay

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    assessments could approach the 30 percent level. The Commission invites

    comment on whether this proposed valuation of assessments is

    appropriate.

    To further increase the likelihood that the DCO will have resources

    immediately available to meet a default, the Commission is proposing

    that, in calculating the financial resources available to meet its

    obligations, a DCO may only count the value of assessments, after the

    haircut, to meet up to 20 percent of the resources requirement

    generated by the stress testing. The Commission requests comment on

    this restriction.

    5. Liquidity of Financial Resources

    In assessing the adequacy of a DCO's financial resources, the

    liquidity of resources must be considered. For example, the time span

    of an intra-day settlement cycle (from the time positions are marked to

    market until the time clearing members are required to pay) may be only

    a few hours. In the event of a clearing member defaulting on a payment

    to the DCO during the intra-day settlement cycle, the DCO would need

    access to liquid assets easily convertible to cash. DCOs often use

    committed lines of credit to provide this liquidity.

    Proposed Regulation 39.11(e)(1) would require a DCO to have

    financial resources sufficiently liquid to enable the DCO to fulfill

    its obligations as a central counterparty during a one-day settlement

    cycle.

    In particular, the proposed regulations would require a DCO to have

    sufficient capital in the form of cash to cover the average daily

    settlement variation pay per clearing member over the last fiscal

    quarter. For purposes of this calculation, if a clearing member had

    pays in both its house and customer accounts, the amount would be the

    sum of the two pays. If the clearing member had a pay in its house

    account and a collect in its customer account, the amount would be that

    of the house pay. If the clearing member had collects in both of its

    accounts, that day's variation settlement would not be included in the

    calculation. The DCO would be permitted to take into account a

    committed line of credit or similar facility for the purpose of meeting

    the remainder of the liquidity requirement.

    The Commission requests comment on the proposed liquidity

    standards. In particular, the Commission requests comment on whether

    the liquidity requirement should cover more than a one-day cycle. The

    Commission also requests comment on what standards might be applicable

    to lines of credit. For example, should the Commission require that

    there be a diversified set of providers or that a line of credit have

    same-day drawing rights?

    Proposed Regulation 39.11(e)(2) would require DCOs to maintain

    unencumbered liquid financial assets in the form of cash or highly

    liquid securities, equal to six months' operating costs. The Commission

    believes that having six months' worth of unencumbered liquid financial

    assets would give a DCO time to liquidate the remaining financial

    assets it would need to continue operating for the last six months of

    the required one-year period. If a DCO does not have six months' worth

    of unencumbered liquid financial assets, it may use a committed line of

    credit or similar facility to satisfy this requirement.

    The Commission notes that a committed line of credit or similar

    facility is not listed in proposed Regulations 39.11(b)(1) or

    39.8(b)(2) as a financial resource available to a DCO to satisfy the

    requirements of proposed Regulations 39.11(a)(1) and 39.11(a)(2),

    respectively. A DCO may only use a committed line of credit or similar

    facility to meet the liquidity requirements set forth in proposed

    Regulations 39.11(e)(1) and 39.11(e)(2).

    To the extent that a DCO relies on a guaranty fund, adequate

    liquidity is crucial. To address liquidity concerns, proposed

    Regulation 39.11(e)(3) provides that: (i) Assets in a guaranty fund

    must have minimal credit, market, and liquidity risks and must be

    readily accessible on a same-day basis, (ii) cash balances must be

    invested or placed in safekeeping in a manner that bears little or no

    principal risk, and (iii) letters of credit are not a permissible asset

    for a guaranty fund.

    6. Reporting Requirements

    Under proposed Regulation 39.11(f)(1), at the end of each fiscal

    quarter, or at any time upon Commission request, a DCO would be

    required to report to the Commission: (i) The amount of financial

    resources necessary to meet the requirements set forth in the

    regulation; and (ii) the value of each financial resource available to

    meet those requirements. The DCO would have to include with its report

    a financial statement, including the balance sheet, income statement,

    and statement of cash flows, of the DCO or its parent company (if the

    DCO does not have an independent financial statement and the parent

    company's financial statement is prepared on a consolidated basis). If

    one of the financial resources a DCO is using to meet the regulation's

    requirements is a guaranty fund, the DCO would also have to report the

    value of each individual clearing member's guaranty fund deposit.

    Proposed Regulation 39.11(f)(2) requires a DCO to provide the

    Commission with sufficient documentation that explains both the

    methodology it used to calculate its financial requirements and the

    basis for its determinations regarding valuation and liquidity. The DCO

    also must provide copies of any agreements establishing or amending a

    credit facility, insurance coverage, or other arrangement that

    evidences or otherwise supports its conclusions. The sufficiency of the

    documentation would be determined by the Commission in its sole

    discretion.

    A DCO would have 17 business days\16\ from the end of the fiscal

    quarter to file its report, but would also be able to request an

    extension of time from the Commission.

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    \16\ This filing deadline is consistent with the deadline

    imposed on FCMs for the filing of monthly financial reports. See 17

    CFR 1.10(b).

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    B. SIDCOs

    As DCOs, SIDCOs would remain subject to the requirements of Title

    VII and the regulations thereunder, except to the extent the Commission

    promulgated higher standards pursuant to Title VIII. With regard to

    Core Principle B, the Commission is proposing higher standards in two

    respects, as described below.

    1. Amount of Financial Resources Required

    Because the failure of a SIDCO to meet its obligations would have a

    greater impact on the financial system than the failure of other DCOs,

    the Commission is proposing that SIDCOs be required to meet a higher

    standard. Specifically, proposed Regulation 39.29(a) would require a

    SIDCO to maintain sufficient financial resources to meet its financial

    obligations to its clearing members notwithstanding a default by the

    two clearing members creating the largest combined financial exposure

    for the SIDCO in extreme but plausible market conditions.

    A fundamental premise of the Dodd-Frank Act is that more over-the-

    counter (OTC) products must be brought into the cleared environment.

    Although no U.S. futures clearinghouse has ever had more than one

    clearing member default at a time, the size and complexity of the OTC

    derivatives markets may increase the chance that more than one clearing

    member could default simultaneously. Consequently, the Commission has

    determined that SIDCOs should be

    [[Page 63117]]

    subject to regulations that increase their ability to contain the

    effects of such defaults.

    2. Valuation of Financial Resources

    In order to add another layer of protection for SIDCOs, proposed

    Regulation 39.29(b) would require that a SIDCO may not count the value

    of assessments to meet the obligations arising from a default by the

    clearing member creating the single largest financial exposure. This

    means that a SIDCO would be required to hold a greater percentage of

    its financial resources in margin and the guaranty fund than a DCO that

    is not a SIDCO.

    However, because the Commission believes that assessment powers can

    be a capital efficient means of providing a back-up source of funding,

    the Commission is proposing to permit SIDCOs to count the value of

    assessments, after the 30 percent haircut, to meet up to 20 percent of

    the obligations arising from a default by the clearing member creating

    the second largest financial exposure. This is the standard proposed

    for non-systemically important DCOs in connection with the largest

    potential exposure.

    The Commission requests comment on the proposed higher standards

    for SIDCOs. In particular, the Commission requests comment on the

    potential competitive effects of imposing higher standards on a subset

    of DCOs.

    III. Technical Amendments

    Proposed Regulation 140.94 would allow the Commission to delegate

    the authority to perform certain functions that are reserved to the

    Commission under proposed Regulation 39.11. Specifically, the Director

    of the Division of Clearing and Intermediary Oversight would be given

    the authority to deem a financial resource acceptable under proposed

    Regulations 39.11(b)(1)(vi) and (b)(2)(ii); to review methodology and

    require changes under proposed Regulations 39.11(c)(1) and (c)(2); to

    request information under proposed Regulation 39.11(f)(1); and to grant

    an extension of the filing deadline for financial reports in accordance

    with proposed Regulation 39.11(f)(4).

    IV. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies

    consider whether the rules they propose will have a significant

    economic impact on a substantial number of small entities and, if so,

    provide a regulatory flexibility analysis respecting the impact.\17\

    The rules proposed by the Commission will affect only DCOs (some of

    which will be designated as SIDCOs). The Commission has previously

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

    Commission in evaluating the impact of its regulations on small

    entities in accordance with the RFA.\18\ The Commission has previously

    determined that DCOs are not small entities for the purpose of the

    RFA.\19\ Accordingly, the Chairman, on behalf of the Commission, hereby

    certifies pursuant to 5 U.S.C. 605(b) that the proposed rules will not

    have a significant economic impact on a substantial number of small

    entities.

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

    \17\ 5 U.S.C. 601 et seq.

    \18\ 47 FR 18618 (Apr. 30, 1982).

    \19\ See 66 FR 45605, 45609 (August 29, 2001).

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    B. Paperwork Reduction Act

    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. OMB has not yet assigned a control

    number to the new collection. The Paperwork Reduction Act of 1995 (PRA)

    \20\ imposes certain requirements on Federal agencies (including the

    Commission) in connection with their conducting or sponsoring any

    collection of information as defined by the PRA. This proposed

    rulemaking would result in new collection of information requirements

    within the meaning of the PRA. The Commission therefore is submitting

    this proposal to the Office of Management and Budget (OMB) for review.

    If adopted, responses to this collection of information would be

    mandatory. The Commission will protect 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.

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

    \20\ 44 U.S.C. 3501 et seq.

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

    1. Information Provided by Reporting Entities/Persons

    The proposed regulations require each respondent to file

    information with the Commission on a quarterly basis, which would

    result in four annual responses per respondent. Commission staff

    estimates that each respondent would expend 10 hours to prepare each

    filing required under the proposed regulations. Commission staff

    estimates that it would receive filings from 12 respondents annually.

    Accordingly the burden in terms of hours would in the aggregate be 40

    hours annually per respondent and 480 hours annually for all

    respondents.

    Commission staff estimates that respondents could expend up to

    $1,840 annually, based on an hourly wage rate of $46, to comply with

    the proposed regulations. This would result in an aggregated cost of

    $22,080 per annum (12 respondents x $1,840).

    2. Information Collection Comments

    The Commission invites the public and other federal agencies to

    comment on any aspect of the reporting and recordkeeping burdens

    discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission

    solicits comment in order to: (i) Evaluate whether the proposed

    collection of information is necessary for the proper performance of

    the functions of the Commission, including whether the information will

    have practical utility; (ii) evaluate the accuracy of the Commission's

    estimate of the burden of the proposed collection of information; (iii)

    determine whether there are ways to enhance the quality, utility, and

    clarity of the information to be collected; and (iv) minimize the

    burden of the collection of information on those who are to respond,

    including through the use of automated collection techniques or other

    forms of information technology.

    Comments may be submitted directly to the Office of Information and

    Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at

    OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy

    of submitted comments so that all comments can be summarized and

    addressed in the final rule preamble. Refer to the Addresses section of

    this notice of proposed rulemaking for comment submission instructions

    to the Commission. A copy of the supporting statements for the

    collections of information discussed above may be obtained by visiting

    RegInfo.gov. OMB is required to make a decision concerning the

    collection of information between 30 and 60 days after publication of

    this document in the Federal Register. Therefore, a comment is best

    assured of having its full effect if OMB receives it within 30 days of

    publication.

    [[Page 63118]]

    C. Cost-Benefit Analysis

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

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

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

    not require the Commission to quantify the costs and benefits of a new

    regulation or determine whether the benefits of the rule outweigh its

    costs. Rather, Section 15(a) simply requires the Commission to

    ``consider the costs and benefits'' of its action.

    Section 15(a) further specifies that costs and benefits shall be

    evaluated in light of the following considerations: (1) Protection of

    market participants and the public; (2) efficiency, competitiveness,

    and financial integrity of futures markets; (3) price discovery; (4)

    sound risk management practices; and (5) other public interest

    considerations. Accordingly, the Commission could, in its discretion,

    give greater weight to any one of the five considerations and could, in

    its discretion, determine that, notwithstanding its costs, a particular

    regulation was necessary or appropriate to protect the public interest

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

    purposes of the CEA.

    The Commission has evaluated the costs and benefits of the proposed

    regulations in light of the specific considerations identified in

    Section 15(a) of the CEA, as follows:

    1. Protection of market participants and the public. The proposed

    regulations would require DCOs to continually assess and monitor the

    adequacy of their financial resources under standards established by

    the Commission. This would further the goal of avoiding market

    disruptions and financial losses to market participants and the general

    public.

    2. Efficiency and competition. The proposed regulations would

    promote financial strength and stability, thereby fostering efficiency

    and a greater ability to compete in the broader financial markets. The

    proposed regulations would reward efficiency insofar as DCOs that

    operate efficiently would have lower operating costs and therefore

    would require fewer resources to comply with the regulations.

    3. Financial integrity of futures markets and price discovery. The

    proposed regulations are designed to ensure that DCOs can sustain their

    market operations and meet their financial obligations to market

    participants, thus contributing to the financial integrity of the

    futures and options markets as a whole. This, in turn, further supports

    the price discovery and risk transfer functions of such markets.

    4. Sound risk management practices. The proposed regulations, by

    setting specific standards with respect to how DCOs should assess,

    monitor, and report the adequacy of their financial resources, would

    contribute to their maintenance of sound risk management practices and

    further the goal of minimizing systemic risk.

    5. Other public considerations. As highlighted by recent events in

    the global credit markets, maintaining sufficient financial resources

    is a critical aspect of any financial entity's risk management system,

    and ultimately contributes to the goal of stability in the broader

    financial markets. Therefore, the Commission believes it is prudent to

    include financial resources requirements for entities applying to

    become or operating as DCOs.

    Accordingly, after considering the five factors enumerated in the

    CEA, the Commission has determined to propose the regulations set forth

    below.

    List of Subjects in 17 CFR Parts 39 and 140

    Commodity futures, Reporting and recordkeeping requirements.

    For the reasons stated in the preamble, the Commission proposes to

    amend 17 CFR parts 39 and 140 as follows:

    PART 39--DERIVATIVES CLEARING ORGANIZATIONS

    1. The authority citation for part 39 is revised to read as

    follows:

    Authority: 7 U.S.C. 7a-1 as amended by Pub. L. 111-203, 124

    Stat. 1376.

    2. Add Sec. 39.11 to read as follows:

    Sec. 39.11 Financial resources requirements.

    (a) General rule. A derivatives clearing organization shall

    maintain financial resources sufficient to cover its exposures with a

    high degree of confidence and to enable it to perform its functions in

    compliance with the core principles set out in section 5b of the Act. A

    derivatives clearing organization shall identify and adequately manage

    its general business risks and hold sufficient liquid resources to

    cover potential business losses that are not related to clearing

    members' defaults, so that the derivatives clearing organization can

    continue to provide services as an ongoing concern. Financial resources

    shall be considered sufficient if their value, at a minimum, exceeds

    the total amount that would:

    (1) Enable the derivatives clearing organization to meet its

    financial obligations to its clearing members notwithstanding a default

    by the clearing member creating the largest financial exposure for the

    derivatives clearing organization in extreme but plausible market

    conditions; Provided that if a clearing member controls another

    clearing member or is under common control with another clearing

    member, the affiliated clearing members shall be deemed to be a single

    clearing member for purposes of this provision; and

    (2) Enable the derivatives clearing organization to cover its

    operating costs for a period of at least one year, calculated on a

    rolling basis.

    (b) Types of financial resources. (1) Financial resources available

    to satisfy the requirements of paragraph (a)(1) may include:

    (i) Margin of a defaulting clearing member;

    (ii) The derivatives clearing organization's own capital;

    (iii) Guaranty fund deposits;

    (iv) Default insurance;

    (v) Potential assessments for additional guaranty fund

    contributions, if permitted by the derivatives clearing organization's

    rules; and

    (vi) Any other financial resource deemed acceptable by the

    Commission.

    (2) Financial resources available to satisfy the requirements of

    paragraph (a)(2) may include:

    (i) The derivatives clearing organization's own capital; and

    (ii) Any other financial resource deemed acceptable by the

    Commission.

    (3) A financial resource may be allocated, in whole or in part, to

    satisfy the requirements of either paragraph (a)(1) or paragraph

    (a)(2), but not both paragraphs, and only to the extent the use of such

    financial resource is not otherwise limited by the Act, Commission

    regulations, the derivatives clearing organization's rules, or any

    contractual arrangements to which the derivatives clearing organization

    is a party.

    (c) Computation of financial resources requirement. (1) A

    derivatives clearing organization shall, on a monthly basis, perform

    stress testing that will allow it to make a reasonable calculation of

    the financial resources needed to meet the requirements of paragraph

    (a)(1). The derivatives clearing organization shall have reasonable

    discretion in determining the methodology used to compute such

    requirements, provided that the methodology must take into account both

    historical data and hypothetical scenarios. The Commission

    [[Page 63119]]

    may review the methodology and require changes as appropriate.

    (2) A derivatives clearing organization shall, on a monthly basis,

    make a reasonable calculation of its projected operating costs over a

    12-month period in order to determine the amount needed to meet the

    requirements of paragraph (a)(2) of this section. The derivatives

    clearing organization shall have reasonable discretion in determining

    the methodology used to compute such projected operating costs. The

    Commission may review the methodology and require changes as

    appropriate.

    (d) Valuation of financial resources. (1) At appropriate intervals,

    but not less than monthly, a derivatives clearing organization shall

    compute the current market value of each financial resource used to

    meet its obligations under paragraph (a) of this section. Reductions in

    value to reflect market and credit risk (haircuts) shall be applied as

    appropriate and evaluated on a monthly basis.

    (2) If assessments for additional guaranty fund contributions are

    permitted by the derivatives clearing organization's rules, in

    calculating the financial resources available to meet its obligations

    under paragraph (a)(1) of this section:

    (i) The derivatives clearing organization shall have rules

    requiring that its clearing members have the ability to meet an

    assessment within the time frame of a normal variation settlement

    cycle;

    (ii) The derivatives clearing organization shall monitor, on a

    continual basis, the financial and operational capacity of its clearing

    members to meet potential assessments;

    (iii) The derivatives clearing organization shall apply a 30

    percent haircut to the value of potential assessments, and

    (iv) The derivatives clearing organization shall only count the

    value of assessments, after the haircut, to meet up to 20 percent of

    those obligations.

    (e) Liquidity of financial resources. (1) The derivatives clearing

    organization shall effectively measure, monitor, and manage its

    liquidity risks, maintaining sufficient liquid resources such that it

    can, at a minimum, fulfill its cash obligations when due. The

    derivatives clearing organization shall hold assets in a manner where

    the risk of loss or of delay in its access to them is minimized. The

    financial resources allocated by the derivatives clearing organization

    to meet the requirements of paragraph (a)(1) of this section shall be

    sufficiently liquid to enable the derivatives clearing organization to

    fulfill its obligations as a central counterparty during a one-day

    settlement cycle. The derivatives clearing organization shall have

    sufficient capital in the form of cash to meet the average daily

    settlement variation pay per clearing member over the last fiscal

    quarter. If any portion of the remainder of the financial resources is

    not sufficiently liquid, the derivatives clearing organization may take

    into account a committed line of credit or similar facility for the

    purpose of meeting this requirement.

    (2) The financial resources allocated by the derivatives clearing

    organization to meet the requirements of paragraph (a)(2) of this

    section must include unencumbered, liquid financial assets (i.e., cash

    and/or highly liquid securities) equal to at least six months'

    operating costs. If any portion of such financial resources is not

    sufficiently liquid, the derivatives clearing organization may take

    into account a committed line of credit or similar facility for the

    purpose of meeting this requirement.

    (3)(i) Assets in a guaranty fund shall have minimal credit, market,

    and liquidity risks and shall be readily accessible on a same-day

    basis;

    (ii) Cash balances shall be invested or placed in safekeeping in a

    manner that bears little or no principal risk; and

    (iii) Letters of credit shall not be a permissible asset for a

    guaranty fund.

    (f) Reporting requirements. (1) Each fiscal quarter, or at any time

    upon Commission request, a derivatives clearing organization shall:

    (i) Report to the Commission;

    (A) The amount of financial resources necessary to meet the

    requirements of paragraph (a);

    (B) The value of each financial resource available, computed in

    accordance with the requirements of paragraph (d); and

    (C) How the derivatives clearing organization meets the liquidity

    requirements of paragraph (e);

    (ii) Provide the Commission with a financial statement, including

    the balance sheet, income statement, and statement of cash flows, of

    the derivatives clearing organization or of its parent company; and

    (iii) Report to the Commission the value of each individual

    clearing member's guaranty fund deposit, if the derivatives clearing

    organization reports having guaranty funds deposits as a financial

    resource available to satisfy the requirements of paragraph (a)(1) of

    this section.

    (2) The calculations required by this paragraph shall be made as of

    the last business day of the derivatives clearing organization's fiscal

    quarter.

    (3) The derivatives clearing organization shall provide the

    Commission with:

    (i) Sufficient documentation explaining the methodology used to

    compute its financial resources requirements under paragraph (a) of

    this section,

    (ii) Sufficient documentation explaining the basis for its

    determinations regarding the valuation and liquidity requirements set

    forth in paragraphs (d) and (e) of this section, and

    (iii) Copies of any agreements establishing or amending a credit

    facility, insurance coverage, or other arrangement evidencing or

    otherwise supporting the derivatives clearing organization's

    conclusions.

    (4) The report shall be filed not later than 17 business days after

    the end of the derivatives clearing organization's fiscal quarter, or

    at such later time as the Commission may permit, in its discretion,

    upon request by the derivatives clearing organization.

    3. Add Sec. 39.29 to read as follows:

    Sec. 39.29 Financial resources requirements.

    (a) General rule. Notwithstanding the requirements of Sec.

    39.11(a)(1) of this part, a systemically important derivatives clearing

    organization shall maintain financial resources sufficient to enable it

    to meet its financial obligations to its clearing members

    notwithstanding a default by the two clearing members creating the

    largest combined financial exposure for the systemically important

    derivatives clearing organization in extreme but plausible market

    conditions.

    (b) Valuation of financial resources. Notwithstanding the

    requirements of Sec. 39.11(d)(2) of this part, if assessments for

    additional guaranty fund contributions are permitted by the

    systemically important derivatives clearing organization's rules, in

    calculating the financial resources available to meet its obligations

    under paragraph (a) of this section:

    (1) The systemically important derivatives clearing organization

    may not count the value of assessments to meet the obligations arising

    from a default by the clearing member creating the largest financial

    exposure for the systemically important derivatives clearing

    organization in extreme but plausible market conditions; and

    (2) The systemically important derivatives clearing organization

    may only count the value of assessments, after the haircut set forth in

    Sec. 39.11(d)(2)(iii) of this part, to meet up to 20 percent of the

    obligations arising from a default by the clearing member

    [[Page 63120]]

    creating the second largest financial exposure for the systemically

    important derivatives clearing organization in extreme but plausible

    market conditions.

    PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

    4. The authority citation for part 140 continues to read as

    follows:

    Authority: 7 U.S.C. 2 and 12a.

    5. In Sec. 140.94, revise paragraphs (a)(4) and (a)(5) and add a

    new paragraph (a)(6) to read as follows:

    Sec. 140.94 Delegation of authority to the Director of the Division

    of Clearing and Intermediary Oversight.

    (a) * * *

    (4) All functions reserved to the Commission in Sec. 5.12 of this

    chapter, except for those relating to nonpublic treatment of reports

    set forth in Sec. 5.12(i) of this chapter;

    (5) All functions reserved to the Commission in Sec. 5.14 of this

    chapter; and

    (6) All functions reserved to the Commission in Sec. Sec.

    39.11(b)(1)(vi), (b)(2)(ii), (c)(1), (c)(2), (f)(1), and (f)(4) of this

    chapter.

    * * * * *

    Issued in Washington, DC, on October 1, 2010, by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. 2010-25322 Filed 10-13-10; 8:45 am]

    BILLING CODE P

    Last Updated: October 14, 2010